The Jobs Crisis Is Not Just About Demand

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.

The origins of the next crisis

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.

2 Responses to "The Jobs Crisis Is Not Just About Demand"

  1. Crimson_Blue   June 14, 2011 at 9:56 am

    U.S. post-recession GDP has been bolstered by a strong recovery in leaner manufacturing, particularly for export.

    High unemployment is the result of the unwinding of a disproportionate amount of investment and employment in low-skilled, labor-intensive construction during the boom. It is further hindered by housing-related immobility.

    Personal balance sheet deleveraging is taking place, starting appropriately with revolving debt. This will allow consumption to continue to increase, creating demand for goods and services. Unemployment will decline as the misappropriated construction-related labor force is assimilated into related industries.

    So, demand-driven recession, unemployment, and housing bubbles are not mutually exclusive or contradictory conditions.

  2. JohnCardillo   June 14, 2011 at 10:39 am

    Debt wouldn't be an issue if the cash made a clean round trip from the borrower/consumer to the producer and back again to the borrower through employment. A fair and balanced economy is like an finely tuned engine … it roars. Instead, we have the borrower/consumer purchasing from producers who choose to employ cheap labor in emerging markets with the cash landing in bloated reserves and corporate balance sheets. The economic engine is out of balance and is being starved by unbalanced trade, greed and hoarding!