Causes of High Unemployment in the U.S.

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There has been an extensive and prolonged discussion in the media about the high unemployment in the United States since 2009.  Some commentators have focused on one cause, some on another.  This article discusses five causes of the current high unemployment, in the order of their importance:

  1. Inadequate aggregate demand.
  2. Migration of jobs to other countries, especially China.
  3. Increased productivity of employed workers.
  4. Inadequate credit for small businesses.
  5. Uncertainty about future taxes and regulations.

Aggregate Demand

Aggregate demand is the demand for goods and services from both the private sector and the public sector.  Demand in the private sector declined precipitously in the Fall and Winter of 2008-2009.

During the period from 2001 to 2007, average household income was stagnant, but there was a housing bubble, with housing prices in some areas doubling.  Homeowners felt wealthier and were able to refinance their homes or take home equity loans to maintain and improve their standard of living.  Banks created complex financial instruments based on mortgage loans, which were widely distributed in the belief that spreading the risk would somehow reduce the risk.  When the housing prices started falling, demand fell and the recession started, officially in the fourth quarter of 2007.

Falling housing prices led to financial crisis, epitomized by the bankruptcy of Lehman Brothers in September 2008.  Financial institutions no longer trusted each other, and the shadow banking system collapsed.  Households and businesses could not get loans.  The decline of housing prices and the tightening of loan standards meant that home equity loans became much more difficult to obtain.  Private-sector borrowing plunged from 28% of GDP in 2007 to minus 17% of GDP in 2009.  Layoffs began.   As unemployment increased, people did not have money to spend, and the economy spiraled downward.

The federal government acted to prevent a depression.  The Federal Reserve stepped in as the lender of last resort and provider of liquidity for many types of credit markets, increasing its assets from $900 billion to $2.3 trillion.

At the request of President George W. Bush and his treasury secretary, Hank Paulson, the Congress approved the $700 billion TARP program.  Treasury used the TARP funds to buy preferred shares in major banks, some of which were threatened with insolvency, as well as to rescue AIG, General Motors and Chrysler.   Most of the TARP funds has been or will be repaid to the Treasury.

At the request of President Barack Obama, the Congress passed the American Recovery and Reinvestment Act of 2009.  This act included $288 billion in tax cuts, primarily for the middle class.  The Congressional Budget Office originally scored the cost at $787 billion, but the tax cuts, unemployment insurance and Medicaid cost sharing with states have pushed the anticipated expenditures above $800 billion, of which about $533 billion has already been spent.  The Recovery Act has created or saved 2.5 to 3.6 million jobs.  However, 8 million jobs were lost in the recession that started in 2007, and the federal stimulus from the Recovery Act was not enough to reduce unemployment below its current level of 9.6%.

The national recession and weak recovery have produced both declines in state and local revenues and increased need for public programs as residents lose jobs, income, and health insurance. In the 2009 and 2010 fiscal years, the imbalance between available revenues and what was needed for services opened up budget gaps in most states. The Recovery Act gave states roughly $140 billion over a two-and-a-half year period to help fund ongoing programs, including K-12 education, higher education, and health care. However, the federal assistance will run out soon.  Most states have now addressed significant budget shortfalls in enacting their 2011 budgets and even more budget gaps are projected for fiscal year 2012. Total shortfalls for 2011 and 2012 (both those that have been addressed and that have yet to be closed) are likely to reach some $260 billion.  The shortfalls would be even higher in the absence of federal Recovery Act aid and the $24 billion state-aid bill to extend support for education and Medicaid for six more months.  Without additional federal aid and if states continue to cut spending as they have in the current fiscal year, the national economy is projected to lose up to 900,000 public- and private-sector jobs.[i]

To get the economy growing again, four out of five economists interviewed by Bloomberg Business Week agree the federal government should increase infrastructure spending.   There are thousands of unsafe bridges thousands of miles of railroad tracks that urgently need repair or replacement.  Our ports are vulnerable to terrorist attack.  Our national electricity distribution grid is a hodgepodge of outdated equipment, vulnerable to both natural and manmade disasters and urgently in need of redesign and upgrade.  The private sector is not going to take the initiative to do it, but the private sector will benefit greatly if the federal government funds and contracts with private companies to fix the national infrastructure.  Now is the time to do it.  It will provide jobs in the near term, but the benefit will continue.  Like the construction of the Interstate Highway System started by President Eisenhower, rebuilding the national infrastructure will lower costs for the private sector long after the federally contracted work has ended.

In addition, because states are required by their constitutions to balance their budgets even during recessions, the federal government should resume federal-state revenue sharing (first proposed and implemented by the President Nixon and ended by President Reagan).  This could save almost a million jobs.

Migration of Jobs to Other Countries

In 1992, erstwhile presidential candidate Ross Perot warned of a “giant sucking sound” of jobs going to Mexico if we ratified NAFTA.  We now know that the “giant sucking sound” did not come from Mexico, it came from Asia.

While the U.S. trade deficit in goods and services declined from $696 Billion in 2008 to $381 Billion in 2009[ii] because of the worldwide recession, it is rising again at an alarming rate.  For June 2010, the U.S. trade deficit was $49.9 billion, up from $42 billion in May, as exports dropped by the most in a year.[iii] Our trade deficit with China is rising and may reach $290 billon this year.  China accounts for more than half the non-petroleum trade deficit.  According to the Economic Policy Institute, the trade deficit with China has resulted in the loss of 2.4 million jobs over 2001-2008.[iv] An additional one-half million jobs could be lost to China this year.

Some economists say that China benefits from an undervalued currency, which it depresses by buying dollars and euros.  Indeed, China has foreign currency reserves of over $2.5 trillion.  The Chinese Renminbi is estimated to be undervalued by 35% to 40%.  This makes Chinese goods cheaper than they should be on the world market, and makes foreign goods, including American goods, more expensive in the Chinese market.  An exchange rate adjustment would make American goods less expensive in China, which would benefit American exporting companies, but would also benefit Chinese consumers, who have been complaining lately about inflation in China.  The Chinese government promised earlier this year to adjust the exchange rate, but there has been little change.  The Economic Policy Institute estimated that ending China’s currency manipulation could add as much 1.4 percent to economic growth in the U.S., based on calculations made by Nobel laureate Paul Krugman. That would lead to $500 billion in additional federal government revenue–or deficit reduction.  Krugman suggests we threaten a 25% tariff on all Chinese goods if China refuses to revalue its currency.[v] We also need to demand the end to illegal subsidies and other unfair trade practices by China and other countries.  While we should not repeat the mistake of broad Smoot-Hawley-style tariffs, a targeted approach may be in order, so long as it is done within WTO rules.

It is hard not to notice that so many goods we buy are made in Asia – clothing, toys, cell phones, television sets, personal and laptop computers, iPods, iPhones, iPads, and even the internet routers that link all these devices.  One company, Foxconn, employs 920,000 workers in China to manufacture the gadgets that are conceived and largely designed in the United States.  To a large extent, this situation is a result of Chinese mercantilist policies taking advantage of naïve American laissez-faire policies.  However, it also results from American investor pressure to lower costs for their own individual profit without regard to the consequences for American society as a whole.

Andy Grove, former chairman and CEO of Intel, published an excellent article in Bloomberg Business Week in July titled “How to Make an American Job”.  He writes cogently that America needs to reinvigorate its manufacturing base that has eroded so dramatically over the past thirty years.  It is only partially true that small businesses generate more jobs.  Our problem is that small businesses do not grow jobs as they used to, because successful small businesses are expanding overseas, building their manufacturing plants in Asia.  Many companies like Apple have generated ten times as many jobs in Asia as in the United States.  This happens not only because of low wages in Asia, but also because Asian countries like China have policies to encourage certain kinds of industries, especially manufacturing.  When American companies build their manufacturing plants overseas, engineering and management jobs go overseas as well.  The manufacturing experience grows in Asia, not the U.S., making it more likely that new technologies will be developed in Asia rather than the U.S.  Grove makes the point that laissez faire works better than communism, but the Asian model of government encouragement for manufacturing is working better than U.S. laissez faire policies in encouraging job growth.  U.S. government intervention is necessary to stop and reverse the hollowing out of American industry.

In the old days, the U.S. manufactured radios, television sets, hi-fi music systems, and personal computers.  However, production of all these products has shifted to Asia under the laissez faire economic policies of the past thirty years.  Some economists welcome the transfer of the production of these “commodity” products to “less developed” countries.  However, we have lost manufacturing skills that have made it difficult to compete in newer technologies.  Flat panel LCD display technology was invented in the United States, but the manufacturing base to support production was not here, so production of flat PC and TV displays scaled up in Asia.  Touch screen display technology was invented in the United States, but American companies went to Asia for mass production.  When Apple developed the iPhone, the production facilities for the main components were in Asia, so it was logical to give the production contract to Foxconn in China.  Semiconductor solar cells were invented in the United States, but now China is dominating the production of lower-cost solar power panels.  As the manufacturing skill shifts to Asia, engineering jobs go to Asia as well.

The United States cannot hope to maintain the American dream of full employment and a vibrant middle class without manufacturing.  Andy Grove says we need to stop the venture capitalist practice of encouraging every new technology startup to plan for production in China.  The government needs to offer financial incentives to keep new product manufacturing in the United States.  “The first task is to rebuild our industrial commons… Tax the product of off-shore labor.”  Use the resulting tax revenues to fund companies that will scale up their new product manufacturing operations in the United States.  We should encourage businesses to consider it their duty to support our industrial base as well as the American Society that made their business possible.

Increased Worker Productivity

Companies are investing in manufacturing equipment and information systems to increase the productivity of the workers they already employ, rather than investing in more employees.  Equipment and software sales increased 24.9 percent in 2Q10 after an increase of 20.4 percent in the first quarter.[vi] Many workers also report that, after deep cuts in their workforces, companies have not been hiring after their business started improving, leaving the existing employees with more work to do for the same salaries.

We don’t want to discourage greater efficiency, as long as it does not come from employee exploitation, because increased worker productivity should lead to improved living standards in future.

Inadequate credit for small businesses.

Small businesses are often said to be the engines of our economy.  In mid-2010, 45% of small businesses reported inadequate credit to support their needs.  The unavailability of credit constrains these small businesses from hiring new employees, and may jeopardize the jobs of existing employees.  The recently-enacted Small Business Jobs and Credit Act establishes a new $30 billion fund for community banks, which will leverage up to $300 billion in new private sector lending to small businesses.  The new legislation provides more than $12 billion in tax relief provisions and creates eight new small business tax incentives aimed to encourage expanded business planning for investments in operations and hiring additional workers.[vii]

On Business Uncertainty Constraining Hiring

Verizon CEO Ivan Seidenberg has said that uncertainty about future taxes and regulation is constraining hiring.[viii] While we have heard this assertion repeated by Republican leaders, we find little compelling evidence to support it.  Uncertainty about the economic expansion is a credible constraint on hiring.  Companies may not feel the need to hire if their markets are only expanding 1% or 2% annually.  However, business leaders are accustomed to making decisions in the face of uncertainty.  Launching satellites or drilling for oil in a new area involves uncertainty, but businesses make those decisions.  Anytime a new product is introduced, there is uncertainty about the size of the market and whether customers will buy it.  Remember New Coke?  How about the Edsel?  Who knew Google would be so successful selling online advertisements?  On April Fools Day 2009, what would the reaction have been if you had said that Susan Boyle’s recording sales were about to make a dramatic change?  When Apple was looking for a wireless carrier partner, there was uncertainty as to the market for the new iPhone.  It might have been a money loser for the carrier who partnered with Apple.  Mr. Seidenberg did not know that AT&T would gain market share and profit from the deal.  (AT&T had to hire many people to sell iPhones and expand its network to keep up with the demand for its services.)  Business leaders who don’t like to make decisions under uncertainty will always have difficulty competing.


[i] http://www.cbpp.org/cms/?fa=view&id=1214

[ii] http://www.census.gov/foreign-trade/statistics/highlights/annual.html

[iii] http://www.bloomberg.com/news/2010-08-11/u-s-trade-deficit-unexpectedly-widens-to-49-9-billion-as-exports-decline.html

[iv] http://www.epi.org/publications/entry/bp260/

[v] http://www.nytimes.com/2010/03/15/opinion/15krugman.html?_r=2

[vi] http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.html

[vii] http://www.suite101.com/content/nuts-and-bolts-of-the-small-business-jobs-and-credit-act-of-2010-a289622

[viii] http://www.washingtonpost.com/wp-dyn/content/article/2010/06/22/AR2010062205279.html (Mr. Seidenberg was more reticent to talk about Verizon charging its wireless customers for services they had not contracted for and were not using.)

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2 Responses to “Causes of High Unemployment in the U.S.”

  1. Unemployment in the United States « Hot Topics in PA Says:

    […] Aggregate demand is the demand for goods and services.  From 2001 to 2007 homeowners felt wealthier and refinanced their homes, banks gave out more loans during this time and when house prices started falling in 2007 the demand fell and caused a recession.  When there isn’t enough demand employers will not need as many workers.  Many jobs have gone to other countries.  Chinese goods are cheaper than the United States goods, we also buy many goods from Asia because they are so much cheaper.  Clothing, toys, cell phones, television sets, computers, ipods, iphones, ipads, and internet routers are all purchased in Asia.  Many companies are creating more work for existing employees and not increasing salaries.  In mid 2010 many small businesses had inadequate credit to support their needs.  This unavailability of credit prohibited these small businesses from hiring new employees and jeopardized the jobs of existing employees.  Uncertainty about the economic conditions has caused companies to decline on their hiring of employees.  (https://westonpolicy.wordpress.com/2010/10/04/causes-of-high-unemployment-in-the-u-s/) […]

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