Why is Unemployment So Stubbornly High? A Look At The Prevailing Theories…

In anticipation of President Obama’s major jobs speech tonight, I’m focusing my posts this week on unemployment and what we can do to address it. Earlier I gave an overview of the situation in 10 Essential Facts About Our Unemployment Crisis. In today’s post, I try to understand where exactly the problem lies.

The recession officially ended in mid-2009 when we halted our economic freefall and slowly started to turn the ship around. But the recovery has progressed more sluggishly than people imagined it would – and slower than previous recoveries – and unemployment still stands at 9.1%. With the recession officially over for two years now, what is holding back employment from returning to pre-recession levels?

Economists have a lot of theories but the one that seems to get the most support is that there is a lack of demand. In the crisis, consumers lost jobs, housing equity, and stock investments they still haven’t recovered. With tight household budgets and uncertainty about the future, people are keeping their pocketbooks closed. Businesses don’t want to hire new workers or make other investments in expansion because the consumer demand isn’t there. This creates a “vicious cycle,” according to economist William Gale, which will take a long time to correct itself without some kind of outside intervention.

How do we know the problem is a lack of demand? First, because employers tell us so. Recent surveys of small business owners find that the issue they most commonly identify as their main business concern is weak sales. Labor data also support the “lack of demand” hypothesis. Companies are currently sitting on large cash reserves, so they have the resources to meet strong demand, if it exists, by increasing production. This would entail hiring additional people or squeezing more work out of existing employees. We know companies aren’t doing much hiring, but we also know that they aren’t maximizing the workers they already have either. The length of the average workweek is still well below what it was before the recession hit and has showed no net growth over the last year.

The demand problem that is holding back private sector hiring is compounded by a jobs crisis in the public sector. The recession has left state and local governments with reduced tax revenues and shrunken pension funds, leading them to layoff workers, particularly teachers. Recent slow gains in private sector hiring have been offset by ongoing job loss in the public sector, in contrast to previous recessions. In the past year, private employment increased by 1.6% but government employment dropped by 2%.

Economists have offered other explanations as to why unemployment is so stubbornly high, though none seem to have quite as much support as the “low demand” hypothesis. Here are a few other popular theories:

  • Skills mismatch. There is a mismatch between the skills employers need and those unemployed workers have. Certain sectors, such as manufacturing and homebuilding, will no longer support as many workers as they once did, and workers in these fields need to be retrained for other jobs. Recent research, however, has found that skills mismatch is responsible for only a very small share of current unemployment.
  • Housing-lock. The weak housing market has left people unable to sell their homes for a decent price, preventing them from moving to areas where they might find better jobs. Sounds logical, but studies have found that interstate migration hasn’t dropped since the recession began and the mobility of unemployed workers isn’t related to the state of the local housing market or whether their homes have lost value.
  • Excessive regulation. Existing government regulations and taxes on business are too burdensome and uncertainty about future regulations makes business owners hesitant to expand or hire. Anecdotal and survey evidence is mixed on whether business owners truly feel regulation is the problem. There are not many regulations or taxes that directly affect broad swaths of businesses that weren’t in place before the recession began. One that supporters of this theory like to point to is the healthcare reform bill, but it doesn’t go into full effect in 2014 and many economists believe it won’t have significant positive or negative impact on employment.

So, if low demand and state and local government layoffs are the main problems, what can the Obama administration and Congress do about it? My next post will look at what proposals Obama might offer in his jobs speech tonight and whether they have a shot at working.

2 thoughts on “Why is Unemployment So Stubbornly High? A Look At The Prevailing Theories…

  1. What about the effect of jobs leaving the country as more American companies move factories to countries where they can hire workers for $300.00 a month? Will there ever be a way to make up those lost jobs?

    • The easiest way to keep jobs that can be done more cheaply in other countries, like manufacturing, to stay in the U.S. is to institute really high trade barriers (i.e. tax imports of cheap shoes made abroad so they cost the same as shoes made in the U.S.). But if we do that, other countries will likely retaliate by taxing our exports and it will hurt the economy as a whole. Many economists feel the better solution is to focus on the areas where we still have a competitive advantage – technology, science, and other knowledge industries – as well as jobs that can’t, by definition, leave the U.S., like service jobs and retail (you can’t move a local restaurant to another country and still serve the same clients the way you can with a factory). So instead of fighting this economic transition, a better response may be to provide new training to people in industries that are dying (like manufacturing) so they can do the kinds of jobs that are in demand now, as well as ensuring our education system is preparing people for the kind of jobs that will be available in 20 or 30 years, not what our economy looked like in the past. This is all related to the “skills mismatch” hypothesis I wrote about above and, while it’s definitely an important issue for our long-term economic health, it’s not the main cause of our current unemployment problems.
      Does that help answer your question? Do you think there are ways we could bring back manufacturing jobs? Some people believe that all is not lost for manufacturing and we can keep some of these jobs here, for example this report which I haven’t ready but looks very interesting: http://www.brookings.edu/papers/2011/06_manufacturing_job_loss.aspx.

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