Is high unemployment the 'new normal' even in a recovery?

McClatchy NewspapersJune 8, 2011 

WASHINGTON — A "new normal" is emerging for the U.S. jobs market, and a growing number of economists warn that it's likely to mean that unemployment will remain persistently high, at 7 percent or more, for years to come.

The 9.1 percent unemployment rate reported in May remains high by post-World War II standards long after the economy resumed growth following the worst recession in 70 years. It's prompting economists to rethink basic assumptions about the U.S. labor market.

At issue is what's called the "full employment" rate. It's generally thought to be the rate at which everybody willing and able to work can find a job. It's a theoretical "ideal" rate; "full" employment can't be zero because there'll always be people in transition between jobs, and others with disabilities or just plain lazy who'll be excluded from the workforce.

For much of the 1980s, the unemployment rate hovered between 6 percent and 7.5 percent. During the mid-1990s, the rate fell steadily to around what economists came to consider the rate of full employment — 5 percent. Anything above that would signal inefficiencies in the economy.

Then in 2000, the improbable happened. It hovered around 4 percent most of the year, then dipped to 3.9 percent during the final four months. Those numbers were stronger than most economists thought possible without triggering inflation.

Today perceptions are far different.

If the "new normal" means a full employment rate of 7 percent, that suggests a wide mismatch between available jobs and the skills that unemployed workers possess — construction workers lost jobs and don't qualify for ones in the booming health-services sector, for example. Economists call this a structural shift in the workforce, and a growing body of research increasingly suggests that's what's happening now.

"It just screams out that there has been a structural break. We try to make it more complicated than it is," said Mark Vitner, a senior economist with the Wells Fargo Securities Economics Group and author of a provocative report on the new normal in the labor market.

Vitner thinks the full employment rate is now around 7.1 percent, a figure he describes as conservative, meaning it could be even higher. The reason for his grim view is the bursting of the housing bubble. The jobs that fed into the boom in real estate amounted to an employment bubble.

These jobs include the construction sector, which lost at least 2.1 million jobs. It also includes the finance sector — sometimes dubbed FIRE for finance, insurance and real estate.

Construction employment peaked in 2006 and 2007, each year exceeding 7.6 million jobs, collapsing to 5.5 million jobs in 2010, the lowest since 1995. Similarly, financial sector employment peaked in 2006 and 2007 at 8.3 million jobs each year, tumbling to 7.6 million last year, the lowest since 1998.

To determine full employment, it's important know what's happening with gross domestic product_ the broadest measure of U.S. goods and services. Real GDP late last year rebounded to its pre-recession peak, an important sign of economic recovery. Employment lags behind economic growth, and that's the case now. But this time the lag is much longer than usual.

Using historical data about past economic recoveries, Vitner determined that the average difference between the jobless rate and the full employment rate when GDP has returned to a pre-recession peak is about 1.3 percentage points. When the U.S. economy passed its pre-recession GDP peak late last year, the difference between the unemployment rate and "full employment" was a whopping 4.6 percentage points.

"This is the largest gap ever recorded for this measurement, even surpassing the recovery following the 1981-1982 recession when the labor market experienced a sizable structural shift associated with the sharp decline in manufacturing employment, particularly in the steel and automotive sectors," Vitner wrote in his research report.

Vitner's is not an isolated view. Economists at Bank of America Merrill Lynch were among the first to notice the trend, referencing in several reports over the past few months that full employment is likely now in the ballpark of 7 percent.

"We do think that we have a structural unemployment rate that's going to be 6.5 percent to 7 percent for a while. ... It will be a number of years before it is meaningfully lower," Michael Hanson, a BofA Merrill Lynch economist, said in an interview.

In an Atlanta speech on Tuesday, Federal Reserve Chairman Ben Bernanke made it clear that the U.S. labor market is clearly impaired.

"Particularly concerning is the very high level of long-term unemployment_ nearly half of the unemployed have been jobless for more than six months. People without work for long periods can find it increasingly difficult to obtain a job comparable to their previous one, as their skills tend to deteriorate over time, and as employers are often reluctant to hire the long-term unemployed," Bernanke said. He was referring to the 6.2 million Americans who in May reported that they had been out of work half a year or longer. They make up 45.1 percent of the unemployed.

Others in the Fed are looking at full employment. In a Feb. 14 economic paper titled "What is the New Normal Unemployment Rate," the Federal Reserve Bank of San Francisco concluded that full employment is now higher than its historical assumption of 4.8 percent to 5 percent.

"An examination of alternative measures of labor market conditions suggests that the 'normal' unemployment rate may have risen as much as 1.7 percentage points to about 6.7 percent, although much of this increase is likely to prove temporary," the San Francisco Reserve Bank economists concluded. "Even with such an increase, sizable labor market slack is expected to persist for years."

The bank's conclusion comes from observations of the so-called Beveridge Curve. This financial indicator plots the relationship between unemployment and job vacancies. When the economy is expanding well, the jobless rate is low and job vacancy rates are high. It's hard to find workers because they are in such high demand.

Likewise, during a downturn, the reverse is true. Job openings are few and far between, yet the jobless rate is high.

Since about April 2010, however, the Beveridge Curve shows something strange. The number of jobs openings is unusually high, but so is the unemployment rate.

To many economists, this indicates a structural mismatch. The skills possessed by today's workers aren't the ones being sought by employers.

"The construction, finance and real estate sectors have shrunk after the bursting of the housing bubble and the subsequent financial crisis. The skills of workers who used to be employed in those sectors may not be easily transferable to growing sectors such as education and health care," the Fed economists theorized. They added that extension of unemployment insurance to 99 weeks during the recession may have led to an erosion of skills and played a role in the trend too.

Still, the San Francisco Fed report concluded that there is "mounting evidence" of structural unemployment that will leave the jobless rate higher than previously was normal for a long time.

ON THE WEB

Wells Fargo report: "Cyclical vs. Structural Unemployment:The Debate Rages On"

San Francisco Fed report

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