Inequality and unemployment: is there really a connection?

Lately I’ve been thinking about the connection between income distribution and unemployment, and I’ve started to question the prominent view among left-leaning economists that full employment is necessary to reduce income gaps.  Their argument is simple and understandable: during periods of high unemployment, workers’ bargaining power are reduced as there is a vast supply of workers willing to work at lower wages.  As a result, wages stagnate or decline among low and middle-skilled workers, while the owners of capital reap large profits.  Ok, that makes sense.  But take a look at the following two standard measures of income inequality and unemployment:

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Notice something?  There seems to be little, if any, correlation between income inequality and unemployment.  The current standard definition of “full employment” among economists is an unemployment rate of between 5-5.5%.  Repeatedly during the past 30 years, the unemployment rate has dipped below this figure (indicating an economy operating at or above potential); yet the Gini coefficient continued its upward march.

Perhaps full employment is one of several different prerequisites for a narrowing of the income gap, assuming that is even a desirable policy goal.  However, I question the idea that it is an essential method to do so.

Another interesting (albeit flawed) view of the “recovery”

This graphic (courtesy of the Economic Policy Institute) shows the employment/population ratio since just before the Great Recession started. Interestingly, although the official U2 unemployment rate has fallen to 6.7% from a peak of 10% in late 2009, the E/P ratio has barely budged since the end of the recession, indicating we have a long way to go before we reach pre-recession levels of “employment saturation”. This indicates that much of the fall in U2 has been due to people exiting the labor force, not actual employment gains. However, even the arguably more reliable E/P ratio is misleading; after all, the baby boomers have begun to retire, naturally putting downward pressure on the ratio. It seems that no matter which measure we choose it is hard to find one that accurately reflects the state of the labor market.

Long-Term Economic Cycles

Here’s a blog post I wrote last summer (with the only caveats that I had no blog and thus no where to post).  Enjoy…

George Friedman, in one of my favorite books entitled “The Next 100 Years: A Forecast for the 21st Century” intrigued me by noting a historic pattern he had observed: Every 50 years, the US goes through a major economic/political cycle. For example, during the Great Depression, public policy turned towards stimulating consumption of the lower and middle classes. To correct inadequate demand while taxing the upper classes to contain investment and excess supply. This coincided with a shift in political power towards the urban working class. However, by the 1970s,
There was excess demand in the economy, and supply was being constrained as years of high taxes and overregulation resulted in inadequate investment and a depleted capital stock, lowering productivity and supply increases. This crisis instigated the next cyclical shift in the early 1980s (50 years after the 1930s cycle began), in which taxes and regulations were cut to boost supply, and political power shifted to the suburbs and away from the urban areas.

In my view, while I agree with Friedman that this shift resulted in a new surge in productivity and efficiency, supply again outstripped demand and sowed the seeds for the Great Recession.
As surplus capital accumulated, much of it was used to sustain the borrowing of the lower and middle classes, temporarily sustaining their consumption (as income growth was inadequate for them). Eventually, the bubble popped, and now demand is severely inadequate relative to supply. According to Friedman’s theory, sometime in the 2030s the US will experience another shift. What will this shift be, though? For although this past cycle seems to have undoubtedly favored capital over labor and supply over demand, it did not completely neglect demand; rather, it sought to prop up demand unsustainably. This calls into question current US economic policies. Right now, the US is undertaking an extremely expansionary monetary policy
and a contractionary fiscal policy. Many Keynesian economists want both to be expansionary. However, will higher government spending and, especially, lower interest rates really help to create sustainable demand in the US economy? The latter is meant to encourage borrowing, consumption (and theoretically investment). However, it was heavy borrowing that got the middle and lower classes into the conundrum they, and the entire economy, face today. Household debt is beginning to increase again after years of deleveraging, a deleveraging that, while significant, still left household balance sheets far from repair. Meanwhile, higher government spending could temporarily help prop up demand, but by putting upward pressure on debt to gdp ratios, it seems unsustainable and a risky endeavor to rely on for economic recovery. As for the neoliberal solution of contracting both monetary policy and fiscal policy, such actions will almost surely depress demand even further (at least temporarily).

I believe ultimately that this crisis is a function of diverging productivity levels for different groups of the population. Higher skilled workers have an inherent financial advantage in our increasingly globalized economy; further compounding their advantage was their lack of supply relative to demand, increasing their price. Meanwhile, an oversupply of less skilled workers (who inherently have less of a financial advantage to begin with due to lower productivity) constrained their price. This has resulted in widespread inequality. Our failure as a nation to convert these less skilled workers to higher skilled workers has resulted in insufficient income to support demand.

Overcoming the Tyranny of Entrenched Patterns

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Lately I’ve been thinking a lot about the inability for some aspects of human society to change – whether it has to do with culture, societal norms, the economy, etc.  We always think of the human species as adaptable – and we are, to an extent – but really, we adapt only when we have no other choice.

Personally, I have had no shortage of instances where have remained stubbornly un-adaptable.  For example, for years I have consistently told myself that I should exercise more.  Exercise begets both good health and a happier mood in the long-term – benefits that clearly outweigh the short-term “benefits” of slothness.  Yet, every day, year after year, I never set aside the time – at least, not on a regular basis – to establish a consistent exercise routine.  This pattern of procrastination and non-adaptation is even evident on this very blog (you’ll notice that, thus far, I generally post only once every couple of weeks, a pattern I am desperately trying to break).

Why is it so difficult for us humans to adapt?  Habits make us practice the status quo.  Consistent practice, in turn, makes it far easier for humans to resort to the status quo rather than trying something new.  Additionally, the environments we choose to live in tend to reinforce the status quo, making it difficult to change behaviors easily.  For example: the environment I live in naturally contains several people who are almost exactly like me, especially when it comes to a lack of consistent exercise.  Even if I wanted to exercise, the people in my life a) give me no competitive urge to exercise b) oftentimes will not go with me to exercise, as their lifestyles are also structured in a way that emphasizes other activities c) the status quo environment provide makes it difficult for them to have the will to exercise/actually exercise, reinforcing my lack of will to exercise/actually exercise.  It is a vicious cycle.  Not that any of this is an excuse for my laziness; I alone am responsible for that.  But the environment I live in certainly does not help.

This lack of adaptability can easily be identified in several economic and overarching social patterns.  For example, think about a scenario of economic recession.  Aggregate demand is declining, and to maintain profits businesses must reduce output and cut costs.  This cost cutting can take many forms, but the focus is usually on two aspects of labor: wages or employment.  In other words, an employer can either lower wages or shrink payrolls to cut costs and remain profitable.  Although both occur, the emphasis tends to be to shrink payrolls.  Why?  One explanation is, culturally, it has always been this way, making a change in behavior more foreign and difficult.  Another is that everyone expects businesses to act this way; their is an expectation that wages remain stable (or, better yet, increase) for the vast majority of employees.  As a result, during recessions, we tend to see shrinking payrolls as opposed to wage cuts (side note: could this actually be increasing income inequality? if wage cuts were pursued, employees would be poorer but everyone would at least have income; however, with payroll cuts, some former employees suddenly receive an income of $0 while the remaining employees continue to receive income; the latter scenario creates a wider income gap, at least within a business).  The question is, to what extent are businesses caving into societal pressure and pre-existing patterns of operation as opposed to sound business/economic practice?

Entrenched patterns also bedevil the consumer.  Think about how people go grocery shopping.  They tend to always go to the same place/places, right?  Over time, this doesn’t really change, even if it would eventually make slightly better economic sense to start buying groceries at Walmart as opposed to a local mom-and-pop store.  Even if we begin our grocery-shopping lives initially by looking at price differentials, we tend to choose places to shop for groceries based on the locations we know and the patterns of grocery shopping of people we know.  As time goes on, shopping at that particular location becomes an entrenched routine in our lives.  Even if it the cost differences between two locations become substantial, we often will still choose the more expensive location just because it is what we are used to; it’s what we know.  Our shopping decisions will change eventually when the cost becomes large enough, but not in time for our change to be reasonably considered “adaptable”.  Something that normally would be a generally competitive market – similar goods offered, few barriers to entry, etc. – has less competitiveness than meets the eye.

Patterns aren’t necessarily a bad thing – they can be good if they promote something that truly is superior.  However, patterns have a tendency to become too entrenched, entrenched in a way that is often a detriment to ourselves and society.  We humans must have the will to adapt when necessary – even when the short-term pain of doing so is severe.  Otherwise, the comfortable little world we create will doom us to long-run failure.

2014: What to Expect

So, it’s 2014 now.  What should we expect in this cycle around the sun?

  • Faster economic growth, but not much faster.  Since 2009, American annual economic output growth has limped along at around 2% annually.  With household balance sheets restored, consumer spending should pick up modestly, boosting GDP growth.  A continuing resurgence in the housing and stock markets should also help lift consumer spending via the “wealth effect”.  Additionally, a long-awaited European recovery from its double-dip recession and higher growth in developed countries should boost US exports, also lifting GDP growth.  Government policy should also be more friendly to growth; local and state governments are finally beginning to benefit from higher tax revenues, and most fiscal adjustment programs have been completed.  At the same time, expect uncertainty and premium spikes due to the rollout of ObamaCare to act as a modest restraint on growth and hiring.
  • Continued (perhaps accelerated) increases in interest rates w/low inflation.  Since May 2013, treasury yields have largely bottomed out and have begun a modest recovery, putting upward pressure on interest rates economy-wide.  Expect this to continued as growth continues and the Fed prepares to further “taper” its quantitative easing (QE) program.  Considering how much “slack” remains in the economy (gap between actual output and potential output), however, expect inflation to remain low.
  • Spring or August stock market correction?  The stock market posted some of its best gains since the boom of the late 90’s last year, despite an economy that is still widely considered to be weak.  This is unsustainable.  Though corporate profits are at record highs, I believe investors are overestimating the earnings potential of companies – expect a minor stock market correction in mid-2014.
  • Small increases in the trade deficit.  Rising interest rates generally put upward pressure on the value of the dollar/are a reflection of a higher dollar value.  A stronger dollar increases the purchasing power of consumers and makes goods produced in other countries relatively more affordable.  Combine this with my expectation of stronger consumer spending in general to get my expectation of import growth exceeding export growth, widening the balance-of-payments deficit marginally.
  • Continued pickup in job creation.  Faster economic growth and reduced ability of employers to boost productivity much more in the short-term should encourage faster hiring, though the jobs created will likely remain exclusively low-skilled low-pay or high-skilled high-pay, reflecting a continuation of decades-long trends in the American labor market.

Like the forecasters, for 2014 I am optimistic; as for the rest of the middle of the decade, not so much.  We’re overdue for another recession.  I’m thinking 2016?

That’s all I’ll write for now.