Economic Growth Yet to Hit Job Market – washingtonpost.com

In AP and IB Economics, we understand the importance of macroeconomics to policymakers, whose primary macroeconomic goal is growth. Economic Growth, defined as an increase in a nation’s total output of goods and service (and therefore the national income), is desidred not only for the sake of growth itself (producing more stuff requires more resources, and may not necessarily make the average citizen better off), rather growth is needed in order to achieve full-employment of a nation’s labor force.

Growth is good. This tenet of economics is rooted in two basic observations: 1. Growth leads to an improvement in the average standard living of a nation’s people, and 2. Growth is needed to employ the growing workforce of a nation experiencing population growth and immigration.

America’s work force is a diverse group of people of all skill levels. 150 million strong, the nation’s workforce requires a healthy national economy with strong investment and consumption to maintain enough jobs to keep unemployment low.   In the last two years, however, the prospect of employment in America has diminished as the number of people out of work has grown to nearly 15 million.

Involuntary unemployment is perhaps the most serious cost of an economic slowdown. A willing and able worker (or 15 million of them!), skilled in mind and body, unable to find prouductive work, represents a monumental failure of a nation’s economy. Policies aimed at promoting growth are in fact aimed at creating employment.

The costs of unemployment affect not only the unlucky  individuals who have have lost their job. Social costs include increased crime and poverty, psychological costs include stress, anxiety, loss of self-image and depression. The economic costs are myriad. Unemployed workers become dependent on the rest of society for support, in one way or another. Benefits for the unemployed payed by the government require greater budget deficits or increased tax burden on the employed. The large pool of jobless citizens seeking work puts downward pressure on the wages of those still working, as employers find it difficult to keep paying high wages while demand for their products has fallen and millions of job seekers are willing to work for less.

The families and friends to whom unemployed workers turn for help find their already stretched incomes spread even thinner. Without steady incomes, the unemployed consume less, putting further strain on an already depressed economy. Deflation can result from unemployment, which can lead to futher layoffs by pessimistic firms, excacerbating the situation and plunging the economy into what’s known as a deflationary spiral.

For all the reasons above, policymakers strive to promote growth. When monetary policy fails to incite spending, the government must pick up the slack, hence the stimulus package so discussed in America today. China’s stimulus of over $500 billion (twice that of the US, as a percentage of its GDP) has had a positive effect on both GDP and the job market.

Employment levels in China began to recover over the past three months in the latest evidence of the rapid rebound in the economy from the international financial crisis as a result of heavy public investment.

Yin Weimin, China’s labour minister, said there had been a modest increase in the number of jobs in the economy during June, July and August, reversing the sharp slump in employment which began last October.

America’s stimlus has also begun to restore growth, but the rise in employment has so far not occured:

Despite an emerging economic expansion, businesses were sufficiently skittish about the future that the job market continued its long, steep decline in August, according to a new government report Friday. The unemployment rate rose to 9.7 percent, from 9.4 percent, as employers shed jobs for the 20th straight month, the Labor Department said.

“Our clients tell us they will not hire in anticipation

of a recovery, but will wait until they see it,” said Jonas Prising, an executive vice president at Manpower, the giant employment services firm. “In a normal recession, people would now start to feel more comfortable and start hiring, but nobody is doing that today. They’ll do it when they see real orders and real business.”

The “silver lining” of the latest unemployment figures is hardly encouraging. The rise in unemployment is not as sharp as over most of the last year. In other words, workers are definitely worse off, but not as badly as they could have been if things were as dismal as they were earlier this year.

While the unemployment rate, as seen on the graph to the right, has risen almost every month since August of 2008, the rate at which the rate has increased has begun to slow. In other words, the economy is probably close to “bottoming out”.

The tally of lost jobs now stands at 6.9 million since the beginning of the recession in December 2007. But the rate of job losses has been declining, if haltingly, since winter. The 216,000 jobs eliminated in August is down from 276,000 cut in July and a peak of 741,000 lost in January.

Here’s what I find most interesting from in the current data. The unemployment rate’s recent rise may actually be a sign that the economy is beginning to recover. Recovery means growth in output, which should mean less unemployment. However, if workers who have been unemployed for a long time, and have therefore stop seeking employment suddenly feel more optimistic about the prospects of getting a job and begin seeking work again, then the nation’s unemployment rate actually rises! How’s that for “silver lining”? The 216,000 additional people added to the list of unemployed may have already been out of work but since they were notactively seeking employment they were not included in last month’s data.

The tricky thing about macroeconomic policy is this:  Monetary and fiscal policies can put billions of dollars into the nation’s banks and households’ and firms’ pockets through tax breaks, government bailouts, subsidies, infrastructure spending and “troubled asset swaps”… but all the money and income in the world will not lead the nation towards full-employment unless the nation’s consumers and producers feel confident. I teach my students that national income is made up of the sum of wages, interest, rent and profit; its spending consists of consumption, investment, government spending and net exports… but without the “big C” of confidence, expansionary policies aimed at increasing employment will come to nought. Confidence, according to John Maynard Keynes, is an animal spirit, a trait of humans beyond the assumption of rational behavior. Until confidence is restored, America’s output and employment levels will remain low.

Help Wanted: Why That Sign’s Bad – BusinessWeek

This week’s cover story in Business Week magazine tells an interesting story about unemployment in America. Listen to the podcast or follow the link above to read more of this story:

Help Wanted: Why That Sign's Bad [ 0:01 ] Play Now | Play in Popup | Download (10)

Surprising statistic: In the midst of the worst recession in a generation or more, with 13 million people unemployed, there are approximately 3 million jobs that employers are actively recruiting for but so far have been unable to fill. That’s more job openings than the entire population of Mississippi.

Sound like good news? It’s not. Instead, it’s evidence of an emerging structural shift in the U.S. economy that has created serious mismatches between workers and employers. People thrown out of shrinking sectors such as construction, finance, and retail lack the skills and training for openings in growing fields including education, accounting, health care, and government. At the same time, the worst housing bust in decades has left the unemployed frozen in place. They can’t move to get work because they can’t sell their homes.

In IB and AP Economics we teach that there are three types of unemployment an economy may experience, ranked roughly in order from the least undesirable to the most undesirable (from a macroeconomic perspective):

• Frictional unemployment: This accounts for people who are “in between jobs” or fresh out of college looking for their first jobs.
• Structural unemployment: This is caused by the changing structure of an economy. As America’s manufacturing sector shrinks and its education and health care sectors grown, those whose skills lie in manufacturing become structurally unemployed.
• Cyclical unemployment: This is also called “demand-deficient” unemployment because it is caused by a fall in aggregate demand or overall spending in the economy.

America today is clearly experiencing all three types, but due to the particular circumstances of the recession, the American worker is finding it it harder than ever to match his skills with an appropriate job. Below are some of the industries with the most and the fewest job openings today:

Most openings:

• Education
• Health care
• Government
• Energy (such as wind, oil, natural gas)
• “Analytics” (i.e. business data analysis by firms such as IBM)

Fewest openings:

• Construction
• Manufacturing

Unfortunately for the large numbers of unemployed construction and factory workers, the kinds of skills required to work in the fields with the most job openings are prohibitively different from those learned in their previous industries. In addition to a mismatch of skills between the industries in which jobs are being lost and those in which labor is in demand, there is also a geographic mismatch in the labor market. Below are the states with the least and the most job openings:

Most job vacancies (states with large energy sectors: oil, natural gas and windmills)

• North Dakota
• Wyoming

Least job vacancies (states with large manufacturing and construction sectors)

• North Carolina
• California
• Michigan

Historically, the geographic factor has not posed an issue to American workers, and when jobs opened up in one part of the country, Americans would pack up and move where necessary to find work. Today, however, with the collapse of house prices, more and more Americans find themselves stuck with a house they can’t sell in a part of the country where they can’t find a job.

To paraphrase the podcast above, “the US in danger of looking like Europe. The European job market has been described as ‘sclerotic’; people don’t respond to want ads because of the generous long-term unemployment benefits offered by European governments. Europeans have historically been geographically immobile due to nationalist ties to their home countries.” Today, the US job market reflects some of the same “sclerosis” as that of Europe.

America is facing the perfect storm of unemployment. At the same time that the economy is undergoing its most significant structural change since the Industrial Revolution brought millions of American workers from the farm fields into factories, it is facing the most significant decline in private sector spending (consumption, investment and exports) since the great depression. Put this together with the relative immobility of the American worker caused by the housing crisis, and unemployment has climbed to its highest level in three decades.

This interesting story ends with a glimmer of hope for the American worker:

To fight this sclerosis, the White House is using $3.5 billion of the stimulus for training, while boosting support for community colleges. Classes for factory workers seeking entry-level health-care careers have shown some success.

The truth is, displaced workers may have to move down a few rungs as they switch careers because their skills are irrelevant in their new roles… Many laid-off Wall Street financial engineers still haven’t absorbed that, says Fred Wilson, a partner in Union Square Ventures, a New York venture capital firm. “For them to take a job that pays a lot less, they have to make a meaningful change in their lifestyle. And that is an issue.”

Employers need to bend as well, recognizing that the candidates they’re seeking may not exist. Mark Mehler, co-founder of CareerXRoads, a staffing strategy consulting firm in Kendall Park, N.J., tells employers: “You’re hiring potential….You’ve got to train them.”

A mismatch of work and workers is never a good thing. But smart policy—combined with realism on the part of employers and job seekers—can minimize the disruption.

Discussion Questions:

1. In what way may structural unemployment be a sign of a healthy economy, rather than a sick one?
2. Part of the Obama stimulus package includes increased benefits for unemployed Americans. How may this pose an obstacle to reducing unemployment in America?
3. Historically, the natural rate of unemployment in most European economies has been higher than that of the United States. Why is this?
4. Do you think America’s NRU will return to its historic level (4-6%) when the economy eventually recovers from the current crisis? Why or why not?

CBO Director’s Blog » Macroeconomic Effects of the Senate Stimulus Legislation

The February 9th edition of the excellent NPR show, Planet Money reported on a letter sent from the director of the Congressional Budget Office to the Senate, forecasting the (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run and long-run macroeconomic effects of the House Stimulus Package.

Crowding-out and the Stimulus Package [ 1:23 ] Play Now | Play in Popup | Download (19)

It turns out the director of the CBO has his own blog on which he published his letter to the Senate. Here are some highlights:

CBO estimates that the Senate legislation would raise output by between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011…

Most of the budgetary effects of the Senate legislation would occur over the next few years. Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity. Short-run stimulative policies can affect long-run output by influencing those three factors, although such effects would generally be smaller than the short-run impact of those policies on demand.

In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt.  To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provisions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.

The fascinating thing about this letter from the Congressional Budget Office to the Senate is that it mentions so many of the Macroeconomic principles we teach in both AP and IB Economics.

• The nation’s potential output (PPC) is “determined by the stock of productive capital, the supply of labor, and productivity”.
  
• Fiscal stimulus’ effects, while possibly significant in the short-run, may result in less long-run growth due to “crowding-out” of private investment as the public puts its savings into government debt and takes it out of the market for loanable funds.
• A stimulus package should be made up of “funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run.” The negative effects of crowding-out could be offset through responsible government spending.

I find this letter to be surprisingly positive. The short-run forecast seems optimistic: as much as 3.6% GDP growth and as many as 3.9 million new jobs by the end of 2010. The negative growth effects of the stimulus resulting from increased government debt and the subsequent “crowding-out” of private investment are not predicted to set in until 2019.

I always tell my students that humans are “short-run creatures living in a long-run world”. I have to admit, this short-run creature is inclined to think that a stimulus package that puts nearly 4 million people to work and turns the US Economy back onto a path towards growth within two years is probably worth the long-run risk of sluggish growth ten years down the road due to the decline in private investment resulting from the debt-financed spending today.

This letter from the CBO also seems to address a debate recently undertaken in the AP Economics teacher email list: whether deficit-financed government spending affects the supply of or the demand for loanable funds in the economy.

To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy.

This passage from the director’s letter indicates that it is the supply, not the demand for loanable funds that shifts, driving up real interest rates in the economy. Savers will take their money out of banks and other lending institutions and put it in government bonds, reducing the amount of capital available for private investment. This can be illustrated as a leftward shift of the supply of loanable funds.

Discussion questions:

1. In evaluating the use of expansionary fiscal policy, we learn in IB Economics that the crowding-out of private investment will reduce the expansionary effect of increased government spending. Is crowding-out a problem during a recession? Why or why not?
2. Discuss the following statement: “In order to finance its budget deficit, the US government must borrow from the private sector.” How does the government borrow from the American people?
3. Will fiscal stimulus in the short-run lead to increased growth or decreased growth in the long-run? Discuss.

Does the Economy Self-Correct? – Welker’s Wikinomics Page

The debate in Washington over Obama’s fiscal stimulus package, which has now been re-written by both the House and the Senate, is ultimately one of the validity of orthodox economic theories. By voting for a nearly $1 trillion government spending bill, the Obama administration and Congress are clearly taking the position that an economy in recession will either not be able to correct itself, or will take too long to self-correct, thus the government is needed to accellerate the recovery process.

Washington’s stimulus package presents students and teachers of economics with an all too rare opportunity to put to the test the two competing hypotheses of macroeconomics: the Demand-side Theory versus the Supply-side Theory.

At the core of the long-running macroeconomic debate is the simple question, “Does the economy self-correct in times of recession?” The supply-side theory, attributed to the “classical” economists dating back to Adam Smith and David Ricardo, argues that the answer to this question is YES. The rationale between this laissez faire approach to macroeconomics is the following:

1. Falling demand in an economy means less output by firms, forcing them to lay off workers.
2. As inventories build up due to their inability to sell their output, firms will be forced to lower their prices, putting downward pressure on the price level in the economy (deflation).
3. High unemployment and falling prices eventually lead to workers in the economy being willing to accept lower wages.
4. Weak demand for commodities such as oil and minerals put downward pressure on raw material and energy prices faced by firms.
5. Falling wages and raw material prices mean more potential for profits for firms in various enterprises, even as overall demand in the economy is weak. Firms begin hiring workers at lower wages, and increase production to take advantage of lower input costs. Overall supply of goods and services in the economy begins to increase due to lower costs faced by firms in all sectors.
6. The downward spiral caused by weak aggregate demand, rising unemployment, falling prices for output, falling wages and commodity prices, is eventually reversed and turns into an upward spiral as firms hire more workers, employ more resources, creating more income and spending, moving the economy towards recovery and economic growth.

The supply-side theory of self-correction (so called because recovery results due to an outward shift of aggregate supply) outlined above depends on the downward flexibility of wages. If wages do NOT fall, as some demand-siders propose, then the idea that firms will eventually begin to hire more workers is busted, and unemployment will only continue to increase as overall demand remains weak.

Today, there is some evidence that wages in the United States may in fact be downwardly flexible.

GM Slashing 10,000 White-Collar Jobs, Cutting Pay – washingtonpost.com

…the base pay of higher-level U.S. executives will be lowered by 10 percent, while other salaried employees will face cuts of between 3 and 7 percent.

General Motors employees are beginning to accept lower wages. Rising unemployment, especially in the white collar sector, mean that the number of highly educated and skilled American workers unable to find work will grow as corporate layoffs continue.

A “shovel-ready” stimulus package from Washington may indeed help to “create or save” 3 million jobs, as Obama claims, but it is the self-correcting nature of markets due to flexible commodity prices and wages that will ultimately contribute to a recovery of the US economy. As prices of commodities fall, combined with lower wages for white collar workers and deflation in the overall economy, firms will find it profitable to begin employing resources at their lower costs, putting people back to work, stimulating spending through market forces.

Fiscal stimulus may accellerate the recovery process, but the threat it poses is the same threat posed by all forms of government intervention in the free market: that the nearly trillion dollars will go towards satisfying the priorities of politicians rather than the wants and needs of society as a whole, resulting in a misallocation of the nation’s resources towards goods, services, and infrastructure projects that are chosen by legislators, not the market itself. Stimulus is needed, but only the right kind. The recognition by politicians and the media that markets may also self-correct is also needed. News like GM’s wage cuts may sound dire, but the underlying implication of falling wages may be a sign that the US economy is already on the path to recovery, even before Washington has spent a single dollar on stimlus.

On my way to work this morning I listened to the latest episode of WEBZ Chicago Public Radio’s excellent show This American Life. The theme of this week’s radio show was “the New Boss”. America’s new boss, Barack Obama, has embarked on an ambitious experiment aimed at rescuing the American economy from the most severe recession it has seen since the Great Depression. The economic theory behind Obama’s nearly $1 trillion economic stimulus package was developed by a man we have all heard of in our AP and IB Economics classes, but probably know little about in a historical sense.

The clip from This American Life that I have included below presents a fascinating examination of Keynes’ life and times, and puts his theory into perspective in the history of macroeconomics of the last century. We learn that Keynesian theory has not been truly put to the test, and that Obama’s $830 billion stimulus package is the first real test of Keynesianism.

Keynes.mp3 [ 0:01 ] Play Now | Play in Popup | Download (29)

The clip is a bit long, but it is definitely worth listening to if you are a student or teacher of economics. I know that when I come teo Macroeconomics and Fiscal Policy in my course this spring, I will have my kids listen to and discuss the podcast below. If you’re teaching or learning Macro now, feel free to listen and leave comments about your impressions of the story here.

FT.com / China / Economy & Trade – China’s 20m unemployed raise risk of unrest

The days of full-employment in China appear to be over. For decades under communism, the unemployment rate in China stood at an official level of 0%. Of course, being guaranteed work by a state-owned farm or steel factory didn’t exactly mean that all adult Chinese were “working”, rather that they were “employed”. The “iron rice bowl” of communism disappeared in the decades following Mao’s death during the period of “reform and opening” begun under Deng Xiaoping in 1979.

Upon its opening to the world markets, China embarked on three decades of transition from command to market economic principles, characterized by near double digit growth. The demand for workers in its export sector, centered mostly in the Eastern cities from Shenzhen in the south to Shanghai and Beijing in the north, led to the largest rural to urban migration in human history, as nearly 300 million Chinese left the countryside to seek employment in the country’s massive export sector.

Today, the very engine of China’s growth is sputtering to a halt. The demand for Chinese exports is falling as unemployment rises and incomes fall among its trading partners in Asia and the West. Subsequently, the flow of labor from the countryside to the city has reversed, and for the first time in its long history, China is experiencing urban to rural migration:

More than 20m rural migrant workers in China have lost their jobs and returned home as a result of the global economic crisis according to government figures, raising the spectre of widespread unrest in the authoritarian country.

By the start of the Chinese New Year Spring Festival on 25 January, 15.3 per cent of China’s 130m migrant workers had lost their jobs and returned from manufacturing centres in the south and east of the country to their home villages or towns, according to Chen Xiwen, Director of the Office of Central Rural Work Leading Group, who was quoting a survey from the Ministry of Agriculture.

What does the new demographic trend mean for the world’s most populous nation? Bad news, most likely. The hope of work in the city dwindles with demand for Chinese products, but the agricultural sector, which is the main source of employment in the countryside, shows little promise of employment for the millions returning home.

China’s farming industry has become less, not more, labor intensive over the decades since “reform and opening”. The acquisition of capital has supplanted the need for human labor in rural farming, which is one of the “push factors” that led to the massive internal migrations to cities in the first place. The “pull factor” leading the masses to the coastal metropolises, of course, was employment in a factory producing goods to be exported to foreign markets.

Today China’s workers find themselves in the worst possible situation. There is now a “push factor” of 15-20% unemployment, combined with the high cost of living and the struggle of living as an outside in a big city creating an incentive for Chinese workers to return to their familial homes in the countryside. But once they’ve returned home, they find the same lack of opportunity that caused them to leave in the first place. Urban unemployment may shrink as a result of the reverse migration of workers, but rural unemployment will rise.

For the first time in decades, China is faced with a problem that only a year ago (when growth reached 11%!) most would have thought it unlikely to ever face: catastrophic unemployment. Economic theory would suggest, therefore, that China is facing a situation where falling demand for its output has led to rising unemployment due to the downwardly inflexible nature of workers’ wages. According to the Keynesian AD/AS model above, if demand for Chinese output is not restored on its own (which seems unlikely as the West enters deep recession), then the government must take an active approach to stimulating demand through expansionary fiscal and monetary policies.

Keynesian theory, formulated during the Great Depression of the 1930′s, says that in times of recession, spending in the economy is unlikely to increase on its own due to the huge increases in unemployment and corresponding lack in consumer and investor confidence. An active role of government, therefore, is needed to supplant the fall in private spending, and create new income, spending, and economic growth.

In contrast to this “demand-side” theory of macroeconomics, the neo-classical economist would argue that China’s government would do best by letting the economy “self-correct” in times of economic slowdowns. The graph below shows that as demand for China’s output falls in the (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run, unemployment will rise and the price level will fall as firms find it hard to sell their output. Because millions are out of work, and because prices are lower, labor will be willing to accept lower wages, encouraging firms to increase their employment of labor, shifting aggregate supply outward and ultimately restoring full-employment at a new, lower price level than before the downturn began. This classical laissez faire theory of “self-correction” has by most account been proven FALSE, as most major recessions, most notably the Great Depression itself, were ended only after massive intervention by the national government.

The most promising solution to the looming social and economic nightmare it faces is for the Chinese government to push forward massive fiscal stimulus plans aimed at putting the tens of millions recently jobless back to work. This may sound like a return to communism at first, but government money can be spent to create jobs in private enterprise, producing goods, services, and infrastructure that leads to real long-run economic growth fueled by domestic, not foreign, demand for Chinese output.

For too long China has depended on demand from the rest of the world to grow its economy. Faced with the largest economic crisis of the modern era, the Chinese Communist Party should take it upon itself to reduce the nation’s dependency on foreign demand, stimulate growth through new public spending on infrastructure, education, health care and social security for the hundreds of millions of Chinese who are left to fend for themselves once they’ve reached retirement age. Meaningful fiscal stimulus aimed at improving the lives of the common citizen, of whom so many have been adversely affected by China’s over-dependence on export-oriented growth, will may be the best response to the most dire social and economic turmoil the country has faced since the end of the Mao era over 30 years ago.

Discussion questions:

1. What is China’s most worrying macroeconomic problem currently? Inflation? Recession? Unemployment? Deflation? Trade imbalance? Income distribution? Which of these does falling demand for China’s exports affect most?
2. What are the social and economic costs of rising unemployment and why is it so important for a government to combat it?
3. Discuss the differences in the Keynesian and the Classical models in their explanation of what will happen to unemployment after a fall in Aggregate Demand.

How high is China’s jobless rate? | The great wall of unemployed | The Economist

China Faces Unemployment Woes

Unemployment in China is a big deal. The legitimacy of the Chinese Communist Party hinges on its ability to assure  stable jobs and income growth for the 300 million “middle class” Chinese who live in the country’s cities. When the urbanites are unhappy, trouble ensues.

So a dip in economic growth rate into single digits, while we in the West may think of it as silly to fret about, is a major deal for China. Interestingly, according to the Economist newspaper, unemployment data in China is notoriously unreliable; in fact analysts have no clear idea of just how much unemployment there is:

Until the 1990s, the government more or less guaranteed full employment by providing every worker with an “iron rice bowl”—a job for life. But when soaring losses at state-owned firms forced the government to lay off about one-third of all state employees between 1996 and 2002, the official unemployment rate rose only slightly. Today it is 4% in urban areas, up from 3% in the mid-1990s.

But the official rate excludes workers laid off by state-owned firms. Thus at the start of this decade, when lay-offs peaked, it hugely understated true unemployment. Over time, as laid-off workers have found jobs or left the labour force, the distortion will have shrunk. Another flaw is that the official unemployment statistics cover only people who are registered as urban dwellers. An estimated 130m migrant workers have moved from the country to the cities, but there is no formal record that they live there, so they are ignored by the statisticians. After adjusting the official figures for these two factors, several studies earlier this decade concluded that the true unemployment rate was above 10%—and might be even as high as 20%.

The textbook definition of unemployment is the percentage of the labor force actively seeking but unable to find a job. In China, however, the “labor force” only includes the 25% of the country’s population that lives in cities, and the massive number of workers who were fired from state-owned enterprises over the last decade are mysteriously excluded from official figures. 4% unemployment, the official number, puts most developed countries to shame, as it represents extremely low levels of unemployment.

Despite the fuzziness in the figures, one thing is for sure, slower economic growth, even though it is still expected to be between 8-9% this year, means fewer new jobs in China, hence the government’s recent slashing of interest rates to re-invigorate investment and spending in the economy.

…on November 26th the People’s Bank of China slashed rates by more than a percentage point—the most in 11 years—to boost growth. The slowing economy has led factories to cut jobs, and there are mounting fears that the swelling ranks of the unemployed might one day take to the streets and disrupt China’s economic miracle.

An interesting point made in this article is that even continued economic growth in China does not guarantee continued job growth. Basic economic theory holds that when a nation’s output is increasing, employment is also increasing, since growth in output implies increase demand for labor. China, however, is experiencing a different type of growth today than that of years past:

China is creating fewer new jobs than it used to. In the 1980s, each 1% increase in GDP led to a 0.3% rise in employment. Over the past decade, 1% GDP growth has yielded, on average, only a 0.1% gain in jobs. Growth has become less job-intensive, so the economy needs to grow faster to hold down unemployment.

One reason for this is that the government has favoured capital-intensive industries, such as steel and machinery, rather than services which create more jobs… China needs to shift the mix of its growth from industry, investment and exports to services and consumption. To adjust the structure of production requires a further strengthening of the yuan, raising the price of energy, scrapping distortions in the tax system which favour manufacturing, and removing various shackles on the services sector.

More labour-intensive growth would also boost incomes and consumption and so help to reduce China’s embarrassingly large trade surplus. But most important, by allowing more workers to enjoy the rewards of rapid growth, it could help to prevent future social unrest.

Discussion Questions:

1. How does China’s current account surplus result in fewer new jobs than a growth strategy based on domestic consumption would?
2. Why would a stronger RMB contribute to greater domestic job creation?
3. “More labour-intensive growth would boost incomes and consumption and so help to reduce China’s embarrassingly large trade surplus” Discuss this statement.
4. Philosophically speaking, why is there more pressure on the Chinese Communist Party to maintain high growth and low unemployment than there might be on a democratically elected party such as the Republicans in the United States?

Federal Reserve sees slow economy, higher prices – Sep. 3, 2008

Weak aggregate demand and rising costs due to still high energy and food prices put the US economy in a tricky situation, one in which the Federal Reserve is forced to make the tough decision between tackling the unemployment problem (jobless rates have risen to 5.7%) or the inflation problem (price levels have also risen 5.7% this year, the highest inflation in 17 years).

The nation struggled with slow economic growth and still-high prices that are weighing on consumers and businesses alike…

Fed Chairman Ben Bernanke and his colleagues are all but certain to leave a key interest rate alone at 2% when they meet next on Sept. 16 and probably through the rest of this year.

Given the fragile state of the economy, the Fed isn’t in a hurry to boost rates to fend off creeping inflation. A growing number of analysts believe the economy is likely to hit another dangerous rough patch later this year as consumers and businesses curtail their spending even more.

Heading into the fall, economic activity continued to be slow, the Fed said. Businesses described the climate as “weak” or “soft” or “subdued.”

Consumers, the lifeblood of the economy, showed caution. Shoppers “concentrated on necessary items and retrenchment in discretionary spending,” the Fed observed.

In the (In macroeconomics): The period of time over which wages and prices are relatively inflexible. A fall in aggregate demand will lead to unemployment and recession in the short-run. Due to the inability of the nation's producers to reduce wages paid to worker, they must lay workers off to reduce costs as demand falls.');" onmouseout="tooltip.hide();">short-run, as year 2 IB students know, society faces a trade off between high inflation and high unemployment. Rising prices and rising joblessness are both harmful to the economy, but when energy and food prices drive up the price level, while week investment and consumer spending lead lead to falling overall demand in the economy, the conditions exist where joblessness and prices can rise simultaneously. This is America’s situation at present.

The Fed must chose which problem to address. Ben Bernake, America’s central bank chief, could chose to tackle rising inflation by raising interest rates, which would discourage new investment and reduce demand for resources by firms in the economy. Investment spending by firms and consumption by households would decline, putting downward pressure on prices across the economy.

In the short-run, however, the decline in investment and consumer spending that would result from higher interest rates would exacerbate the already weak level of aggregate demand in the economy, driving unemployment even higher.

By keeping rates low, Bernanke hopes to encourage investment and consumption, which will contribute to overall demand in the economy. By encouraging new spending and investment, however, the threat that inflation will rise even more remains present.

In the trade off between unemployment and inflation, the Republican White House and the Democratic Congress made it clear that unemployment was the most important problem to address when they announced the $160 billion expansionary fiscal stimulus package earlier this year. By keeping rates at a low 2%, America’s central bank is also indicating that increasing employment is of greater importance than lowering the price level.

Discussion questions:

1. Low interest rates are clearly a demand-side policy, since they should lead to higher investement and consumption. But how might lowering interest rates result in positive supply-side effects for the economy?
2. Why do you think increasing employment is of a higher priority to policy-makers than bringing down the inflation rate? Does the fact that it’s an election year matter?
3. “Workers’ wage gains – characterized as ‘modest’ – aren’t raising
   inflation worries. Wary employers have cut jobs every month so far this
   year and aren’t inclined to be overly generous in their compensation to
   workers amid ‘a general pullback in hiring,’ the Fed said. If wages continue to rise even as unemployment rises, is it likely that the US economy will ever “self-correct” from in times of an economic slowdown?
   

U.S. food stamp use up sharply, sign of hard times (Reuters) by Charles Abbott