Sunday, January 16, 2011

The unemployment problem

Published in Standard-Examiner, Ogden, Utah, December 9, 2010

Vijay K. Mathur

Americans are frustrated about the unemployment picture and, in spite of the efforts made by the administration to stimulate the economy, unemployment is stubbornly parked between 9 and 10 percent. It is higher than the unemployment rate, which prevails when the economy's growth rate is at full employment without significant inflation rate. Now you may ask why there is unemployment when there is full employment? Let me explain.

At any given time there is always unemployment because the labor market is constantly in flux. There are three main types of unemployment in addition to seasonal. The first is frictional unemployment. During any month, thousands of people are changing their jobs, waiting to start a new job, waiting to be recalled after being laid off from the job, and entering and reentering the labor force to look for jobs. This unemployment is for a short duration (usually 1 to 26 weeks); 54.2 percent of the people were unemployed for one to 26 weeks in the second quarter of 2010. It has decreased from 82.8 percent in the second quarter of 2007. This is partly due to the fact that those who are employed are not leaving their jobs, causing a drop in turnover rate, and those who are unemployed are unemployed for longer durations (27 weeks and more).

Frictional unemployment arises when the labor market is in the process of matching workers with available jobs. This matching process takes time until workers with different talents, experiences, aspirations, and at different locations, find jobs which match goals of businesses at different locations looking for workers with certain skills, experiences. If people with skills in demand are frequently in and out of the labor market and if duration in searching for jobs increases due to wage expectations, lack of information, uncertainty, and locational immobility, frictional unemployment will rise. For example, an IMF study estimates that negative equity problem in the housing market, which has led to decreased mobility, has added 0.5 percent to 1.5 percent to the unemployment rate.

The second type of unemployment is structural unemployment, which arises when people are chronically unemployed. Their skills do not match what businesses demand due to changes in industrial composition or they are unskilled, hence they are employed for very short periods of time. Full employment implies that the only unemployment left is frictional and structural; economists call it a full employment unemployment rate or natural rate of unemployment (NARU).

Following the consensus among economists on NARU of 5.5 percent before this recession, the current unemployment rate of 9.8 percent in November 2010 is 4.3 percent above NARU. This 4.3 percent unemployment rate is cyclical unemployment, which arises due to lack of aggregate demand in the economy for goods and services. This is the third type of unemployment rate.

Growth rate of GDP currently is below the full employment growth rate because of the excess unemployment rate above NARU. But, we have come a long way since the decline in growth rate at around minus 6.8 percent. That was at the lowest point of the recession in January 2009.
The good news in October 2010 was that from September 2009 to September 2010, the job openings' rate was constant, the hiring rate increased, the job separations' rate decreased and all components of GDP grew in the third quarter. However, the unemployment rate is stuck at a higher level. Most likely, NARU has increased as well because of changes in both frictional and structural unemployment. Bureau of Labor Statistics (BLS) data show that from the second quarter of 2007 to the second quarter of 2010, one- 26 weeks of unemployment as a share of total unemployment decreased by 28.6 percent. The share of 52 weeks or more increased by 21..4 percent. These were record-high increases since 1967.

The current high unemployment rate is not due to the entry of more people into the labor force, because labor force participation rate has been stuck at 64 percent to 65 percent since last January.

To bring down the unemployment rate, policies must be aimed at reducing cyclical, frictional and structural unemployment. Reducing cyclical unemployment requires increasing aggregate demand (consumption, private investment, government expenditure, and net-exports). Reducing frictional unemployment will require stimulating demand, removing uncertainties in regulations and fiscal policy, detailing better information flow in labor markets and fixing the mortgage mess. Training and technical education programs must be implemented on a large scale for people who are structurally unemployed.

Let us hope that Congress does its part in implementing a far-sighted expansionary though sustainable fiscal policy, which complements the Fed's monetary policy to stimulate aggregate demand. Congress also has to work on the long-term goals of energy independence, reducing carbon imprint, building human capital stock, sensible immigration and free trade policy, which does not encourage outsourcing.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden. He also offers blog posts for the Standard-Examiner at

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