Unemployment vs. Local Public Policy

My friends are telling me I'm an idiot. I was quoted in the local newspaper last week saying that our high unemployment rate was a bit of a mystery. Both friends and strangers have told me that it's simple: Our state has high unemployment because of bad policy, such as high tax rates and restrictive controls on growth. Here's why they are wrong and I am right.

Unemployment is a labor market phenomenon, not a general economic phenomenon. Weak demand for labor may arise from bad policy. "Businesses won't create jobs if they are taxed too high" is the common theme. But labor demand is not based solely on public policy. The number of workers that a business will hire depends also on how much those workers need to be paid. I would expect poor public policy to lead to weak demand for labor, and thus low wage rates rather than high unemployment.

The price system usually brings supply and demand into balance.
Nobody wants to sit in the middle seat of an airplane on a long trip, but those middle seats are pretty much full. Why? The airlines set prices so that the seats sell. Or consider gasoline. People drive fewer miles in the winter than in the summer, but we don't see unemployed gasoline in January. Instead, we see (on average) lower gas prices in winter than in summer. When we have unemployment, we ask, "Why doesn't the wage rate drop to keep all of the people employed?"

There are both long-run issues and short-run issues. In the long run, there's a natural level of unemployment that reflects the time it takes for a person to find work. We have new people coming into the labor force, as well as people quitting and being dismissed, and most of these people would rather take some time looking for a good job than accepting the first job opening they come across. This natural unemployment rate is higher in states that have a great deal of in-migration (such as Oregon), because the newcomers need time to find jobs. While they are looking, they are unemployed.

The minimum wage prevents price adjustment for low-skilled workers, so states with higher minimum wage rates experience higher unemployment rates, especially for youth and minorities. This is an instance where state policy does come into play.

In the short run, recessions bring high unemployment because wage rates are slow to adjust to weak demand, for a wide variety of reasons. The extent of unemployment in the recession depends on how the state or local area is impacted by the recession. Those places (such as Oregon) with a greater concentration in manufacturing and construction have a bigger change in labor demand and thus a greater rise in unemployment.

However, aside from the minimum wage, bad long-term public policy does not explain a higher unemployment rate. It could explain lower wage rates in general, though.

Comments

[user396040:]

Wages are notoriously sticky which I believe is why deflation leads to unemployment. Think of it this way - you are running a small business, you have 40 employees with various levels of pay, every month the price index declines so you are giving them a real wage increase unless you cut their wages. Most employers will opt to let someone go, forego hiring a replacement for someone who leaves, get rid of a subcontractor and do the work internally - long before they will implement an across the board wage cut. For the same reason, inflation - at least initially - is marginally beneficial to employment. Employers can give employees a reduction in real wages simply by keeping their salaries level.
This isn't the whole story. Certain industries have seen demand fall off a cliff and must reduce employment. Most businesses are still very nervous about liquidity and want to preserve cash at all cost - this too leads to a tendency to reduce employment.

May 29 04:48 PM

[Jason Rines...:]

Bad long term policy does affect unemployment. It's a monetary policy. Borrowing costs drop because of interest rate reductions. Businesses load up on debt to expand including hiring employees. Let's say that 20% of 2007 GDP was based on debt expansion (bubble). The debt to GDP ratio becomes non-sustainable. The bubble bursts. Massive layoffs result. Then, factor in long-term policy on international trade/globalization. The U.S. became a service based economy rather from a producer economy. Who would hire a U.S. I.T. worker at $35 dollars over an Indian worker for $10 an hour? That's an example. The Finance economy grew from 30% to 41% between 1999-2007. Financial innovation through de-regulation was a long-term policy and non-sustainable. The brokers/middlemen are being shed throughout our economy. Clients can get directly to the producer and DO when the economy gets tough. Your arguments aren't all bad, they are more symptoms then causes.

May 29 05:42 PM

[Leftfield:]

Saying bad public policy doesn't affect unemployment is like those who don't distinguish between stupid debt and productive debt, which is common. Unfortunately, we have veered so far over to the stupid side we may not come back this time.
If the rules set by government require astronomical numbers of lawyers and accountants, two earner families to pay taxes, wildly inordinate regulation and rules for average people but no rules for Wall St., you crush the productive economy. It's called strangulation.

May 30 12:43 AM

[Gregman2:]

"In the short run, recessions bring high unemployment because wage rates are slow to adjust to weak demand..." I think the key here is that unemployment is really a [f]unction of goods/service [d]emand. Yes, wage rates should adjust to less demand (for a good/service), but consider margin and price analysis: as you note, gas prices may drop slightly in winter as people drive less, but inventories also typically adjust, thereby retaining approximate margins. Gasoline is not the best analogy.

May 30 10:54 AM

[Jade Queen:]

Oregon is atypical for cultural reasons in additional to the rate of in-migration. For example, quite a few of the young people coming here are not typical of their age group elsewhere. Also, we have a filtering effect because our population center in Portland is so close to Washington, where tax policies are so different.

May 30 02:25 PM

[masf:]

I'm not impressed by arguments that the minimum wage or wage rates in general cause unemployment or other economic woes. That money goes back into the economy. The "poor public policy" I wonder about is the type allowing our tax-funded bailout to be used for bonuses at such companies as AIG. I say "wonder" because I don't have enough information to know if these incidents are mainly headline-grabbers or are widespread enough to have a real impact. But I would bet that much of that bonus money goes to offshore tax-havens.

May 30 04:01 PM