From boom to bust …

The Sydney Morning Herald is running a series at present looking at the labour market prospects in the coming year. It is a welcome return of emphasis to the massive labour wastage that this country endures given that the major media has up until now largely bought the erroneous “we are at full employment” rhetoric pumped out by the previous federal government.

The story entitled Statistics point to hard time on job front, written by Andrew West and Jessica Irvine and published today (January 24, 2009) began with:

AS MANY as 2 million Australians could be jobless or working fewer hours than they would like by the next federal election – the highest rate of “labour wastage” in a generation …

An analysis by a leading labour economist, Professor Bill Mitchell of the University of Newcastle, predicts the total rate of labour wastage could rise to about 20 per cent of the workforce by mid-2010.

So I am now in the crystal ball gazing profession. There have been some who argue that economists are not doing anybody a service by publicly projecting bad outcomes over the next 12 months. I don’t share that view. If my research and my experience is worth anything then I am obliged to provide this “independent” information … given how much of the public debate is skewed by “business economists” working for banks etc who have clear vested interests in pushing the debate in a direction commensurate with the best interests of their corporate masters and also the politically-motivated and usually uninformed statements coming from the politicians of all persuasions.

Is 20 per cent being alarmist? I doubt it.  I constructed a graph to assist in understanding what happens during a major economic downturn, of the type that is clearly moving through the world economy.  Here it is:

The graph shows the official unemployment rate (UR) and the CofFEE Labour Market Indicators broad measure of labour underutlilisation (CU8) from their lowest respective values to their highest values during the 1982 and 1991 downturns compared to 2008. So the lower three lines are the UR and the upper three lines are the CU8 measures  (which are more accurate indicators of how much labour is being wasted).

The UR reached its lowest value of 5.5 per cent in 1981Q2 and then peaked 9 quarters later at 10.3 per cent in 1983Q3. It took until 2004Q2 to get back below 5.5 per cent. By comparison, the broader measure CU8 (which adds underemployment and hidden unemployment to official unemployment) went from 8.7 per cent to 16.5 per cent over the same 9 quarters.

In the 1991 recession, which was much longer and deeper, the UR went from 5.7 per cent to 10.8 per cent over 12 quarters, while CU8 went from 9.7 per cent to 19.3 per cent over the same period.  So the labour market deteriorated over 3 full years during this downturn.

One of the significant difference between the 1982 and 1991 episodes was the role that underemployment played. In the 1982 downturn, underemployment (UE) went from 1.4 per cent to 2.3 per cent. So while it was an issue the number of part-time workers who wanted to work more hours but couldn’t find the extra hours was relatively modest. However, in the 1991 downturn, a fundamental shift occurred in the labour market as employers scrapped full-time jobs rapidly and so began the sharp jump in underemployment. Over the 12 quarters that the labour market deteriorated, UE jumped from 2.2 per cent to 4.3 per cent. You can see that even in the recovery of the late 1980s, UE never really returned to its lower levels.

You will also notice that the UR reached similar levels in both the 1982 and 1991 recessions, the latter just being longer. The reason CU8 was higher in 1991 was the UE effect. This is likely to be must more significant in the coming downturn.

In the current period, with the labour market beginning to deteriorate, the UR has gone from its lowest value 4 per cent (February 2008) to 4.3 per cent (November 2008) and CU8 has climbed from 8.8 per cent to 9.3 per cent. UE has edged up from 3.7 per cent to 3.8 per cent.

You can see that while the UR hasn’t yet started its quick climb, CU8 is already tracking the 1982 levels and will go above them relatively soon. This is why I think UE will be a significant component of the labour underutilisation in the coming downturn.

Significantly, the so-called “full employment” era under the previous regime, still could only produce a labour market where at best 8.8 per cent of the willing workforce was underutilised. That is a long way from my definition of full employment.

The other point worth mentioning is that in the 1982 recession hidden unemployment went from a low of 1.8 per cent to a high of 4 per cent over the 9 quarters of deterioration. In 1991, over the 12 quarters, it went from 1.9 per cent to 4.2 per cent. Hidden unemployment occurs when workers become discouraged from the lack of job vacancies and give up looking for work. The Australian Bureau of Statistics then count them as not participating and so they do not enter the official unemployment statistics. However, if a job was offered to them they would immediately take it and be glad for it. In February 2008, CofFEE estimated hidden unemployment to be around 1.1 per cent and it had edged up to 1.2 per cent by November 2008.

What the graph shows is that the labour market deteriorates fairly quickly once things turn ugly. The current downturn in the world is looking to be very deep. Governments are still thinking that monetary policy will help solve it. It will not. Major fiscal expansion is required – a deficit in Australia upwards of 5-6 per cent of GDP will be required. More in other posts on this topic.

Further, this recession was instigated by a major financial crisis which has now spread to the real sector. The SMH article this morning quoted me as saying:

“This time we have a recession and a crisis in financial markets concurrently,” he said. “The slowdown in China is likely to make this coming recession a bigger world event than in 1991.”

We are entering this downturn with the UR a bit (but not much) lower than where we started out the previous recessions. Hidden unemployment is also a bit lower reflecting the strong positive participation effects of the growth period we have been through. However, underemployment is much higher and the industrial relations changes made under Workchoices, which unfairly shifted power to the employers, will ensure the acceleration of UE will be greater this time around.

So you put that together and a 20 per cent projection is reasonable. Neither conservative or “out there”. Recessions are major events and this one is looking to be one of the bigger variety.

The SMH article further says:

“The general rule to calculate the rate of labour wastage is to double the official rate of unemployment,” Professor Mitchell said.

Total labour wastage peaked at 19.3 per cent during the last recession. “This one could be a little bit better or a little bit worse but it will be very much in the same ballpark.”

Anyway, I will update the chart over the next few quarters and we will see where we get to.