Tuesday, August 31, 2010

The Debate to Provide Unemployment Insurance

During the past year Congress has fiercely debated the extensions to unemployment compensation.  Typically unemployment compensation lasts 26 weeks, during the current recession recipients are allowed to receive compensation for 99 weeks. Democrats argue unemployment compensation provides a large economic stimulus. The Congressional Budget Office estimates for every $1 provided in unemployment compensation increases GDP by as much as $2. It is by far the biggest bang for our buck program (you can view the report here). With that said, Republicans argue extensions to unemployment compensation create a disincentive to find employment.

In the current labor market, most available jobs are paying near minimum wage. If someone found a job paying $10/hour working 40 hours per week they would earn approximately $1600 per month (less taxes). This same individual can receive $1500 through unemployment compensation. Individuals would conduct a minimal job search. Robert Barro argues that if we had only extended unemployment compensation to 39 weeks the unemployment rate would be 6.8% (you can view his article here).

Now 6.8% sounds like a magical number. Previously I argued the large losses in manufacturing would make it difficult to have unemployment under 7%. Who am I to argue with Robert Barro. After all he is a Harvard economist and a fellow at the Hoover Institute. I see two major problems with Barro's analysis. First he uses the 1982-83 recession as his baseline and second he fails to account for any structural change in the economy.

The 1982 recession was largely driven by a supply side shock, high oil prices. Once oil prices started to drop the economy slowly began to recover. Our current recession is driven mainly by a large fall in demand. The recovery is conditional on household spending and firms increasing production. During the 1980's firms were able to increase production as oil prices fell, the same is not true today.

The second, and perhaps larger problem, is the failure to account for a structural change. From 1999-today our economy has lost 7.5 million manufacturing workers. Simply put the jobs are not available for these workers. Perhaps the following graph will help my cause:

What do we learn from the graph. First, job losses were minimal in 1980 compared to today (notice the small decrease in the red line from 1982-1984). Second the job losses were not in the manufacturing section, there were about 1.5 million jobs lost in manufacturing compared to the 7.5 million today. Once we include the construction industry we have 10 million unemployed workers. Given the skill set of these workers I fail to see how they could have found employment in the current labor market.

Finally, Mr. Barro assumes the labor force would remain constant at 153 million workers. This is hardly true. From the beginning of 1982 through 1984 the labor force increased from 109.5 million to 114.7 million. The labor force in 2008 was 154 million. In order to compare apples to apples Mr. Barro should have assumed a labor force of 160 million. So now where do these 6 million workers go? I think most would agree they are discouraged workers, students, and full time parents. Inevitably they would be in the unemployed group. If we add in these workers the unemployment rate today increases to 13.1% and even under Mr. Barro's analysis it would be 10.7%.

Mr. Barro's magical 6.8%, is indeed a magical illusion. The government needs to tie in work and school programs for those wishing to receive unemployment compensation. Why not make them go back to school or work in community service programs. Mr. Barro is right, we should not pay people for doing nothing, but simply cutting unemployment compensation does not solve our unemployment problem. We need to find 21 million jobs (15 million that are unemployed and 6 million not in the labor force) or even if we minimized unemployment compensation like suggested our economy still needs to find 17 million new jobs.

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