Behind the Numbers: The End of Unemployment?

Whether our current, relatively low unemployment rates
can be sustained without increasing inflation has been a point
of contention among economists, financial market analysts, and
policymakers. Arguments over trade-offs between unemployment
and inflation, however, too quickly gloss over the causes of our
falling unemployment. The cause seems relatively straightforward:
a sustained upturn in the business cycle. But this simple explanation
overlooks another potent factor: the rising rate of labor force
participation.

Compared to previous economic expansions, the economic growth
of the last few years has actually been quite weak. During the
previous two economic expansions, of 1975-1980 and 1982-1990,
real economic growth averaged 4.3 percent and 3.6 percent per
year, respectively. Real economic growth since the end of the
last recession in early 1991, by contrast, has averaged an anemic
2.7 percent per year, even taking into account the recent economic
surge. It seems improbable that such slow economic growth is alone
responsible for our current low rate of unemployment. But if the
business cycle is not solely responsible, what else is?

One deeper explanation is a quiet but fundamental shift in the
workforce over the last few decades, reflecting demographic and
cultural changes. These shifts, the focus of this article, deserve
far more scrutiny. If they are even partially responsible for
our current low unemployment rates, they could easily produce
a further drop in unemployment and a substantial increase in wages.
But given the Fed's aversion to tight labor markets, that happy
result could produce more restrictive monetary policy and even
slower growth.



EVERYBODY WORKS

While the unemployment rate has waxed and waned with changes in
the business cycle, employment as a percentage of the population
has increased quite dramatically. In 1963, the last year of the
Kennedy administration, just 35.8 percent of the population worked.
Today that number is 47.9 percent. This job growth has paralleled
a substantial increase in labor force participation. In 1963 just
38 percent of the U.S. population was in the labor force. Today,
thanks to a huge infusion of baby boomers and women, more than
50 percent of the population is in the labor force—working or
seeking work.*

Given this sizable influx of job seekers, it is not surprising
that the U.S. economy has experienced periodic high unemployment.
On the contrary, what is surprising is that unemployment rates
have been as low as they have been. The American economy has shown
a tremendous capacity to put job seekers to work.

But even despite a small jump in recent months, this steady increase
in people seeking employment seems to be reaching its natural
limits. Growth in labor force participation rates, which began
in the early 1960s, peaked in the 1970s at about two-thirds of
a percentage point per year. The rate of growth began to slow
in the 1980s, dropping roughly in half, and finally slowed to
a crawl from about 1989 onward, when increases averaged about
0.07 percent per year, or roughly one-tenth the rate of increase
during the 1970s. The influx of baby boomers into the job market,
which crested in the late 1970s, has played out, and women's participation
rates now nearly equal men's.

Flattening labor force participation rates spell good news for
unemployment, as fewer applicants chase the existing supply of
jobs. But they spell bad news for economic growth, which has been
boosted substantially by the increased output of the new labor
force participants. This combination provides a compelling explanation
for our otherwise confusing low-growth, low-unemployment economy.
Slower workforce growth may also help explain why unemployment
is just now returning to levels rarely seen since the early 1970s,
when the most dramatic increases in labor participation were just
getting started. Employment, which has at times over the last
three decades lagged well behind accelerating labor participation,
may finally be catching up.



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To fully understand its impact, imagine that the labor
force growth rate in 1996 was what it averaged during the 1975-1980
expansion. The workforce would have grown by 3.5 million instead
of 1.6 million, adding an additional 1.9 million job seekers to
the 7.2 million already unemployed. Absent any additional job
growth, the unemployment rate would have risen to 6.7 percent
in 1996, up from 5.6 percent in 1995, instead of dropping to 5.4
percent as it did. In fact, had Bill Clinton faced the same labor
force trends that confronted Jimmy Carter, last year's elections
might have turned out quite differently.

Moreover, the aging of the labor force may be just as important
as changes in its size. Younger workers possess fewer skills and
encounter greater difficulty in both obtaining and retaining jobs.
The baby boomers exacerbated unemployment not just because of
their sheer numbers, but because of their youth and inexperience.
The baby bust could have the reverse effect. As young workers
become a smaller fraction of a labor force that is itself already
shrinking, unemployment may fall even more.

In a sense, the effect of the baby boom on labor force participation
has camouflaged a longer-term trend. Since as far back as World
War II, male labor force participation rates have actually been
dropping, mostly due to the increasing custom of retirement and
the lengthening life spans of retirees. At some point this drop
will occur among female workers as well. When that happens, overall
labor force participation rates will contract, probably around
the time baby boomers begin retiring 15 years from now. So our
current labor surpluses could easily become labor shortages. Generalized
unemployment might virtually disappear.


WAGE INFLATION AND THE FEDERAL RESERVE

Left unimpeded, unemployment, already hovering close to 5 percent,
could easily dip toward 4 percent in the next few years. Four
percent unemployment is not unheard of in this country. It once
was the level economists considered full employment.

But Alan Greenspan and his compatriots at the Federal Reserve
are not likely to welcome that prospect. Fearing inflation, they
would feel enormous pressure from the financial community to raise
interest rates to halt the downward trend. Of course unemployment
has dropped to its current levels with little or no impact on
inflation (perhaps due, at least partially, to the restraining
impact of international trade on prices and wages). But to expect
wage inflation to remain low indefinitely as unemployment continues
to drop is overly optimistic. At some point the Fed would feel
compelled to act.

Raising interest rates to forestall wage inflation would jeopardize
the ongoing health of the entire economy, and for very dubious
reasons. In the current economic climate, wage increases are something
to embrace, not something to fear. Real wages have been allowed
to stagnate for far too long, notwithstanding recent debates by
the Boskin Commission and others about the real rate of inflation
and its impact on the value of those wages. Even accepting the
Boskin adjustments, which remain controversial, real growth has
slowed since the postwar boom and income inequality has widened.
According to the Economic Policy Institute, from 1973 to 1995
real median wages dropped from $11.02 to $10.13 per hour (1995
dollars), a decline not significantly offset by a slight increase
in fringe benefits. Over that same period the percentage of workers
earning poverty-level wages—$7.28 or less in 1995 (1994 dollars)—increased
from 23.5 to 29.7 percent.

Falling wages are often blamed on a host of factors, including
slower productivity gains since 1973, dropping rates of unionization,
increased trade with low-wage countries, the loss of relatively
high-paying manufacturing jobs and their replacement with low-paying
service-sector jobs, and a failure to raise the minimum wage enough
to keep pace with inflation. But basic supply and demand at a
grander scale has probably also played a role. Over the last several
decades, with the labor pool expanding so quickly, the oversupply
of potential workers has, no doubt, put significant downward pressure
on wages. If a tightening of the labor supply is at long last
turning the tables on employers, forcing them to pay more, so
much the better. After years of profiting from a surplus of labor,
it seems only fair that employers pay more once the surplus has
dried up.

True, some of those wage increases will be passed on to consumers
in the form of higher prices, and since workers are also consumers
the real value of their increased wages will be somewhat diminished.
But some of the cost also will be passed on to business owners
and stockholders in the form of reduced profit margins. For stockholders
in particular, given the rising stock prices of recent years,
this seems a small price to pay. Even if real median wages are
increased by just 1 percentage point a year, keeping pace with
rising productivity, it would be a significant improvement over
the record of the past few decades—and an improvement with practically
no inflationary implications for the economy as a whole.


HIDDEN UNEMPLOYMENT

Putting aside the possibility of Fed-induced stagnation, an economic
future featuring lower unemployment and rising wages sounds rosy
enough. But it would be a mistake to assume that demographics
alone will solve these problems entirely, even if they do have
a positive influence. Even if unemployment drops, the depth of
our unemployment problem is much deeper than official figures
indicate. In 1996, a year when the official unemployment rate
was just 5.4 percent, the total number of unemployed and underemployed
was actually 9.7 percent. On top of the 7.2 million Americans
who were unemployed, an additional 1.6 million were discouraged
or otherwise marginally attached—workers who were neither working
nor looking for work, but would have taken a job if one were offered.
Another 4.1 million Americans, desiring full-time jobs, were involuntarily
working part-time.

Much of this unemployment and underemployment is highly concentrated
in inner-city and rural communities that are too often left behind
during periods of economic prosperity. Even during times of economic
growth, the unemployment rate among 16- to 19-year-old black males,
for example, ranges from 30 to 50 percent. If future job growth
continues to concentrate in the suburbs, many of our hardest-hit
communities may continue to miss out on the benefits of an improved
economy.

If the problem were just physical location, empowerment zones
and transportation subsidies might be the answer, the first taking
jobs to people, the second taking people to jobs. Unfortunately,
the situation is more complicated than that. Job openings typically
occur all along the skills spectrum, while a disproportionate
number of the unemployed are unskilled. Unless enough low-skill
jobs or training slots are created, a general labor shortage caused
by changing demographics is no guarantee that unemployment will
be eliminated.

Another potential problem has more to do with the theory itself.
Neoclassical economists would argue that changing labor force
participation rates have little effect on unemployment, because
prices (in this case, wages) adjust to reflect changing quantities.
If the labor supply expands, wages will drop until the excess
labor is fully utilized. As labor force participation rises, employment
will too—as has happened. If a subsequent contraction of the labor
force takes place, as may occur in the next 15 years, it will
simply have the reverse effect. A tighter labor supply will push
up wages, forcing many employers out of the labor market, until
a new equilibrium is reached at a lower level of employment. As
employment paralleled the expanding labor force on the way up,
it will parallel it again on the way down, leaving unemployment
unchanged.

Keynesians would dispute this simple view of labor markets and
unemployment, but the potential impact of contracting labor force
participation rates on unemployment should
be interpreted cautiously. Interestingly, since the neoclassical
view predicts rising future wages, it still leaves open the possibility
of a Fed-induced recession. Knowing which view is correct will
require waiting a few years. But since neither view predicts the
elimination of unemployment entirely, government activism on the
issue will still be necessary.

What form should activism take? The Clinton administration's
primary approach to joblessness is a combination of job training
and job subsidies. Unfortunately, these initiatives are probably
too limited to have much impact, and may be the wrong policy solutions
even if pursued more aggressively. While job training, if performed
effectively, could help some of these workers, for many more the
real educational challenge is basic literacy, not a lack of higher-order
skills needed in our increasingly high-tech economy. Nor will
training programs obviate the need to create more entry-level
jobs.

Job subsidies, an increasingly prominent fixture in the Clinton
administration's arsenal of policy prescriptions since the enactment
of last year's welfare reform law, are also a less than satisfactory
answer. Studies
by the New York-based Manpower Demonstration Research Corporation
indicate that job subsidies have had, at best, a limited impact
on unemployment. Job applicants who should benefit from such subsidies
are too often stigmatized by them instead, and this hampers their
job search efforts. When they do find jobs, the subsidy typically
rewards employers for hiring someone they would have hired anyway,
or subsidizes the hiring of one worker at the expense of another—with
little or no net impact on unemployment.

Ultimately, eliminating the last vestiges of unemployment may
require both a friendlier Fed and a targeted public jobs initiative
modeled after the Works Progress Administration (WPA), a program
that em ployed millions of Americans during the height of the
Great Depression. The nation's experience in the 1970s with the
poorly run Comprehensive Employment and Training Act (CETA) program,
our most recent experiment in public service employment, may make
the creation of such an initiative more difficult politically.
But workfare programs popping up all over the country in response
to last year's welfare reform law may give
the concept another chance. Unfortunately, workfare poses its
own problems, including the potential for subminimum wages, inadequate
child care, nonuniversal eligibility, and possible displacement
of government workers, to name only a few. But if workfare can
be transformed into a true public service employment program with
jobs paying a livable wage, it could have an enormously positive
impact. Certainly the Clinton administration's Nation al Service
program has shown that community service is an idea not completely
without merit. And if national unemployment levels continue to
drop, the cost of eliminating the last trace of unemployment through
such programs will become substantially more affordable.

True full employment is a worthy goal. Too often policymakers
are lulled into believing that because an official 5 percent unemployment
rate is low by both international and recent historical standards,
there is nothing left to do. But "low" unemployment,
by these measures, is not low enough. It still leaves millions
of Americans desperate to earn a living for themselves and their
families. Calling our current levels of unemployment "low"
really says more about our standards than it does about the economy.





*Employment and labor force participation rates
are both expressed as a fraction of the entire
population, not the noninstitutional civilians
aged 16 and over, a more traditional measurement
that undervalues the impact of baby boomers entering the workforce.

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