From the November 2010 issue of Research Magazine • Subscribe!

Broken Jobs Machine

Why unemployment remains high.

In the early 1990s, when I was setting up the office of my consulting firm, we had a friend from Paris staying with us. He wanted to come along, so I took him to our local Staples, where I picked up some pens and paper, as well the cheapest desktop computer on the shelf. He helped me carry it into a room I rented in an office building — and there I was, in business.

Of course it required registering my business as a sole proprietorship, getting a business account at a bank and a few other minor things. Still, he was awed by the ease and simplicity of the process. In France, he averred, it probably would take years and involve considerable outlays. An entrepreneur would be required to shell out money to the government even before he earned his first franc.

Lack of red tape and a can-do, pro-business regulatory climate in the United States have been the envy of businesspeople everywhere. For decades, this environment has been credited with robust jobs creation, in a sharp contrast with Western Europe, where the labor market was mired in stagnation. Economic reformers there have been trying to emulate the American system.

But this economic cycle has been different — in fact, unique since World War II. When the recession came, jobs were shed with catastrophic speed, pushing the unemployment rate toward 10 percent within months. Not only millions of jobs were lost but, more to the point, the labor market uncharacteristically failed to come back in a recovery. The usual excuse — that employment is a lagging indicator and companies begin hiring only after a lag — no longer seems to apply. Why?

I see several snags in the U.S. labor market. First, the structure of employment has changed. In 1988, 18.3 percent of jobs were in manufacturing. Two decades later, at the start of 2008, the number of manufacturing jobs declined by one third, while their share in total employment fell to just over 10 percent. Manufacturing jobs were replaced by much fluffier service sector jobs. One great example is the number of registered realtors, which has rocketed over the past decade and now adds up to over 1.3 million — or nearly 1 percent of all U.S. jobs.

Many services, especially in once fast-growing industries such as leisure and hospitality, financial services and professional services, rely on consumers and businesses having a solid amount of discretionary cash. Such jobs were quickly shed in a recession and are having trouble coming back.
Moreover, the kind of manufacturing jobs that remain on these shores also present a problem. Any recession decimates manufacturing jobs, notably in durables and investment goods production.

However, people continue to purchase certain categories of basic consumer goods and smaller staple products even during severe recessions. Ironically, more jobs in the durable goods sector — notably in the auto industry — have been retained in the U.S., while consumer goods production has moved offshore. When investment came to a halt in 2008-2009 and the auto market fell off the cliff lots of manufacturing workers were fired.  

Even now, more than a year into a recovery and some renewed hiring by Detroit, manufacturing jobs make up less than 9 percent of total U.S. employment — a 10 percentage point drop in just two decades! Defense-related industries now seem to be the only manufacturing that is done in this country.

Cautious Companies

We know that taxes are bad for business. They penalize successful companies and siphon funds away from productive investments that create jobs. But governments are not the only economic actors who can take money out of businesses. Owners, too, can become too greedy, taking too much out of the business and reducing employment over the long run.

Ronald Reagan famously wanted to get government off businesses’ backs and there have been considerable strides in that direction over the past three decades. Taxes on corporate profits hovered around 35-40 percent through 2000, but measured only 24 percent in the second quarter of this year. Corporate profits, meanwhile, increased fivefold since the late 1980s, whereas GDP rose by only half as much during the same period. After-tax profits rose a portentous 6.66 times between 1989 and mid-2010.

Executives in large corporations are rewarded based on the performance of the share price of their companies and their wealth is locked in the shares of the companies they head. Companies that fail to show robust profits growth are penalized by Wall Street, sometimes severely. So it makes sense to cut costs and try to get as much as possible out of the existing workforce. Companies are now sitting on over $1 trillion in cash, an unprecedented amount, but it clearly makes more sense from their standpoint to distribute it to shareholders in the form of higher dividends or stock repurchases, thus raising share prices.

Since a low point in late 2008, profits of U.S. corporations have already increased by 80 percent. Needless to say, no similar rise has taken place in any other section of the economy.

Stagnant Government

The task of bailing out the labor market has fallen, ironically, to the world’s second largest debtor, the U.S. government. (The world’s largest debtor is currently the government of Japan). Federal, state and local government jobs held steady in the two decades to 2008, at around 16 percent of all employment. Not anymore. Government now accounts for 17 percent of U.S. employment, and climbing.

Wages in the public sector are also higher than in the private sector, and if fringe benefits are included, public sector employees earned more than one third more for working the same jobs that also exist in the private sector. While trade unions have been decimated in most private sector industries — except the auto industry, which is hardly a good advertisement for unionization — public sector jobs are more likely to be unionized. Overall, by some estimates public sector employees earn twice as much as private sector ones. Add to this 1.5 million active duty military personnel and some 850,000 reservists.

As Western Europeans found out at their own cost, public sector jobs are bad for overall employment, and not only because cozy government jobs, in which nothing is expected to be produced, sap the entrepreneurial spirit. In the private sector, higher productivity or a job well done may lead to higher wages and create additional jobs. If a waitress at a restaurant, for example provides good, courteous service, she is likely to make more money and, by attracting more customers, create a need for another employee. Nothing of the kind can happen in the public sector, which functions on a different principle.

The prevalence of the public sector is one way in which the U.S. is starting to resemble bad old Europe. There are others. America’s famed mobility, which allowed workers to get up and move to where the jobs were on offer in a continent-wide economy, has been curbed because of the housing crisis. People can’t sell their homes without taking a loss.

Worse, this economy perpetuates unemployment because it deprives young people and recent graduates of an ability to find a meaningful career job. Some economists estimate that it will take four or five years of job creation at a pace seen in the late 1990s to make up for all the jobs lost since the start of 2008. This will mean that the current batch of graduates will be a lost generation — by then employees will be hiring new graduates for entry level positions.

The waste associated with high youth unemployment is especially galling, because the innovative economy of the 1990s was driven largely by kids leaving colleges and joining the tech boom. Not surprisingly, it was a period that produced the fastest employment growth in recent decades.
Given the current structural rigidities, it is highly unlikely that jobs will come back all on their own. Solving this problem is crucial, and both the left and the right in the U.S. will need to set aside their ideological preconceptions to find a solution.

Alexei Bayer is an economist and author based in New York City.

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