The Daily Beast (I write a column for them, incidentally) has published an interview with the great Edmund Phelps, and I’m sorry to say that Phelps is convincingly pessimistic.
It would be a pipe dream to think we could get back to 4.5 percent unemployment such as we had in the middle years of the present decade. For some time, I thought of the middle 1990s as a kind of benchmark year that was normal for its time, when the unemployment rate was about 5.5 percent, but now we’ve got two fundamental reasons why we can’t even get back there. The first is that the financial sector and particularly the banking industry is in very bad shape. The balance sheets are very weak. They appear to be making a lot of profits these days, but it still is going to take years for them to build a strong equity position that will make them feel like taking on a lot of risk. The second problem is that households have lost a tremendous amount of housing wealth and the drop in housing prices is not going to be reversed. That was a bubble and I presume that the bubble won’t regrow, so consumer demand is going to be weak.
So will this decline in consumption lead to greater investment that will then fuel a rapid recovery? Well, no.
That’s what we always wanted a few years ago when we thought consumers were spending beyond their means and investors were being starved and growth was threatened. People were saying, “Look at China where they save so much,” etc., etc. But there are reasons why investment won’t rush in fully to crowd in and take the place of consumer demand. For one thing, it’s not a closed economy. Interest rates can fall only so much in the U.S. economy because we’re operating in the global economy and in much of the world, not only China and India, but maybe Latin America to some extent, things are not as bad. This means that the weakness of consumer demand to some extent is going to create a weakness, causing a net decline of employment that will weigh down total employment.
As far as policy responses, Phelps is skeptical about the wisdom of a third stimulus. He does, however, favor low-wage employment subsidies, an idea he brilliantly advanced in Rewarding Work: How to Restore Participation and Self-Help to Free Enterprise, easily one of the most convincing books I’ve ever read.
Some countries like France, Singapore, have instituted programs that pay employers for hanging on to employees, especially low-wage employees, so as to make employment higher than it otherwise would be. Singapore is having pretty good success with that program right now—output looks like it will fall by 9 percent but so far employment has held up. Why don’t we do that in the U.S.?
Note that this approach is exactly the opposite of raising the minimum wage in the middle of a catastrophic recession: rather than punishing employers for hiring workers with a marginal attachment to the overground laborforce, it rewards them for doing so.