Abstract

The unemployment rate in America jumped from 4.9 percent in late 2007 to 10 percent in November this year. The conventional wisdom that unemployment is rising because more people are losing their jobs is only partly true. Job-loss rates have increased, but the largest force driving unemployment is the sharp drop in private-sector job creation. The massive stimulus bill championed by President Obama did nothing to “create or save” millions of jobs. Heritage Foundation labor-policy expert James Sherk explains why any “jobs bill” that relies on govern­ment spending without improving the investment and entrepreneurship climate will fail.

Despite assurances that the $787 billion stimulus bill would “create or save” millions of jobs, the unemployment rate has risen to 10 percent since it became law in February 2009. Members of Congress need to understand that sharply lower job creation has driven the largest part of this rise in unemployment. Businesses and entrepreneurs have cut back on investment, and are creating fewer job opportunities for unemployed workers. Any proposed “jobs bill” that relies on government spending without improving the climate for investment and entrepreneurship will fail.

Rising Unemployment

Since the recession began almost two years ago, unemployment has more than doubled, rising from 4.9 percent in December 2007 to 10 percent in November 2009. This rising unemployment was the justification for the massive stimulus package Congress passed early this year. President Barack Obama promised that the stimulus package he signed would “create or save” 3.5 million jobs. His economic advisers warned that unemployment would rise to 9 percent by 2010 if Congress did not pass the stimulus bill, but that with the stimulus, unemployment would stay below 8 percent.

Instead, unemployment has risen above the Administration’s projections. Chart 1 shows the unemployment rates that the White House predicted would occur depending on whether Congress passed the stimulus, along with the actual unemployment rate since then. The number of Americans without jobs is now higher than that which the White House predicted if Congress were to do nothing. By the President’s own measures, the stimulus has failed

Unemployment Spikes: Blame Layoffs

Much of the media coverage of the rising unem­ployment rate during the recession has focused on job losses.[2] Behind this coverage is the strong implication that unemployment rises during downturns because firms become more likely to lay off employees, swelling the ranks of the unemployed.

This view is understandable; it was conventional economic wisdom for many years. It also contains a large element of truth: Layoffs have increased noticeably over the past year and a half. The Bureau of Labor Statistics’ Job Openings and Labor Turn­over Survey (JOLTS) tracks new hires and job separations on a monthly basis. In each month of Q4 of 2007, private-sector employers laid off or discharged an average of 1.8 million workers. That fig­ure rose to 2.4 million workers a month in January, and currently stands at 2 million workers laid off in October 2009.[3] Layoffs rose by as much as one-third during the recession and are currently one-ninth higher than when the recession started.

These job losses are real and painful for the workers involved, but they are not large enough to explain why the unemployment rate has doubled. Recent research shows that an increased likelihood of workers separating from their jobs is not the main reason unemployment rises during downturns.[4] In the relatively mild 1990-1991 and 2001 recessions, greater job separations caused very little of the increase in unemployment. In more severe recessions, such as that in 1981-1982, a rise in job sep­arations explained only one-third of the increased unemployment.[5]

The main reason unemployment rises during economic downturns is that job creation falls while the labor force continues to grow, and new jobs are more difficult to find.[6] Those without work stay unemployed longer, driving up the unemployment rate. This may seem counterintuitive, and it is not the impression that most people receive from the media. It is also cold comfort to any breadwinner who has just received a pink slip, but it is nonethe­less true and implies distinct policy strategies to reduce unemployment.

It is a drop in job creation, not a rise in job losses, which explains the majority of the increase in the unemployment rate during recessions.

Labor Market Dynamism

How does lower job creation send unemployment skyward? The American economy is highly dynamic. Industries continually expand and contract, while entrepreneurs create new companies and uncompetitive firms go out of business. Workers move between jobs frequently as this occurs. In good times and bad, the number of jobs created (or lost) each month is the difference between the number of workers starting new jobs and the number of workers leaving old ones.

Changes in either job-loss rates or job-creation rates cause unemployment to rise. Unemployment obviously rises when employees leave their jobs — either voluntarily or involuntarily — directly increasing the number of job seekers. But unemployment also rises when job creation falls. In that case, even if workers are no more likely to lose their jobs, the workers who naturally leave their jobs or enter the labor force have difficulty finding work — because fewer jobs are available. Consequently, they remain unemployed longer and the unemployment rate rises.

In the average month in 2008, 4.7 million workers began new jobs, despite the recession. Another 4.9 million workers left their jobs, either voluntarily or involuntarily. These vast movements in and out of jobs dwarf the net 200,000 jobs that were lost each month in 2008 and that the media typically reports.[7] Even small shifts in job-creation rates and job-loss rates have large effects on net job losses.

Blame Decline in Job Creation

This is exactly what has happened since the recession began. JOLTS survey data reveal this clearly. Chart 3 displays the number of monthly job hires and job separations since December 2000. The figure also breaks down job separations into involuntary layoffs and voluntary terminations.