The daily losses from unemployment

I have been doing some work again on the costs of unemployment and this blog gives a snapshot of part of that research. One of the strong empirical results that emerge from the Great Depression is that the job relief programs that the various governments implemented to try to attenuate the massive rise in unemployment were very beneficial. At that time, it was realised that having workers locked out of the production process because there were not enough private jobs being generated was not only irrational in terms of lost income but also caused society additional problems, such as rising crime rates. Direct job creation was a very effective way of attenuating these costs while the private sector regained its optimism. In fact, it took about 50 years or so for governments to abandon this way of thinking. Now we tolerate high levels of unemployment without a clear understanding of the magnitude of costs that that policy position imposes on specific individuals and society in general. The single most rational thing a government could do was to ensure that there were enough jobs to match the available labour force. Mostly, they fail badly to achieve this level of sophistication.

In the growth period before the current crisis few countries had returned to the full employment states that they achieved in the Post World War 2 period up until the mid-1970s when the OPEC oil shocks led to a paradigm change in macroeconomic policy setting. The neo-liberal approach emphasised fiscal austerity to support an increasing reliance on monetary policy for counter-stabilisation.

So already in this period of relatively better economic growth there were substantial losses being recorded both in terms of lost GDP (production and income foregone) and the additional personal and social costs that accompany persistent unemployment.

It is well documented that sustained unemployment imposes significant economic, personal and social costs that include:

• loss of current output;
• social exclusion and the loss of freedom;
• skill loss;
• psychological harm;
• ill health and reduced life expectancy;
• loss of motivation;
• the undermining of human relations and family life;
• racial and gender inequality; and
• loss of social values and responsibility.

These costs are enormous and dwarf the measures that various governments have come up with to estimate losses arising from so-called microeconomic inefficiencies (such as transport systems not running on time etc).

In the past I have done work on this with a colleague Martin Watts and you can see an early working paper (subsequently published but the working paper is free), which outlined the sort of method we used to compute the “costs of unemployment”.

Even before the crisis hit, these costs in most countries were huge and they are irretrievable every day that the economy remains above full employment. It shows the powerful hold that neo-liberal thinking has had on policy makers that these massive losses have largely been tolerated. Policy makers began using unemployment as a policy tool rather than a policy target as the obsession with inflation-targetting took hold.

To some extent these losses are a mystery to society in general. While the unemployed and their families are certainly aware of them, the remainder of the society are less aware. For example, we might notice rising crime rates in our neighbourhoods but do not associate it with unemployment.

Neo-liberalism has also changed the way we think about unemployment. In the past we understood clearly that it arose as a result of a shortage of jobs. In recent decades, we have been conditioned by a relentless (lying) press and government statements to perceive unemployment as an individual problem.

So the unemployed are lazy; have poor work attitudes; refuse to invest in appropriate skills; are subject to disincentives arising from misguided government welfare support, and all the rest of the arguments that mainstream uses to obfuscate the social problem. In Australia, this sort of “blame the victim” approach was accompanied by a new nomenclature that entered our daily public discourse and was promoted by government ministers including successive prime ministers.

We were told that the unemployed were bludgers, job snobs, cruisers and worse. Television current affairs programs targetted unemployed families and lured them into looking as though they didn’t want to work.

All of this despite the overwhelming evidence from studies in most countries that the unemployed were highly motivated to find work and were victims of a shortage of jobs.

The dominance of the neo-liberal ideology led governments in most countries to have eschew the adoption of policies of direct job creation to reduce the rate of unemployment and to minimise these massive costs. Fiscal policy became geared to the achievement of budget surpluses as some sort of token of prudent financial management.

Employment policy shifted from a demand-side emphasis to a supply-side focus (active labour market) which targetted individuals with futile training programs divorced from a paid-work context and pernicious welfare-to-work rules.

What was going on with respect to the deregulation of labour markets and the retrenchment of the Welfare State in the face of persistent unemployment was being mirrored in the approaches governments were taking to financial markets. The lack of oversight of the latter has been the fundamental reason we are now enduring the worst crisis from 80 years.

Given the costs of unemployment are so large and irretrievable, one would think that at the very least direct macroeconomic intervention should have been a priority in these years – that is, direct job creation.

In 1978 while still a student at the University of Melbourne and in recognition of the then rising economic and social costs of unemployment, I formulated an early model of what I now call the Job Guarantee approach to full employment.

The JG would work under the principles of a buffer stock mechanism and the jobs would be designed to increase per capita social welfare by satisfying social needs that are not met by the private sector in areas including environmental services, community and social services, health and education.

Thus this increase in public sector employment would contribute to the reduction in the negative externalities that tend to increase with increasing levels of production by increasing the share of final output that is associated with green, public sector employment.

With the current crisis, it should be clear to everyone that the neo-liberal construction of unemployment is (and always was) patently false – just an ideological gimmick to transfer power away from workers to ensure a greater share of national income was available for capital.

Now it is clear – 6 or so percent of the US labour force; or 10 per cent of the Spanish labour force; or 2 per cent of the Australian labour force didn’t suddenly get lazy; or were waylaid by government welfare benefits; or lost their skills – in the space of a year or so.

The crisis should make it obvious that unemployment arises when there are too few jobs being created (net) relative to the available labour force. There should be no mystery about that now for anyone.

But despite the transparency of the causes of mass unemployment governments have failed to use direct job creation as a way of dealing with the rising costs associated with the joblessness. The vestiges of neo-liberal ideology are proving hard to shake.

If governments had have had a Job Guarantee in place there would be hardly any discernible rise in official unemployment and the costs of the crisis would have been significantly reduced. Yes there would have been some skills-based structural underemployment (high skills workers taking Job Guarantee jobs) and some obvious loss of income.

But overall these losses would have been attenuated and some of the other costs would have been mostly negated. Of significance, which shows you how ideologically-blinded our policy makers have become – their budget deficits would not have risen by nearly as much as they have. While I don’t pay much attention to the actual budget deficit figure, you might have thought a government facing a chorus of squawking neo-liberal mouthpieces (the media) would have found the lower deficits to be something of a political advantage.

Anyway, today I was doing some updated calculations on the daily costs of persistent unemployment as a consequence of the economic crisis. In this blog, I will report some results for Australia and the USA.

While the previous work I have done on this topic has sought to compute the broadest possible measure of costs, in this blog I just focus on lost GDP income. T

In focusing on the foregone output resulting from unemployment and underemployment you have to decide a benchmark to measure the current situation against.

In the work that follows, I used the low-point unemployment rate prior to the crisis – for the US 4.5 per cent in March 2007 and Australia 4.0 per cent in March 2008 and the high-point participation rate prior to the crisis – 66.3 per cent for the US and 65.5 per cent for Australia.

The high-point participation rate allows us to adjust the labour force to eliminate the cyclical decline that occurs in a crisis as the discouraged workers who stop looking for work are not counted by the statistician as being unemployed. Economists call these people the hidden unemployed – they would work immediately if a job was offered to them.

The use of the low-point unemployment prior to the crisis is just a convenience and does not presupposes that this level was a full employment state. The question being asked is: What are the daily GDP losses arising from the increases in the unemployment rate as a result of the crisis?

For Australia, I also compute the daily GDP losses that arise from the economy being away from full employment (which I assume would occur at an unemployment rate of 2 per cent – the so-called frictional level of unemployment). So the question that is being asked then is: How has the divergence from full employment which has been exacerbated by the crisis impacted on daily GDP losses.

I also ignore underemployment in this analysis. So the estimates that follow are underestimating the true costs of the fiscal austerity. I use the term fiscal austerity because even though governments are running relatively large (historically) budget deficits as a proportion of GDP, they are still inadequate to effectively deal with the unemployment problem. The austerity reflects an overhang of the destructive neo-liberal ideology.

Method

First, I computed potential employment – so this can be computed as the employment level that would have existed given population growth had the crisis not occurred. In this way we fix the participation and unemployment rates at the peak of the last growth cycle as described above (we do this for the US and Australia).

Also for Australia, I computed the potential employment level which would exist if the unemployment rate was 2 per cent (that is, the full employment unemployment rate).

Second, I computed potential GDP using the potential employment levels multiplied by actual labour productivity (real GDP per person employed). So this series tells us what real GDP would have been if employment was at its potential level (defined above) and those workers were producing the average GDP per unit. Note that the concept of potential in this case does not mean the maximum GDP that could be produced.

Remember the selective way I am defining potential employment – as a departure from the maximum achieved prior to the crisis. For Australia the full employment employment potential is more accurately thought of as the highest employment level one could attain given other parameters.

Further, some will ask – why use average productivity when it is obvious that the unemployed are typically drawn from the lowest productivity pool? Surely putting these people back to work will not generate average productivity per person. That is true but not relevant in this case. By using actual labour productivity series I am actually understating the production gains that would occur.

Third, I calculated the daily real GDP losses in billions of dollars per day for the US and millions of dollars per day for Australia by dividing the gap between actual and potential real GDP by the number of days in each quarter.

This approximates the daily loss (never to be regained) in real income that is foregone by allowing unemployment to remain either above the level that was achieved immediately prior to the crisis (in US and Australia) or in the second case for Australia, by allowing unemployment to depart from its true full employment level of 2 per cent. The first estimates (deviations since the start of the crisis) understate the true costs by a greater margin than the second estimates for Australia (the departure from full employment).

Given the results are terrible as they stand and demand immediate policy attention, the fact the true results are in fact worse than these estimates just adds to culpability of our national governments.

Finally, I also computed as a standalone exercise a simulated real GDP series for the US and Australia based on the assumption that from the respective peaks (June 2008 for the US and September 2008 for Australia) real GDP continued to grow at the average rate of real GDP that had held for the 8 quarters prior to the peak – 2.4 per cent per annum for the US and 3.6 per cent for Australia.

These simulations converted into index numbers to allow for comparability are shown in the first graph below along with the actual path of real GDP for each country.

The comparison gives you a good idea of the relative depths of the crisis in each country.

Results

The following graph shows the indexed time series for actual real GDP and the simulated potential GDP (if potential employment was achieved) where the base = 100 was the GDP peak quarter (June 2008 for the US and September 2008 for Australia). The horizontal axis represents the quarters after the peak up until September 2009 (the last available national accounts data). The index numbers allow us to compare the evolution of the two economies.

So actual US real GDP went from 100 at the peak to 96.2 at the trough and in September 2009 was 96.7 (index number values). Over the same period, its potential GDP rose from 100 to 103 leaving a huge gap of 6.3 percentage points.

For Australia real GDP went from 100 at the peak to 99.1 at the trough and in September 2009 was 100.5 (index number values). Over the same period, its potential GDP rose from 100 to 103.7 leaving a smaller gap of 3.2 percentage points.

So the cumulative GDP losses have been much smaller in Australia’s case but still significant.

The daily GDP losses that the US economy is enduring as a result of the decline in economy activity below it previous peak are shown in the following graph. You can see that in the September quarter these stood at 10.3 billion per day.

Just say it to yourself – every day the US government is allowing $A10.3 billion to go down the drain in lost income just because they are too stupid to implement sensible direct job creation strategies.

There has been a marked unwillingness by the US government to engage in direct job creation. How can these deadweight daily losses be justified? The policy inaction is culpable in the extreme in this regard.

For Australia, I compared the daily losses that have occurred since the crisis began in Australia with the actual losses that have been on-going for some 35 years as a result of the contrived departure from full employment that has been imposed on us by the free-market ideological dominance?

One of the reasons I didn’t do this for the US is because I am less sure what the frictional unemployment rate is. The point is that it is probably below the 4.5 per cent benchmark I used so the daily losses I report are likely to seriously understate the actual losses.

There was also no point comparing the US and Australian losses in equivalent units because the relative costs for Australia are very small when you convert into billions of USD. But relative to each economy the respective losses are enormous.

The following Table shows the calculations. Relative to our recent best unemployment rate we are now losing $A74 million every day as a result of allowing the unemployment rate to rise. When considered against the current departure from true full employment unemployment rate (a 2 per cent) we are foregoing $147 million every day.

Just say it to yourself – every day we are throwing $A147 million down the drain because of our neo-liberal policy obsessions. No one in their right mind could justify that. It is the ultimate con of the mainstream economics profession.

The average daily loss since June 2006 as a result of the Australian government allowing unemployment to persist above the full employment level of 2 per cent was $A95.5 million.

Those losses are enormous and as noted above understate the true cost of the policy failure in allowing the unemployment rate to rise in the current crisis and also maintaining a fiscal regime that has stopped the economy achieving full employment.

The following graph shows the comparison for Australia (that is, just graphs the data in the Table above).

Conclusion

Even under conservative assumptions, the economic and social costs of sustained high unemployment are extremely high. The inability of unemployed individuals and their families to function in the market economy gives rise to many forms of social dysfunction, in addition to output loss.

The apparent failure of neo-liberal supply side policies to reduce unemployment prior to the crisis is now highlighted during the crisis. There is now an urgent need to address the large pools of unemployment in world economies.

The daily income losses alone are enormous and overwhelm other inefficiencies notwithstanding the productivity heterogeneity that exists across the workforce.

There is no financial reason why the government should not deal with this problem directly by introducing a Job Guarantee. If the Government had the political will, it could readily overcome the problem of persistently high unemployment.

Tomorrow – the Australian Labour Force survey for December comes out and so I will surely have something to say about that data.