The jobs crisis is not just about demand

Recessions are times when there is too little demand for the products of businesses, and so they fail to employ all those who want to work. That the problem in a period of high unemployment like the present one is a lack of business demand for employees not any lack of desire to work is all but self-evident. It is demonstrated by the observations that (i)the propensity of workers to quit jobs and the level of job openings are at near-record low levels; (ii) rises in nonemployment have taken place among essentially all demographic skill and education groups; and (iii) rising rates of profit and falling rates of wage growth suggest that it is employers, not workers, who have the power in almost every market.

The jobs crisis, Larry Summers, Reuters

Here, here. I agree with Larry Summers that a shortfall in demand is creating a US jobs crisis. However, I don’t agree with the thrust of his blog post that there is any magic in the concept that a “lack of demand is the fundamental cause of economies producing below their potential”.

Take a look at this chart and tell me what you see?

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Here’s what I see. I see two economies in the Netherlands and Germany where there was no housing bubble and unemployment had risen during the global recession but not by mind-bending amounts. Then I see four other economies wracked by massive housing bubbles in Ireland, Spain, the UK and Latvia where unemployment had skyrocketed.

Moreover, Britain has seen the most muted rise in unemployment amongst the bubble economies, presumably because it is a monetarily and fiscally sovereign nation that can use these tools to address shortfalls in demand and cushion the downturn.

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Every single economy that has had a housing bubble has seen a massive rise in unemployment. That speaks to the destruction of credit bubbles. It’s not just about demand.

Here are another chart from the FT. Take a look and tell me what you see.

Here’s my question: if the jobs crisis is only about demand, why does the US have the G-6’s highest relative post-GDP numbers? It doesn’t look like a shortfall in demand is driving the unemployment increase differentials in those economies since the US has the highest relative post-recession GDP (see Chart of the Day: How Deep Was Your Recession?)

Again, while demand is the key factor holding back employment growth, it seems these charts are telling a story of structural issues holding back that demand. To my mind, these charts speak to the over-riding importance of high private sector debt and deleveraging after a credit bubble. This has not been a garden-variety recession.

"it’s the debt, stupid." When aggregate debt levels build up across business cycles, economists focused on managing within business cycles miss the key ingredient that leads to systemic crisis. It should be expected that politicians or private sector participants worried about the day-to-day exhibit short-termism. But [former BIS head William] White says it is particularly troubling that economists and their models exhibit the same tendency because it means there is no long-term oriented systemic counterweight guiding the economy.

This short-termism that White refers to is what I call the asset-based economic model. And, quite frankly, it works – especially when interest rates are declining as they have over the past quarter century. The problem, however, is that you reach a critical state when the accumulation of debt and the misallocation of resources is so large that the same old policies just don’t work anymore. And that’s when the next crisis occurs.

The origins of the next crisis

If the US wants job growth, it will need to reduce private sector debt levels – and that takes time. It does not follow “that the central objective of national economic policy until sustained recovery is firmly established must be increasing… borrowing and lending,” as Larry Summers asserts. The government can act as a counterweight to the demand drag but I am very sceptical of claims like Summers’ that doing so would solve a jobs crisis borne out of a debt crisis.

Source (EU unemployment graph): Google

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31 Comments
  1. Richard Rosso says

    Well, this is so true however this to me is the primary reason there’s a problem with aggregate demand.

  2. Richard Rosso says

    Household deleveraging is headed in the right direction but quite frankly I thought we would be further ahead. I was surprised the savings rate remains stuck at 4.9%. I believed we would be closer to 7% by now but then I realized the poor state of jobs and wages drags on our abilities to aggressively pay down debt or increase savings rate dramatically. My thought is households will be much closer to healthier debt ratios once savings hits double digits again. It could happen..Great stuff this morning Edward thanks for keeping my brain going.

    1. David Lazarus says

      You also need to consider the fact that the savings rate is the aggregate savings. The rich who probably lost most in the staock market crash probably saved more initially and so made up much of the increase. They may have stopped saving as their savings have recovered to a level that they are happy at. For the majority they may have had very little in the way of savings to start with, and with the non stop squeeze on incomes for the last thirty years they probably have not added anything to their savings. if there was wage growth then their could be decent savings that does not endanger the economy.

  3. Richard Rosso says

    How do you get this stuff out so fast? You’re amazing lol

  4. Tschäff Reisberg says

    How does this square with the debt service ratios being back to 1997 levels http://www.federalreserve.gov/releases/housedebt/

    1. Edward Harrison says

      Debt service is a poor reflection of debt stress in my view. You need to also look at aggregate debt/income and debt/GDP ratios. See here: http://pro.creditwritedowns.com/2009/12/on-the-sovereign-debt-crisis-and-the-debt-servicing-cost-mentality.html

      1. David Lazarus says

        The problem is that no one was while everything was going well. There are two other aspects that your post on debt servicing mentality did not cover and one was that taxes also played a huge part in the problem. Capital Gains Tax on your main residence is zero in the UK so when we had the MP’s expense scandal a large number of MP’s been manipulating the system to get tax free gains. Many buy to let investors also did this. Tax free gains were the additional element that sparked the boom in the UK, especially after the lax returns in the stock market.

        If you also factor in the impact of low interest rates on annuity returns and you can see that they are creating a pensions problem at the same time, as well as not encouraging a rebalancing of the economy. Individuals need to save much more in the west, and this means much lower consumption. Which the government should make up with deficit spending on investment projects. The problem with this is that the UK government has already drained the budgets for future investment with PFI and other off balance sheet vehicles.

    2. Edward Harrison says

      Jeff, also remember that economies and markets tend to overshoot in both directions. That means we should fully expect debt servicing AND debt/income ratios to even better than average as the psychology changes to the balance sheet recession mode

  5. Thurston Howell III says

    What do you think about people like Rush Limbaugh and others who trash any Obama proposal regardless of it’s merits. Don’t they drive the market psychology to some degree?

    1. Edward Harrison says

      Thurston, sure, but only for people who are politically/philosophically pre-disposed to that particular messaging. If people have jobs and rising income, they cut leaders a lot more slack.

      1. Thurston Howell III says

        Edward, I really wonder about that. To me it seems they have a philosophical or ideological mindset that ignores facts, economic well being, and a number of other relevant factors.

      2. Thurston Howell III says

        Don’t you think that people who are pre-disposed to this thinking affect the economy?

        1. Edward Harrison says

          Thurston, they do affect the economy, sure. And this cherry picking, ignoring of facts is bi-partisan because confirmation bias is hard-wired in humans: http://pro.creditwritedowns.com/2011/05/how-political-bias-alters-economic-understanding.html

          1. Thurston Howell III says

            Yes , I read that and I agree.

  6. Richard Rosso says

    I’m with Edward 1). We will overshoot to be better than average but it will take time 2). During better times of higher wages, gainful employment people will cut leaders much more slack and those leaders will not affect the psyche as dramatically. Those who are pre-disposed to radical right or left leaning media are going to vocalize respective messages passionately regardless of the economic conditions.

  7. Richard Rosso says

    That’s part of my belief as to why the savings rate will eventually exceed early to mid 1980’s levels

  8. Thurston Howell III says

    I really believe that media messages have adversely effected the psychology of saving for decades. Recall when you got 5 credit card offers in the mail daily?

  9. Tschäff Reisberg says

    Corporate propaganda machine vs personal memories of the great recession.. Who will win the heavyweight title? I’m betting we’ll continue to be a nation of spenders if consumer confidence gets a boost.

    If saving rates continue to be high we’ll need to transform this economy so that it doesn’t depend on consumer spending for jobs. That means legislating paid vacation days and/or job guarantee and/or a massive effort to achieve something great like getting gasoline out of cars and trucks in ten years.

    1. Thurston Howell III says

      I’m betting on propaganda. Good propaganda always wins. And when you control the outlets that distribute propaganda, how can you not win? As Edward inferred but in a much more sophisticated and less blunt manner. ” People are sheep” they are willing to be lead by messages that support their biases.

  10. Tschäff Reisberg says

    People of all incomes now spend an enormous fraction of their day plugged in to some connectivity device. They are relatively inexpensive and don’t take a great deal of the labor force to produce. It’s possible that national consumption patterns will change as a result especially as these devices become more addictive.

  11. Roger Malcolm says

    I do not understand your disagreement.

    Deleveraging by the private sector would be demand reduction by definition, no? And the greater the credit bubble, the greater that reduction. So the two go hand in hand to me.

    And if you want to increase private sector savings/reduce private sector debt, then you need to increase government debt and/or an increase exports relative to imports.

    1. Edward Harrison says

      What Summers is saying is that: “the central objective of national economic policy until sustained recovery is firmly established must be increasing… borrowing and lending” and by that I understand him to be saying that we want to releverage the private sector. I vehemently reject that as the central objective of national economic policy. What we want is deleveraging in the private sector – and to the degree the shortfall in demand that creates can be counteracted via fiscal policy, that is the purpose of stimulus.

  12. Roger Malcolm says

    I do not understand your disagreement.

    Deleveraging by the private sector would be demand reduction by definition, no? And the greater the credit bubble, the greater that reduction. So the two go hand in hand to me.

    And if you want to increase private sector savings/reduce private sector debt, then you need to increase government debt and/or an increase exports relative to imports.

    1. Edward Harrison says

      What Summers is saying is that: “the central objective of national economic policy until sustained recovery is firmly established must be increasing… borrowing and lending” and by that I understand him to be saying that we want to releverage the private sector. I vehemently reject that as the central objective of national economic policy. What we want is deleveraging in the private sector – and to the degree the shortfall in demand that creates can be counteracted via fiscal policy, that is the purpose of stimulus.

  13. DavidLazarusUK says

    The problem is that if the private sector wants to delever then the public sector has to increase that debt to allow them to do so. A public works progam allows everyone to reduce debts to a level that they can manage. That fact has been lost on the austerity brigade. If austerity is the order everywhere then it means that the debt burden becomes worse. Look at Ireland to see that effect. The government cut spending as did everyone else forcing losses on the banks. If the US tries that now then those just holding on will soon find it better to default, imposing losses on the banks. 

  14. Anonymous says

    The problem is that if the private sector wants to delever then the public sector has to increase that debt to allow them to do so. A public works progam allows everyone to reduce debts to a level that they can manage. That fact has been lost on the austerity brigade. If austerity is the order everywhere then it means that the debt burden becomes worse. Look at Ireland to see that effect. The government cut spending as did everyone else forcing losses on the banks. If the US tries that now then those just holding on will soon find it better to default, imposing losses on the banks. 

  15. Anonymous says

    There is another reason why Netherland’s and Germany’s unemployment rates are so low. It’s called job sharing. Workers agree to work fewer hours and share the cost with employers and the Governments rather than face layoffs. It’s a policy that’s been adopted by both of these two states since the crisis.

    1. Edward Harrison says

      The Netherlands has had this system in place for quite a while. It was a major factor in their declining unemployment rate before the downturn. Within the Netherlands, it was the subject of some controversy because some felt these were not ‘real jobs’. But, the downturn has validated this approach as a counter-cyclical economic stabilizer.

      My understanding is that the Germans saw the success in the Netherlands and decided to take the same approach – to good effect. 

  16. Anonymous says

    There is another reason why Netherland’s and Germany’s unemployment rates are so low. It’s called job sharing. Workers agree to work fewer hours and share the cost with employers and the Governments rather than face layoffs. It’s a policy that’s been adopted by both of these two states since the crisis.

    1. Edward Harrison says

      The Netherlands has had this system in place for quite a while. It was a major factor in their declining unemployment rate before the downturn. Within the Netherlands, it was the subject of some controversy because some felt these were not ‘real jobs’. But, the downturn has validated this approach as a counter-cyclical economic stabilizer.

      My understanding is that the Germans saw the success in the Netherlands and decided to take the same approach – to good effect. 

  17. Thurston Howell III says

    But people choose meeting in accordance with their biases.

  18. My previous post should have read: People choose Media in alignment with their biases. Sorry for the confusion.

  19. Credit Writedowns says

    Stephen Roach: America is a Zombie Nation just like Japan | Money News Link – Sharing real information to help you make real money. says
    […] -The jobs cri&#115&#105&#115 is not just about demand, Jun 2011 […]

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