The Corner

‘A Labor Market Stuck In The Mud’

The Grumpy Economist’s John Cochrane points to a striking chart from the Wall Street Journal. Here it is:

It’s from a piece from Ed Lazear called “The Hidden Jobless Disaster.” Here’s a tidbit:

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely… The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working. 

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That’s why jobs still seem so scarce. 

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards….

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago’s Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.

In other words, until now labor-force participation would increase as unemployment decreased, and government benefits may amplify this trend. Nobel laureate Ed Prescott’s research seems to suggest the same, even though he looks at the question of labor supply and incentive to work in a different context. In his famous 2004 paper “Why Do Americans Work So Much More Than Europeans?,” he shows that workers spend considerably more hours working when marginal tax rates on their incomes are lower. So basically, over time people reduce the number of hours they work, economic growth slows down, and less revenue is collected. But Prescott’s other big insight, as Garett Jones explained in this piece, is that a generous redistributive system makes it easier to reduce one’s labor supply. Jones writes:

Here’s the Wisdom of Prescott: If the government raises the tax rate on you and all of your friends, and then divides up all the tax revenue and dumps it from a helicopter, what do you get?  Well, none of the money gets wasted, so the tax hike doesn’t have a direct income effect (there’s a small indirect one I’ll ignore here). 

If the tax hike is used for pure redistribution from the “average person” back to the “average person,” then the tax hike doesn’t make the “average person” poorer: The government is taking money out of everyone’s right pocket and slipping it into their left.  
But if the income effect is gone, what’s left?  The disincentive to work: The pure substitution effect. 
Jones’s entire post is well worth reading, and so is Cochrane’s piece.
 

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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