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In the Nation's Interest

Jobless Recovery Is Not The Problem

The concerns about a jobless recovery are fully understandable but do not get to the heart of the problem. Of course we should help the part of the workforce that is unnecessarily unemployed because of the shameful mistakes of our financial sector. This piece is not about how we do that. This piece is about why in our current situation, the jobless recovery is better than the alternative, which is a recovery without productivity growth. It is also about the fundamental forces that are preventing us from returning to full employment.

A jobless recovery implies immediately that productivity is growing. That means that we are increasing the amount of goods and services we produce without adding back the working hours we lost during the recession. Work is being reorganized and performed more efficiently. That means that when, or if, our economy gets back to full employment, it will be at a different place from where it was when we entered the recession. We will have higher total income per hour worked.

You might say however, we would prefer a third alternative, Germany. Germany came through the recession without a significant increase in unemployment. It did so by retaining its work force in place even though the demand for goods and services dropped significantly. That means of course, that its productivity dropped at the same rate as demand. With the recovery, its productivity has also increased as the production of goods and services has increased. So Germany ends up now at about the same place it was before the recession. The same is true for France and Japan (pre-tsunami).

According to The Economist, labor productivity in the U.S. and Germany peaked in the first half of 2008. Between then and the bottom of the recession in 2009, productivity declined by 6% in Germany, but by only 1% in the U.S. Then from the bottom of the recession to the end of 2010, productivity increased by 4% in Germany and by 7% in the U.S. Thus from the beginning of the recession to the end of 2010, productivity declined by 3% in Germany, but increased by 6% in the U.S. The U.S. economy has been restructuring; the German economy has not.

However, the question remains: will the U.S. ever return to full employment? There are no guarantees here.

Unemployment is frustrating because the private sector does not manage employment directly. The private sector reacts to the potential for providing more goods and services by creating new capacity by investing in plant and equipment and hiring additional workers. Part of the investment decision is how the mix of plant, equipment, and new workers will be organized into a process for the production of additional goods and services. The number of new workers needed is thus determined by the amount of additional goods and services to be produced and the way the work is organized.

Work is continually being organized more efficiently. Competitive pressure for capturing market share forces this behavior. It is the creative destruction process that has generated ever-increasing standards of living in the advanced economies. So it's possible that this increasing efficiency could mean that no new workers were needed to satisfy the private sector's judgment about the potential for the production of new goods and services.

Our situation may be close to these conditions right now. So we turn to government to fix the problem. However, the only near term way the government can create jobs is to hire people directly itself, such as Census workers, or give money to others to spend on such things as building roads and bridges. Politically, and possibly from a creditworthiness point of view, we have reached the limit for using these methods.

So we come back to the private sector for a solution. We cannot expect the private sector to decide to slow down its rate of efficiency improvement. So we're left with the private sector's judgment about the potential for producing profitably new goods and services. What could be holding back the decisions to produce more goods and services?

First of all, there's the trauma from the financial crisis. All private parties in this economy, both households and firms, should have learned that they need to be more conservative in their financial planning to allow for massive screw-ups like the one inflicted by our financial institutions. In fact, it seems these screw-ups are a necessary part of our high performing market economy. Government regulators can not be smart enough to foresee them and prevent them. So we all, households and firms, need more readily accessible liquid assets to see us through such a crisis. We need less debt and more cash. Households and firms have been moving in this direction. It is the widely understood deleveraging process.

During this process, households and firms will be saving more and spending less on goods and services. Thus while this process is going on, the private sector will judge that the potential for producing more goods and services is diminished, and they are right.

However, increasing the safety margin by deleveraging is a one-time step. After the increased cushion is achieved, no additional savings are needed. At that point, demand for goods and services should increase. There should be better analysis from the economics world about how far we are through this process. My guess is we still have some ways to go.

Even after demand picks up again, we have to reallocate the workers laid off during the recession and the organizational restructurings to other parts of our economy. This is especially acute for construction because construction skills are specific and have been relatively high paid. The retraining process and the adjustment to lower wage rates will take some time.

All these factors suggest that we will get through the aftershocks of the financial crisis sooner or later and be back on the way to full employment. However, there is another problem of increasing importance everyday. That is the problem of the Federal government's inability to manage its own financial affairs. This problem is compounded at the local level by such states as California. The diminished creditworthiness of government, as officially recognized by Standard & Poor's, Moody's, and Fitch, causes households and firms to conclude they need even larger safety margins. This postpones the day when production of goods and services will return to full potential and we reach full employment.

So rather than politicians commiserating so much with us about a jobless recovery, they should make decisions about how we are going to get government finances in order. That is the problem.

William Lewis is a Trustee of the Committee for Economic Development and the Founding Director of the McKinsey Global Institute. The views in this article are solely the author's.