With a presidential election looming, the state of the economy — nationally and locally — will be a hot topic of discussion in the months leading up to November.
May 17, 2004
During the 1988 presidential election year the slogan was: "Read my lips. No new taxes." In 1992, the slogan changed to: "It's the economy, stupid." This year, the following expression is catching on like wild fire: "2.6 million new jobs before the election."
It is not surprising that unemployment has become the defining pocket-book issue of the election campaign. Recent headlines read, "February Job Growth Surprisingly Weak." "U.S. Job Growth Anemic." "Promise of creating 2.6 million new jobs a pie in the sky." The situation is even worse, because people dropping out of the labor force are offsetting the impact of plummeting. True, the situation changed somewhat in March when 308,000 new jobs were created, especially since that number was much higher than the job growth economists were expecting. However, everyone is wondering if the job gains would continue. Also, to everyone's surprise, despite job gains, the unemployment rate has actually increased from 5.6 percent to 5.7 percent.
But even that's not the whole story. Political rhetoric, coupled with myths and economic fallacies, creep into media reporting as well as into discussions of economic policy issues, compounding the emotionally charged problem facing us in this election year. In a series of four columns, I will examine the nation's current unemployment problems in detail and in the end suggest possible solutions to this issue.
How We Define Unemployment
An employed person is one who is 16 years old or older and works for pay for at least one hour per week. People who work without pay for 15 or more hours per week in a family enterprise, or who have a job but have been temporarily absent are also counted as employed. By contrast, a person 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks is counted as unemployed. The unemployment rate is the number of people unemployed divided by people in the labor force. So if 7.8 million people are out of work and 130 million people are in the labor force, then the unemployment rate would work out to be 6 percent {(7.8/130) X 100}.
It is important to note that the labor force consists of both the employed and the unemployed people. By this criterion, a person who is not looking for work, either because he or she does not want a job or has given up looking is not in the labor force and is not counted as unemployed. Clearly, when people get discouraged and drop out of the ranks of unemployed, they artificially lower the unemployment rate. This is known as the discouraged-worker effect, and it understates the unemployment rate.
There is yet another fly in the ointment. The unemployment rate measures the number of people unemployed at a given point in time. It tells us nothing about how long the average unemployed worker is out of work. That is one of the key deficiencies of unemployment statistics.
As a general rule, during recessionary periods the average duration of unemployment rises. For instance, between 1979 and 1983, the average duration of unemployment rose from 10.8 weeks to 20 weeks. The slow growth following the 1990-1991 recession resulted in an increase in duration of unemployment to 17.7 weeks in 1992 and 18.8 weeks in 1994. By 1999, average duration was down to 13.4 weeks. The government usually takes this duration factor into account in designing its strategy for reducing unemployment.
And that brings us to the main puzzle: We are told that when the nation is at full employment, our unemployment rate is 5 percent. But we are also informed that our current rate of unemployment is only 5.7 percent, which is only a shade higher than the full employment rate. That's puzzling, especially since so much is being made of this problem during this election year. Unfortunately, we can't solve this puzzle until we differentiate between various types of unemployment.
Types of Unemployment
*Frictional unemployment. It arises from people entering and leaving the labor force and from the ongoing creation and destruction of jobs. This type of unemployment is a permanent and healthy phenomenon of a dynamic, growing economy.
*Structural unemployment. This arises when changes in technology or international competition require advanced skills to perform jobs or change job location. This type of unemployment constitutes an extremely painful long-term problem. But it is also essential to endure if the United States expects to remain the leader of the free world.
*Seasonal unemployment. This represents unemployment arising from seasonal weather patterns, usually rising during the winter months and declining during spring and summer.
*Cyclical unemployment. This type of unemployment is caused by a business cycle. For instance, workers are laid off because the economy is in a recession; later, when economic expansion begins, many of these laid off workers are rehired.
And now we can solve the puzzle. People counted in frictional, structural and seasonal unemployment categories are assumed to be unemployed for natural reasons and not looking for work. Therefore, the government does not need to intervene and create jobs for these people. Currently, 5 percent of the labor force falls in these categories. That's why 5 percent is known as the natural rate of unemployment and we say that 5 percent unemployment is consistent with full employment.
Put differently, the government should attempt to bring only the level of cyclical unemployment to zero by resorting to appropriate monetary and fiscal policies. In addition, given the significant technological changes in the world, we now expect the government to reduce the structural unemployment through re-education and re-training of laid-off workers. That implies that the government should explicitly recognize that the other three types of unemployment are an integral part of a free and vibrant enterprise system and hence should not be tempered with.
It is apropos to add an important caveat here. While economists may feel happy at reaching full employment when the nation's unemployment rate drops to 5 percent, in the current political environment, some people may still not be entirely happy. That is because there is still the tendency to compare a normal full employment scenario with the super boom of the 1990s. During that period, we had reached an overfull employment situation (the unemployment rate had dropped to 3.9 percent) and an additional 1.43 million people (assuming a labor force of 130 million) held steady jobs. It is well to remember that, when it comes to unemployment, false perceptions about what constitutes full employment can become a disturbing reality.
Within this framework, we can see that today the government does have a job to do. The current rate of unemployment is 5.7 percent, and the natural rate is 5 percent. Considering that the economy has been out of a recession and steadily advancing since the first quarter of 2003, our rate of unemployment should not be that high, and an effective strategy is urgently required to solve this problem.
Unemployment in Macomb County
During the recession of 2000-2002, Macomb County set one of the worst unemployment records anywhere in the country. In July 2002, unemployment in the county jumped to 6.9 percent — the highest monthly rate for the country since January 1994. This is particularly troublesome, since from the summer of 1994 to the summer of 2001, unemployment in the county never went above 5.5 percent.
In view of this dismal unemployment record in Macomb County, it is fair to say that all the fancy theories of the world justifying the free enterprise system cannot accurately measure the pain and suffering of those people who are desperately looking for jobs but can't find them. The toll that long unemployment takes on the families and the psychological pain it inflicts on people can be devastating. Therefore, an unemotional analysis of the problem is needed if we are to find a permanent solution to this problem.
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