Recessions are times when there is too little demand for the products of businesses, and so they fail to employ all those who want to work. That the problem in a period of high unemployment like the present one is a lack of business demand for employees not any lack of desire to work is all but self-evident. It is demonstrated by the observations that (i)the propensity of workers to quit jobs and the level of job openings are at near-record low levels; (ii) rises in nonemployment have taken place among essentially all demographic skill and education groups; and (iii) rising rates of profit and falling rates of wage growth suggest that it is employers, not workers, who have the power in almost every market.
–The jobs crisis, Larry Summers, Reuters
Here, here. I agree with Larry Summers that a shortfall in demand is creating a US jobs crisis. However, I don’t agree with the thrust of his blog post that there is any magic in the concept that a “lack of demand is the fundamental cause of economies producing below their potential”.
Take a look at this chart and tell me what you see?
Here’s what I see. I see two economies in the Netherlands and Germany where there was no housing bubble and unemployment had risen during the global recession but not by mind-bending amounts. Then I see four other economies wracked by massive housing bubbles in Ireland, Spain, the UK and Latvia where unemployment had skyrocketed.
Moreover, Britain has seen the most muted rise in unemployment amongst the bubble economies, presumably because it is a monetarily and fiscally sovereign nation that can use these tools to address shortfalls in demand and cushion the downturn.
Every single economy that has had a housing bubble has seen a massive rise in unemployment. That speaks to the destruction of credit bubbles. It’s not just about demand.
Here are another chart from the FT. Take a look and tell me what you see.
Here’s my question: if the jobs crisis is only about demand, why does the US have the G-6’s highest relative post-GDP numbers? It doesn’t look like a shortfall in demand is driving the unemployment increase differentials in those economies since the US has the highest relative post-recession GDP (see Chart of the Day: How Deep Was Your Recession?)
Again, while demand is the key factor holding back employment growth, it seems these charts are telling a story of structural issues holding back that demand. To my mind, these charts speak to the over-riding importance of high private sector debt and deleveraging after a credit bubble. This has not been a garden-variety recession.
“it’s the debt, stupid.” When aggregate debt levels build up across business cycles, economists focused on managing within business cycles miss the key ingredient that leads to systemic crisis. It should be expected that politicians or private sector participants worried about the day-to-day exhibit short-termism. But [former BIS head William] White says it is particularly troubling that economists and their models exhibit the same tendency because it means there is no long-term oriented systemic counterweight guiding the economy.
This short-termism that White refers to is what I call the asset-based economic model. And, quite frankly, it works – especially when interest rates are declining as they have over the past quarter century. The problem, however, is that you reach a critical state when the accumulation of debt and the misallocation of resources is so large that the same old policies just don’t work anymore. And that’s when the next crisis occurs.
If the US wants job growth, it will need to reduce private sector debt levels – and that takes time. It does not follow “that the central objective of national economic policy until sustained recovery is firmly established must be increasing… borrowing and lending,” as Larry Summers asserts. The government can act as a counterweight to the demand drag but I am very sceptical of claims like Summers’ that doing so would solve a jobs crisis borne out of a debt crisis.
Source (EU unemployment graph): Google
This post originally appeared at Credit Writedowns and is reproduced here with permission.