Government and the Slow Jobs “Recovery”

Government finally starts to get out of the way of recovery. In an earlier post today on the good news of the January 2012 employment report, I observed that one of the major factors resulting in an improved (but not good enough) jobs report was that government employment numbers stopped dragging down the total.  I wanted to briefly expand on that idea here.

First, let’s make no mistake the “recovery” from this last recession has been very, very weak.  Private sector growth has been anemic at best. In employment, the recovery has largely been missing in action.  Today, 31 months after the supposed end of the recession, we have only recovered 1/3 of the jobs we lost during the 19 months of recession. As I’ve mentioned before, we are well on our way to a lost decade or more before we regain full employment.  A huge part of the weak recovery has been slow and at times negative growth in private sector employment.

But a bigger problem has been government.  Government has a three-fold impact on employment during a recovery.  Government spending by itself will create employment in the private sector.  For example, if the government chooses to react to a recession and high cyclical unemployment by increasing it’s spending it can create new private sector employment. This would be a classical stimulus program.  The government could embark on highway, bridge, or school construction.  The spending with construction contractors causes those contractors to hire employees. That’s direct private sector employment through government spending.  As long as there are significant unemployed resources (workers), such government spending will increase employment.  Arguments about crowding out do not apply when large unemployed resources exist.

The increased government spending then has a second effect, a “multiplier” effect.  The multiplier effect reflects the idea that workers who got jobs in the initial round of spending themselves spend their incomes and create more demand for more goods. This increased demand for goods results in even more employment.  In other words, the construction workers hired to build the new bridges or schools spend their paychecks.  The firms selling those workers goods then have to hire in order to produce the goods/services the construction workers want.  The exact size of the multiplier effect is uncertain and subject to dispute depending on the econometric methods used to measure it.  However, it’s clear that as long there were substantial unemployed resources to begin with, there is a positive multiplier effect on private employment from increased government spending.

But what I want to draw attention to today is direct employment effect of government.  One of the greatest reasons why we have had a very slow employment recovery is because government in the U.S. has been aggressively cutting jobs for the last 2-3 years. Conservative critics of government have been partially right. Government has been part of the problem – but not in the way they think.  Let’s look at total government employment in recent years:

The data series can be a bit tough to read because government employment has a very seasonal pattern to it.  That’s shows up by the regular up-and-down pattern each year.  Let’s focus on the trend, smoothing out the ups-and-downs. There’s four patterns. Government employment was essentially flat in 2002 and 2003.  Then a period of employment growth in government began running form 2004 through early 2008.  During the recession itself government employment was essentially flat.  Since 2009, though, government employment has been declining.  Cutting government employment is contractionary.  It directly reduces retail demand for goods and services by reducing the incomes of what were formerly government workers.

The pattern is a little clearer if we look at the data in a slightly different way.  The following graph, courtesy of Menzie Chinn at Econbrowser.com, shows the a smoothed trend.  It does this by plotting the 12-month change in government employment (000’s of jobs) by month.

While private employment continues to grow, government employment continues to fall; the decline is most pronounced at the state and local level (Wisconsin is a good example of the contractionary impact of such measures [1] [2]). However, civilian Federal government employment is also declining.

janempsit3.gif
Figure 3: Twelve month change in government local employment (blue), in state employment (red), and government employment ex.-temporary Census workers (geen), 000’s, seasonally adjusted. NBER defined recession dates shaded gray. Source: BLS via FRED, NBER and 

One thing I particularly like about this graph is that it shows the relative contribution of federal, state, and local governments. What this graph shows is that before the recession (the grey zone), government was net hiring approximately 250,000 additional jobs per year. Of that, most was at the local level and some at the state. Very little was federal hiring.

Since the end of the recession in June 2009, government has been firing more workers than it hires.  It has been reducing employment.  The federal government, contrary to popular belief, began shrinking (in employment terms).  State governments were largely able to hold the line on employment until early 2011.  Then state governments began reducing employment in rapidly increasing numbers.  But the big impact again came from local governments.  For the last 30 months, they have been laying off large numbers of workers. The reductions have slowed in 2011, but they are still cutting workers at nearly the same rate that they added them in 2007 – hundreds of thousands of lost jobs each year.

There is a temptation among politicians and commenters to think of government employees as representing largely just some bureaucrats mindlessly pushing paper in large bland office buildings.  That is not true.  At the federal level, most federal government employees are either soldiers or part of some security forces (TSA, FBI, ICE, etc).  At the local level, the vast majority of local government employees are police, fire and emergency workers, and teachers. Reductions in local government employment directly translate into fewer services and less education for children.

Why are state and local governments cutting employment?  Simple.  It’s reduced taxes combined with balanced budget requirements.  State and local governments, unlike a sovereign national government, must balance their budgets.  They are budget constrained.  The recession and weak recovery have hit income and sales taxes hard.  Even more significant is that the collapse of home prices a few years ago has translated into lower property tax collections.  Either way, state and local governments have been pinched.  The response has been to reduce government employment – fire police, firefighters, and teachers.

Paul Krugman notes the how this reduction in state and local government revenue has translated into reduced spending, which in turn has translated into lower employment.  Despite the federal government embarking on a stimulus spending program in early 2009, a program which is over and done with now, it was not large enough to offset the reduction in state and local spending.

if you look at what’s being cut, it’s heavily focused on investment:

That is, we’re sacrificing the future as well as the present. Oh, and the cuts that aren’t falling on investment in physical capital are largely falling on human capital, that is, education.

It’s hard to overstate just how wrong all this is. We have a situation in which resources are sitting idle looking for uses — massive unemployment of workers, especially construction workers, capital so bereft of good investment opportunities that it’s available to the federal government at negative real interest rates. Never mind multipliers and all that (although they exist too); this is a time when government investment should be pushed very hard. Instead, it’s being slashed.

What an utter disaster.

On this point, I have to agree with Paul.  Unless we reverse course and do it strongly, we are flirting with a long-term disaster.  We are under-investing in our future.

Fixes for Unemployment Depend on Whether It’s Cyclical (It Is) or Structural (It Isn’t)

Yesterday I recapped the November employment report. The employment picture remains grim.  The workers depression continues.

As my favorite graph from Calculated Risk shows here, regardless of what happens to the unemployment rate, our recovery from the jobs lost in the recession is incredibly slow.  At the pace we have been on for the last 2-3 years, we won’t recover the jobs lost in the recession until around 2018 – a full lost decade.

Thanks partly to the #OccupyWallStreet movement, these 14 million unemployed aren’t so invisible as they seemed last summer when the policy debates were all about debt and deficits.  Since denial of a problem has failed, folks who argue against any attempts by the government to stimulate the economy need a different pitch.

That revised pitch is that the unemployment problem is “structural”, not “cyclical”.  Now before I move on to show the problem is not structural, let me explain the difference. I’ve looked at structural vs. cyclical before here and here, but I’ll summarize.  In economist-talk, “unemployed” means you are part of the labor force but you don’t have a job.  To be part of the labor force, you must be actively looking (“willing and able”) to work.  Those numbers come from government surveys. Economists unofficially classify those unemployed workers according to why they don’t have a  job.  There’s four possibilities:

  1. Frictional – there’s a job for them, they simply haven’t been matched with it yet.
  2. Seasonal – the job will exist again next year when the season is right (think downhill ski instructors in July)
  3. Structural – empty jobs exist but the unemployed workers either don’t have the right skills or aren’t in the right location.  Train the workers or move them and unemployment disappears.
  4. Cyclical – there simply aren’t enough empty jobs for the number of unemployed workers.  If the GDP were larger and spending greater, then jobs would be created and the people put back to work.

For policy reasons we aren’t concerned with frictional or seasonal. Time cures those individual unemployment situations. But if we only had frictional or seasonal unemployment, our unemployment rate would be much, much lower – 4% or even lower.  Clearly we have either have a lot of structural or cyclical or both.

Which we have matters for policy reasons. If unemployment is structural, then we can effectively blame the unemployed for their fate.  They didn’t get the right skills. They chose to live in the wrong place. From a policy standpoint, the government might adopt policies that support re-training but that’s about it.   If, however, unemployment is cyclical, then government has plenty of room to reduce unemployment through stimulus programs, either effective tax cuts and/or increased government direct spending.

Brad Delong points us to David Wessel of The Wall Street Journal who tells us how and why today’s high unemployment is not structural. In other words, we could bring down the unemployment very dramatically and very quickly if we chose to.  Politicians in Washington simply choose not to do so. (bold emphases are mine)

DW:

Untangling Long-Term Unemployment: Herman Cain, the Republican presidential candidate, avoids carefully calibrated talking points. “If you don’t have a job and you’re not rich, blame yourself,” he said in a Wall Street Journal interview.

Beneath Mr. Cain’s blunt words lurks an economic hypothesis: that there’s nothing much government policy can do to bring unemployment down from today’s 9.1% rate…. [I]f the unemployed aren’t willing or able to fill jobs that muscular stimulus might produce then there’s little wisdom in borrowing more money or chancing inflation. We just have to suck it up.

But according to Fed governor Daniel Tarullo, a veteran of the Clinton White House and Obama presidential campaign who has spent the past few months consulting with Fed and other labor economists for a speech on the job market he is to deliver Thursday at Columbia University, there is little evidence that the bulk of today’s unemployed would still be unemployed if the economy were growing faster or that the bulk of today’s unemployment is, in the jargon of economists, “structural.”…

The Labor Department counts 14 million unemployed and 3.1 million job openings, or 4.6 jobless workers per job opening. Before the recession, the ratio was 1.5. If every opening were filled instantly, there would still be many unemployed.

Wages aren’t rising. “We don’t see rapid wage growth almost anywhere, which is what you would expect if firms were bidding up the wages of qualified workers and were unable to find qualified workers among the unemployed,” said Harvard University’s Lawrence Katz.

Unemployment is up across ages, occupations, industries and years of schooling. “We had a fast-advancing economic decline with layoffs and hiring freezes in a broad range of sectors of the economy. That is not consistent with an increase in structural unemployment being the big explanation,” Mr. Tarullo said…

 

Stimulus Requires More Than Taking Your Foot Off the Brakes

Last week I discussed how I think the President’s jobs proposal, the American Jobs Act, will be less than stimulating.  I updated it here.  I based my analysis on what economists call “back of the envelope” calculations – quick simple estimates of the key variables using rounded numbers.  Now the folks at Goldman Sachs research have put the proposal through their more sophisticated and complex econometric models.  And they come to … roughly the same conclusion.  Paul Krugman at the NY Times observes:

Goldman Sachs (no link) has a nice chart showing just how much fiscal policy has been a drag on the economy since the second half of last year, and also shows that the Obama jobs plan, even if enacted in full, would only be enough to put it in neutral:

Just worth bearing in mind.

The graph (the line) shows the effect that total government fiscal policy, including federal, state, and local, has had / will have on GDP growth rate.  In 2009, Q1-Q3, governments were having a very positive effect on GDP growth, adding up to 2.5 percentage points to the GDP growth rate.  By 2009 Q4, though, this stimulus effort had deteriorated and was starting to have a negative effect, slowing GDP.  Initially this was because state and local spending cuts were overwhelming the federal increases in spending.  But the 2009 stimulus bill ran it’s course and the feds joined the austerity party and started cutting spending along with state and locals in late 2010.  In 2011, our problems have been the austerity programs, the spending cuts at state, local, and federal level. Government has had it’s foot on the brakes trying to slow an already weak economy.  It’s worked. The economy is coming to a halt.

Unfortunately, the proposed jobs program isn’t really much of a stimulus. It’s too weak. It’s too small. And it’s focused too much on tax cuts that won’t be spent instead of spending.  The blue line above shows the likely effects.  Even if passed (a near impossibility given the Republican majority in the House), it will only reverse the contractionary effects of spending cuts without adding any new stimulus to grow GDP further.

Stimulus is supposed to be about speeding up GDP growth – hitting the accelerator.  Simply taking your foot of the brakes isn’t the same thing as hitting the gas.

 

UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

First an update on a post I made a few days ago. When I commented last Monday on President Obama’s jobs proposal, I was less than excited. Having read more detail of the proposal, I should correct some statements I made.  I incorrectly left the impression that the payroll tax (Social Security/Medicare tax) cut that the President was proposing was only an extension of the present year cut that is scheduled to expire December 31, 2011.

In fact, the President is proposing not only a 1 year extension of this year’s temporary payroll tax cut, but an increase in the size of that tax cut.  Estimates are that for a median household income of near $50,000, it would result in a $1,500 reduction in payroll taxes compared to not having any payroll tax cut at all. However, the existing, this-year only, payroll tax cut had already cut payroll taxes by up to $500 per household.  So of the claimed $1,500 tax cut for next year for the median household, $500 is an extension of this year’s situation and  $1000 is new stimulus.  Today’s economy is weak even with the existing temporary $500 tax cut, so extending that cut won’t improve things. It will only prevent things from deteriorating further.  In my world, simply agreeing to not put on the brakes is not the same thing as actually hitting the accelerator.

But, the proposal does contain perhaps $1000 worth of tax cut stimulus to nearly all working households. That’s perhaps $150 billion of pure, new stimulus to economy.  It’s more than I estimated on Monday, so the plan will likely have some more stimulative effects than I thought.  But how much?  Let’s do a quick “back of the envelope” type calculation.  The proposal puts $150 billion in consumers’ hands that wouldn’t have been there without it.  But for this money to generate jobs, people have to spend the money.  Simply saving the money or paying down debt won’t cut it.  That improves individual household balance sheets but it doesn’t cause any firm out there to go “oh, more business! I need to hire people!”  In normal times like the 1960’s or 1970’s people would have spent 85-90% of the tax cut.  But these aren’t normal times. We live in high debt, high debt payments, and scared-of-the-future times.  More people save in these kind of times. (paying down debt is economically the same as savings – think of your debt as a negative balance in a savings account).  Let’s assume that people spend 2/3 of the money.  Both history and theory indicate that people save more of a tax cut when they know it’s temporary, but let’s be generous/optimistic and say 2/3 gets spent.  That’s $100 billion in new spending.

Now when it gets spent, it generates business demand and jobs.  Those people get paid and then they go spend the money again – the circular flow of money in the economy.  How much?  That’s a huge controversy in empirical macroeconomics.  This is the question of what the spending multiplier is.  Estimates vary widely, although often the studies are heavily biased by ideology to begin with.  Let’s be modestly optimistic and say the multiplier is 1.5 – 2.0.  This is a relatively high estimate given recent studies as far as I know, but let’s run with it.  That means that after some months, this initial $150 billion in tax cuts becomes $100 billion in new, initial spending which ultimately increases total spending by $150-$200 billion.  Total spending is another way of saying GDP.  This puts it in the range of 1.0% to 1.5% of GDP.

There’s a rule of thumb about the relationship between changes in GDP to changes in unemployment rate. It’s called Okun’s Law.  It’s not a law so much as a statistical regularity. There are many versions, but let’s use a real simple one: each 2 percentage point change in GDP equates to a 1 percentage point change in the unemployment rate.  So if we have GDP growth increasing by 1.5% points, we can count on unemployment rate going down by 0.75 to 1.0% points.

We’re currently over 9% unemployment rate and stuck there.  I’m not real excited about a proposal that aims to reduce the unemployment rate from over 9% to maybe 8%.  We know 4-5% unemployment is possible.  We did it in 2006 even with the slow-growth policies of the Bush administration.  We did better than that under Clinton. In the 1960’s we were even below 4%.   Why are we settling for tepid responses and setting goals of only getting to 8% unemployment and then calling this “bold”?  I don’t know.  But then maybe I’m just a grumpy old man.

The Obama Jobs Proposal Is Less Than Stimulating

After over a year of Presidential and Congressional debate and sparring about how to reduce spending, cut deficits, and limit debts, the politicians in Washington have finally taken notice that we have a “jobs crisis”.  Specifically, we simply aren’t creating new employment fast enough to reduce our high levels of unemployment.

Timidity wrapped in strong words does not make boldness. The words on the teleprompter were bold and the President almost sounded passionate and concerned about jobs.  Unfortunately, in my opinion, this proposal is too timid. I see repeats of the errors of 2009 and the first stimulus bill, the ARRA.

First, let’s go over the details of the proposal.  The White House Fact Sheet is here. I’ll let Calculated Risk summarize the key parts for me:

1) Payroll tax cuts (approx $240 billion):

• Cutting payroll taxes in half for 160 million workers next year: The President’s plan will expand the payroll tax cut passed last year to cut workers payroll taxes in half in 2012 …
• Cutting the payroll tax in half for 98 percent of businesses: The President’s plan will cut in half the taxes paid by businesses on their first $5 million in payroll …

2) Schools and teachers / aid to states (approx $60 billion):

• Preventing up to 280,000 teacher layoffs, while keeping cops and firefighters on the job.
• Modernizing at least 35,000 public schools across the country,supporting new science labs, Internet-ready classrooms and renovations at schools across the country, in rural and urban areas.

3) Other infrastructure ($75 billion)

4) Extend unemployment insurance benefits ($49 billion).

5) Helping More Americans Refinance Mortgages (there are no details yet). “The President has instructed his economic team to work with Fannie Mae and Freddie Mac, their regulator the FHFA, major lenders and industry leaders to remove the barriers that exist in the current refinancing program (HARP) to help more borrowers benefit from today’s historically low interest rates.”

In total the whole package is estimated as a near $447 billion package of tax cuts and spending.  That sounds like a lot. And at first comparison it seems like a lot. The 2009 ARRA “stimulus” bill was approx. $780 billion spread out over 2.5 years. This “American Jobs Act” is supposed to be only a one year deal (part of the problem, by the way), so it sounds like it’s more in one year than the 2009 stimulus bill was.  But it’s not really.

For any government action, be it increased spending, tax cuts, or regulatory reform, to be a stimulus effect, it must provide a net change beyond what is currently happening.  That’s a major reason why this proposal fails as a stimulus.  Over half of the proposal, the $240 billion in payroll tax cuts provides no new stimulus beyond what’s happening this year already.  These payroll tax cuts, which should be called  cuts in funding for Social Security and Medicare, aren’t really a tax cut from what’s happening now.  It’s a proposal to delay the return to higher rates.  Payroll taxes were already cut temporarily for one year at the beginning of this year as part of the deal with Congress to extend income tax cuts for the highest-income bracket folks.  But that was only supposed to be a one-year cut.  This proposal basically extends that cut for another year and postpones the return to normal tax rate for another 12 months.  If these payroll tax reductions were enough to put people back to work in large numbers we would have seen it happen already.  We haven’t.  Deciding to delay applying the brakes as you had planned is a good thing, but it hardly qualifies in my book as hitting the accelerator.

In a similar fashion, the $60 billion in aid to states & local governments to help prevent teacher, police, and firefighter layoffs is a good and positive measure.  But it’s not really stimulus.  It’s a step that keeps the states and local governments from harming us further through their budget cuts.  I am concerned this only kicks the can down the road a little further, perhaps another 12-15 months, when state and local governments will repeat the layoff drive. Of course, if I were cynical, I’d observe that 12-15 months doesn’t really change the long-run growth picture for the U.S. but it’s enough to delay any second dip into recession until after the next presidential election.

We see the same dynamic in the extension of unemployment benefits.  Make no mistake, this is a seriously needed action for both economic and moral reasons.  But it won’t have a lot of stimulus bang – certainly less than the $49 billion sounds like.  That’s because it’s basically restoring the existing unemployment benefits that are expiring for the long-term unemployed.  Thus it will help prop up existing aggregate demand, but it’s not likely to deliver much new stimulus punch.

Part of the $60 billion  for schools and teachers (the White House doesn’t split it out) is aimed at infrastructure re-building for schools.  My estimate is that maybe it’s half of the $60 billion, or $30 billion.  That portion, along with the $75 billion in other infrastructure spending constitutes real stimulus.  It’s additional spending that will translate directly into new jobs. Those new jobs will then have a multiplier effect as these workers spend their money.  Unfortunately, both of these items together total maybe a little over $100 billion.  Even with estimates of spending multipliers on the high side at 2 or 3, it means a boost of maybe $200-300 billion in GDP.  But we’re in a more than trillion dollar hole of lost GDP potential.  So, yes, there’s some stimulus here, but it’s far too little.  Just like the 2009 stimulus bill was too small and too slow.

There are of course, some other items in the proposal.  I don’t see them having any effect.  There are proposals for some tax credits for small businesses to hire some businesses.  I don’t see that working.  Businesses hire because they are selling things, not because they can get a $5,000 tax credit.  There’s simply not enough aggregate demand for businesses to hire.  There’s also a pitch about helping Americans “refinance mortages”.  They tried this in 2009 and the program has been a miserable failure with very few refinancings done.  The incentives simply are wrong for the banks.  The proposal lacks specifics other than the President will “urge” agencies to do more.  I am skeptical.

So overall, I am disappointed.  Much of this stimulus proposal amounts to agreeing to delay the current contractionary policies.  That’s not the same as stimulus.   Too little. Too late.  And let’s remember, there’s not much chance that this Republican House of Representatives will pass much, if any, of this proposal.

There Was No “Stimulus” Spending in Aggregate

One of the claims that Tea Partiers, Republicans, and conservative/neo-liberal economists have been making for some time is that “the stimulus has failed”. They conclude that Keynesian economics and economic policies are failures.  Since, like most claims of Republicans and other politicians, these assertions are usually repeated uncritically by the news media, it’s close to becoming accepted “common wisdom” that the stimulus failed.  It’s not true, though.  What happened is that Keynesian stimulus was never tried.  Yes, U.S. federal government spending temporarily increased for 2 1/2 years.  But the so-called “stimulus” bill of $780 billion passed in Feb 2009 wasn’t all a stimulus spending bill. Much of the money, approx. $380 billion IIRC, was tax cuts.  People didn’t really spend much of those tax cuts because they were paying off debt with the money. That’s not a Keynesian stimulus spending program.  Keynes pointed out that tax cuts are a weaker way of stimulating spending.

But most important is that the additional spending was over 2 1/2 years, and it was only federal spending.  It was completely offset by cuts in spending at the state and local government level.  In aggregate, there was no stimulus spending program. It’s now over anyway.  What people are doing these days is confusing the increased deficit with increased spending, ignoring the fact that the deficit is so big because tax collections are down. Tax collections are down because too many people aren’t working.  And firms won’t hire those people because nobody (including aggregate government) is spending enough.

Paul Krugman notes:

In effect, although without saying so explicitly, the Obama administration has accepted the Republican claim that stimulus failed, and should never be tried again.

What’s extraordinary about all this is that stimulus can’t have failed, because it never happened. Once you take state and local cutbacks into account, there was no surge of government spending. Here’s total (all levels) government spending over the past 10 years:

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Looking at this graph, if you didn’t know there had been a “massive” stimulus, would you even have suspected that there had been any stimulus at all?