Full Employment at Risk

Even before the World Trade Center tragedy struck a blow at the economy, the
national unemployment rate had begun to rise in recent months--and comments like
these began appearing in the press:

"The economy is moving to a more normal, sustainable unemployment rate after a
period of rapid growth" (Neal Soss, chief economist at Credit Suisse First
Boston, quoted in The Washington Post, May 5, 2001).

"Unemployment, despite thousands of recent layoffs across a
wide range of sectors, is still well below the rate commonly associated with
stable inflation and growth" (New York Times editorial, June 28, 2001).

And even though the recent rise to 4.9 percent was enough to frighten
the stock market and provoke calls for anti-recession measures, attention was
focused more on the slow growth rate and stagnant corporate profits. Where
unemployment is concerned, the conventional wisdom is that 4.9 percent, if
anything, is too low.

Important policy-making institutions echo these sentiments. According to the
Congressional Budget Office--the budget-battle scorekeeper for more than two
decades--the recent rise in unemployment is simply a return to normal. It views
the sustainable unemployment rate as being 5.2 percent, more than a full
percentage point above the 3.9 percent low hit last year. The influential
Organization for Economic Cooperation and Development takes a similar position.

The cost of taking these ideas seriously is terribly high, and it
is a cost that falls disproportionately on working people. In fact, working
families have no better ally in today's economy than full employment. Maintaining
it should be our foremost goal. Those who advocate settling for unemployment
rates above the low and sustainable rates of the late 1990s are engaged, perhaps
unknowingly, in a subtle breed of class warfare. In the next recovery, if we
settle into unemployment rates like those that prevailed over the 1980s and early
1990s, we will be consigning middle- and low-income families to the raft of
economic problems that beset them over these years: stagnant incomes, falling
wages, and growing inequality. With a stimulus package now before Congress, let's
not forget that a prime benefit of restoring high growth is a return to full

What Is Full Employment?

For our purposes, full employment means that virtually
everyone who wants a job has one. It doesn't mean that there are no unsuccessful
job seekers or that the unemployment rate is zero. It allows for "frictional"
unemployment--the reality that at any given time a small share of the workforce
are between jobs. Aside from that, at full employment the number of workers
seeking jobs matches up neatly with the needs of employers; the supply of labor
and the demand for it are in equilibrium, and the available labor force is fully

Even so, some disadvantaged persons experience persistently high
"structural" unemployment. Their rates of unemployment are consistently many
times that of the overall rate. These are the very persons helped the most by
full employment, because tight labor markets force employers to dig deeper into
the pool of job seekers. Based on the experience of the past few years, the
effective full-employment rate in the United States is certainly no higher than
4.0 percent.

The labor market was slow to recover from the last recession. Officially, the
economy bottomed out in March of 1991, but unemployment continued to rise until
mid-1992. It finally began to fall, and by January of 1996 it had leveled off
midrange between 5 percent and 6 percent, about where it was at the end of the
last recovery in 1989. Few expected it to fall much further.

But fall it did. In May of 1997, it fell below 5 percent for the first time
since 1973; and in September of 2000 it hit 3.9 percent, the lowest rate in three
decades. Consider some of the benefits that this low unemployment rate generated:

Great gains for minorities. While the overall rate of joblessness fell by 2.1
percentage points between 1994 and 2000--from 6.1 percent to 4.0 percent--the
rate among African Americans fell 3.9 percentage points, from 11.5 percent to 7.6
percent. The decline for black teenagers was particularly steep--from 35.2
percent to 24.7 percent, a drop of more than 10 percentage points. For all blacks
and for African-American teens, the 2000 rates were the lowest since data
collection on these groups began in the early 1970s. The same holds for

While we judge these gains to be evidence for the importance of full
employment, we don't want to lose sight of how high these rates remain. The fact
that one-quarter of teenage black job seekers unsuccessfully sought work in the
"best economy in 30 years" may seem to some a strange victory. Similarly, the
ratio of joblessness among blacks to overall unemployment was little changed.
This suggests that structural problems persist. Still, though the unemployment
levels faced by blacks are more than disconcerting, the trend over this period
was very impressive.

Opportunities for the least skilled. Practically every labor-market analyst
argued that in the new economy the only thing that would help the least skilled
was for them to get more schooling. Yet unemployment rates fell faster for
high-school dropouts over this period than for any other education group. True,
their rates were the highest to start with, so they had more room to move; but
this is still a trend that deserves close scrutiny. Did skills suddenly rain from
the heavens on them, or had the pundits forgotten about the demand side of the
equation? Skills do matter, but evidently a tight labor market is the working
person's best friend.

A recent Wall Street Journal feature article reported on furniture
manufacturing in the Carolinas, where the local unemployment rates abruptly rose
from under 4 percent to over 7 percent. Managers were delighted. They could stop
raising wages to attract employees; they could say no to demands concerning
working conditions. This shift had nothing to do with skills and everything to do
with the looser labor market.

Higher wages. The most important result of all this labor-market tightening is
that these employment gains translated into higher wages and incomes for broad
groups of working-class families who had seen their incomes stagnate over the
previous few decades.

The real hourly earnings of low-wage male workers fell at an annual rate of
about 1 percent between 1973 and 1995--a 20 percent cumulative loss. They then
reversed course and grew at a rate of 1.5 percent per year from 1995 to 2000. For
low-wage women, wages were flat over the earlier period but grew at a rate of 1.8
percent annually in the latter half of the 1990s.

The real wages of high-school dropouts grew 1 percent per year post-1995,
after falling at about that rate from 1973 to 1995.

After dropping 0.6 percent annually over the 1980s and early 1990s, the real
income of the poorest 20 percent of families grew by 2 percent per year from 1995
to 1999 (such data are available only through 1999). In real 1999 dollars,
low-income families were $400 worse off in 1995 than in 1989. By 1999 their
average yearly income had increased by $1,000.

These wage increases led to dramatic declines in poverty rates, especially for
African-American families, whose poverty rates fell 5.7 percentage points between
1995 and 1999, while the overall rate fell by 2 points. (By 1999 the black
poverty rate was 23.6 percent, compared with 11.8 percent for the overall rate.)

More people employed. In some ways, employment rates--the share of the
population employed--are more revealing than unemployment rates, because the
former also capture how a tight labor market draws in people who were formerly
not even looking for work (and thus not counted among the unemployed). Between
1995 and 2000, employment rates grew fastest for the least skilled, increasing 4
percentage points, while the rates for other education categories were fairly
constant. Employment rates among whites increased by 1.3 points over this period;
rates among blacks by 3.7 points. To appreciate the impact, you have to look at a
particularly disadvantaged group: young African-American women who didn't finish
high school. Their rates of employment rose from 23 percent to 37 percent--a
whopping 14-point increase. The fact that this large increase partly reflects the
work requirements in the 1996 welfarereform law only underscores the importance
of full employment in enabling poor women to move from welfare to work.

Greater equality. Finally, the tight labor market and the resultant increase
in the bargaining power of low-wage workers led to a clear slowing in the growth
of inequality. The long-term trend hasn't reversed course--most measures of
income or wealth inequality remain at postwar highs. But over the 1980s and early1990s, inequality's growth seemed inexorable--an unwelcome feature of the new
economy. Many argued that this was the predictable outcome of technological
changes, which offered huge rewards for the computer literate and punished
everybody else. Now inequality's upward trek appears to have been at least partly
a function of too much slack in the labor market.

How do we get back to 4 percent unemployment or less? Monetary
policy plays a key role: If unemployment is above 4 percent, the Fed chairman
should say why we're not at full employment and what the Fed plans to do about

The other instrument is fiscal. While inveighing against public
spending may send valued political signals of fiscal rectitude, it is pretty much
nonsense from the standpoint of economics. Keynes imparted lasting lessons about
government's role in stimulating demand when the private-sector economy slows and
unemployment rises. Similarly, investment in needed public infrastructure--from
roads and mass transit to the development of airline security measures and human
capital--can help to boost economic production and lower unemployment.

Rough times are ahead as the economy recovers from recent excesses in the
stock market, business overinvestment, high levels of household indebtedness,
and now the September 11 attacks. But the lessons of the late 1990s must not be

The unemployment rate fell to levels that very few economists thought were
obtainable just five years earlier, and there was no increase in the inflation
rate. The 4.0 percent unemployment rate reached in this period should be the
benchmark against which the economy is measured in the future. If anything, we
should be looking to push the unemployment rate even lower, not throwing people
out of work because of a questionable economic doctrine. This will require a
continued commitment from the Federal Reserve Board to support economic growth by
maintaining low interest rates. And given the slowdown, lowering the unemployment
rate may also require expansionary fiscal policy, even government deficits. There
is simply no policy that offers as much benefit to the country, and especially to
the disadvantaged, as does genuine full employment.

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