Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Unemployment: Structural & Residential

Recently, several articles have been contributed to SA regarding the unemployment situation. The articles that I read, with some exceptions, generally emphasized structural unemployment as a major problem. Surprisingly though, none of them have mentioned the critical role that housing inventories are currently playing in the situation.

The two most recent articles I read, written by Messrs
Felix Salmon (seekingalpha.com/article/298230-unemployment-s-here-to-stay) and Brad DeLong (seekingalpha.com/article/298321-most-of-our-problem-still-is-that-we-have-a-dead-battery-felix-salmon-is-wrong-edition), were opposite, commonly held, views on the issue. Mr. Salmon basically concluded that persistent structural unemployment would keep unemployment elevated for the foreseeable future. On the other hand, Mr. DeLong argued that structural unemployment was not preventing unemployment from declining--he opined that some major external intervention, presumably Keynesian stimulus or the like, is what is needed to drastically reduce unemployment.

As Mr. DeLong noted, the Beveridge Curve--a graph of the relationship between job vacancies and employment as a percentage of population--is wonderful for detecting structural unemployment. And, as he also pointed out, it currently indicates that there is much that can be done to help the employment situation without dealing with what structural unemployment we may have. But it is narrow-minded to go from saying that structural unemployment is not the problem to concluding that the economy only needs a "jolt" to restart activity and restore jobs.

Unemployment is best explained as a result of the elimination of much of Americas construction activity. As the graph above shows, for the most recent business cycle, new residential housing starts (seasonally adjusted)--a widely used metric for residential construction activity--have been roughly reflected in the employment to population ratio. Obviously, there is about a two year lag; but adjusting for that, the employment situation is certainly highly correlated to the residential construction industry. This relationship between U.S. Construction and employment is widely accepted, and other SA articles go into more detail but arrive at the same conclusion (see seekingalpha.com/article/200741-predicting-u-s-unemployment-rates-based-on-housing-starts).

Correlation does not prove causation. However, that the loss of the majority of the home building industry would cause a significant decline in employment is unsurprising. Housing is generated by a vast amount and wide diversity of economic activity. The components of a house include a wide range of materials, each of which is produced by many different companies, of which each employs a part of the population. Wood, stone, sand, and steel extracted by an army of equipment, engineers, and low-skill labor become trusses, rebar, block, and concrete under the hands of a secondary workforce and finally a structure with the labor of yet another mass of capital, human and mechanical. And the broader effects, caused by the necessities of this construction supply chain, draws on the efforts of the entire economy. Thus, residential construction has an immeasurably huge effect on the employment situation.

However, the essential elimination of much of that industry would not yet constitute structural unemployment. As the jobs were actually eliminated, vacancies were not created, keeping the vacancy rate low while the employment ratio declined. Consequently, Mr. DeLong was rightly able to conclude that structural unemployment is not the only and certainly has not been the main cause of the persistent unemployment.

But as the residential construction industry specifically and the global economy as a whole recovers, one would expect that a certain amount of structural unemployment will reveal itself. The industry is not going to regain its former size. Consequently, even with the industry running normally again, many workers are going to have to be retrained for other jobs or else vacancies will rise in the economy as a whole

This matter has perhaps already begun to have an effect, but 9%+ unemployment is not the new natural rate. As Mr. Salmon noted, the new entrants into the labor force seem to be the ones hired, leaving a group that appears to be unemployable. And the Beveridge Curve shows signs of having shifted upwards, indicating that structural unemployment is having an effect. But it is still undeniable that the problem is a lack of jobs, not a trained labor supply crisis. And many of those currently unemployable will have jobs when the construction industry recovers. Cyclical unemployment due, I believe, to the decline residential construction activity, is still a major force.  

And unfortunately it will continue to be for a long time. We have overbuilt housing to a huge extent over the last decade, driven by encouraging financiers, who were in turn spurred on by yield hunting retirees and working investors and savers. That excess inventory will cushion any major changes in housing demand, preventing a quick construction recovery. For a long time. The surplus is nearly impossible to measure, but the overwhelming consensus is that it is enormous. Some say the market will take until 2018 to work it off at current sales and starts rates. That would be 7 years of soft housing construction and high unemployment

Now, the government has tried and is staging another effort to reduce unemployment. But it continues to try short-term, "jolt" measures--tax breaks, tax credits, outright transfer payments and the like. If we assume that the cyclical unemployment is largely driven by the lack of home building activity, then it becomes clear that these attempts will not have any material effect whatsoever. Uncontinuous stimulus is not going to change the employment situation because it does not address the driving, fundamental issues.
 
The bottom line is that the reduction of excess housing inventory will drive the unemployment rate going forward. And it appears that it will be a long, slow process. Nothing will change that--if we may paraphrase Warren Buffet, the governments ability to reduce unemployment for now is limited to blowing up houses and/or marrying 12 year olds (reducing supply and increasing demand, respectively). As neither are likely to be policy for the foreseeable future, we need to learn to live with elevated unemployment for now.  


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.