Why I’m Worried About Slack in Unemployment Rate

In regards to today’s unemployment number release showing the lowest rate since before the George Bush housing collapse (it came in at 5.9 percent), I feel it’s my obligation to tamp down any undue euphoria–regardless of how it might help Democrats in the upcoming mid-term elections–because there’s considerable slack, in terms of underutilized resources, in the American economy in general and the labor market in particular; so why isn’t anyone but me seemingly worried about it, and why am I?slack

For one, it’s important to gauge the amount of slack in the economy because it’s a valuable data point into the ways the Federal Reserve makes decisions about little things like money supply and interest rates (I’m betting the Fed finally starts slowly raising interest rates by mid-year 2015).

As anyone who has even a basic understanding of how macroeconomics works—which is apparently about the same percentage of the U.S. population that plays professional football—the Fed has been providing extensive monetary stimulus to the lagging economy for years now, and as the recovery has slowly taken hold primarily due to that stimulus, they need to gauge when it would be safe to start pulling back on their support.

Secondly, businesses, governments, employers and investors all need to know how the near-term economy is doing in order to plan for the future, including hiring, sales and budgeting spending and income levels.

Third, Congress, albeit functioning about as well as an automobile functions on moonshine, would “normally” need to know the level of slack to calibrate temporary policy measures, like extended unemployment insurance benefits or a job-creating infrastructure program (not that this Congress would use any useful information)— to offset the slack until the private market is once again expanding and GDP is steadily rising.

So why isn’t simply looking at the unemployment rate enough? Because we are not operating as a country in a normal fashion, and the circumstances in which the overall economy is now operating makes the jobless rate a completely inadequate measure of slack. In fact, at 5.9 percent, it’s within spitting distance of the rate “many” economists consider to be consistent with full employment, about 5.5 percent—which I think is way too high, but seems to be a consensus, whatever that’s worth.

There are at least two abnormal elements that are misrepresenting the unemployment rate’s importance. First, there are over seven million involuntary part-time workers, almost 5 percent of the labor force, who want, but can’t find, full-time jobs. That’s still up full two percentage points from its pre-recession level; and the unemployment rate doesn’t capture this aspect of slack at all — as far as it’s concerned, you’re either working or you’re not. Hours of work shouldn’t effect the equation at all.

The second abnormality masking the extent of slack (as relevant to unemployment) is the participation in the work force. Once someone stops even looking for work, they’re no longer counted in the unemployment rate. Therefore, when many of the unemployed exit the work force altogether–because of the same slack we’re trying to measure–it artificially lowers unemployment, making a weak labor market look better than it actually is.

Both of these conditions exist now, and have existed throughout the recession that happened on George Bush’s watch, just like 9/11 happened on GWB’s watch, and yet somehow President Obama gets the blame; go figure.

Moreover, the two factors above have been skewed by a more nonthreatening source of work force exits: the retirement of aging baby boomers (like me). A whopping 10,000 seniors are retiring every day ! So economists have floundered about trying to discern how much of the three-percentage-point decline in the labor force participation rate–from approximately 66 to 63 percent–to attribute to slack and how much to so-called structural (vs. cyclical) factors.

And the answer, according to the Dartmouth economist Jan Hatzius, is that about one percentage point, or about a third of the total, is because of slack. Therefore, if that is a safe assumption (not accounting for the involuntary part-timers), that implies an unemployment rate more like 7 percent. That’s roughly another 1.6 million people worth of slack, people who could get back into the job market and spending discretionary funds—and thus stimulating the economy even more–if the jobs existed.

But there is new evidence regarding this question of the extent of slack that I found to be especially convincing. David Blanchflower, an economics professor at Dartmouth, and Adam Posen, added a critical variable to the slack analysis: wage growth. The persistently slow growth of wages in recent years is a primary component in the case for slack, which, if true, provides an important data point.

The unemployment rate normally would draw a parallel negatively with wage growth: the tighter the job market, the faster the wage growth. But when people give up the search and leave the job market, if they’re truly out of the labor force, neither working nor looking for work, they shouldn’t be contributing to slack.

Yet according to the two scholars, they are. As the two economists above stated, labor force inactivity correlates consistently with wages, implying that a significant percentage of those who’ve left the labor force are indeed adding to the existing slack.

Statistically speaking, even once you account for unemployment, the relationship between wage trends and the declining labor force becomes stronger as the recovery proceeds. The implication is that those who are apparently lost forever and out of the work force and no longer able to contribute to the growth of productive GDP could be brought back in. According to Mr. Blanchflower and Mr. Posen put it, “A substantial portion of those American workers who became inactive should not be treated as gone forever but should be expected to spring back into the labor market if demand rises to create jobs.”

Thus, it’s important and clear: There’s more slack in the American job market than you’d glean from the unemployment rate alone. Moreover, some of those who’ve left the labor market would come back if the jobs were there. Congress won’t help, so it will be up to the Fed to keep pushing until the recovery absorbs a lot more of that slack.

This conclusion is supported by an even more important work published by Thomas Piketty, Capital in the 21st Century, which illustrates that income inequality—exacerbated by the enormous tax advantages that have been showered upon the wealthy through extremely low capital gains tax—has produced no growth in the labor force, and has produced two thirds of the slack we are now experiencing in the overall economy.

And yet, any move to reduce this tax advantage is met by Republican cries that these advantages are necessary to prevent slipping back into recession when the exact opposite is true. And despite the fact that it’s being proven in more and more ways, from many different angles, the vast majority of the American voting public remains unaware that the GOP is selling them out to the highest bidder; or rather the highest briber.

Harvey A. Gold