By William Apfel, CFA
From the Summer 2011 Edition of Values

The Great Recession is officially over. Gross domestic production (GDP) is higher today than its prerecession peak. Corporate profits this year are forecast to hit an all-time high. The stock market is about twice the level it was in March 2009 when the financial system was on the brink of collapse. But one critical element of all past rebounds is absent: U.S. labor markets have only recently begun to recover, and the anemic upturn has barely kept pace with the natural growth in the workforce.

Never before in the post-World War II period has a revival in the job market lagged a recovering economy so severely. The well publicized high unemployment rate is only the best known indicator. The weak labor market has led increasing numbers of people to give up the search for work. The so-called labor force participation rate, which rose steadily for over a generation as the economy boomed and women entered the labor force, has now sunk to its lowest level in 10 years, robbing the economy of a big source of productivity. If the participation rate were as high today as it was in 2000, the headline unemployment rate would be 13 percent rather than 9.1 percent. Perhaps most troubling is the burgeoning ranks of the long term unemployed: According to government statistics, persons unsuccessfully seeking work for 27 weeks or more are five times more numerous today than they were, on average, over the prior 20 years, and double the peak reached during the severe recession of the early 1980s.


As much as some commentators might suggest, there is no simple explanation for this situation. Economists, however, have generally fallen into two camps, those who emphasize “structural” factors and those who blame “cyclical” ones. At its core, the structural argument contends that long simmering constraints in the labor markets have discouraged companies from adding to U.S. payrolls. The most important factor, according to this analysis, is the high relative wages of U.S. workers in the global labor pool. Making this worse are regulations in areas like worker safety, the environment, and employment discrimination, all of which can lead managers and entrepreneurs to conclude that the costs of hiring and firing in the United States are prohibitive. Moreover, the United States has among the highest corporate tax rates in the developed world; payroll taxes, which add directly to the cost of adding workers, have continued to rise, and the future uncertainty regarding taxes and other obligations tied to hiring, particularly health care costs, make long-term investments in the United States unappealing.The cyclical case is simpler. Businesses don’t hire if they have plenty of workers to meet the demand for their products. True, the economy has recovered some, but consumer demand has barely risen as households are unlikely to boost spending while constrained by excessive debt, depressed home values, and by way of a perverse feedback loop, the insecurity they feel about their own employment. The U.S. situation has also been more difficult to ameliorate during this recession compared to past downturns because this time virtually all the developed economies have been similarly affected. That limits opportunities for a rebound in exports. On top of all that, two years into the recovery, the troubled condition of state and local finances is leading to an accelerating trend of government layoffs.It is not at all surprising that these rival analyses fall comfortably into political categories. Conservative economists tend to favor structural explanations because those imply that less regulation and lower taxes are the best balm. Liberal economists, following the Keynesian tradition, believe government has failed to fulfill its proper role of filling the demand gap through aggressive countercyclical spending and are highly suspicious of explanations that suggest that profit motive would not spur hiring if profits were indeed to be had.Without arguing that one of these characterizations has the best of the controversy, it’s worth noting that one study [Wiedner and Williams] finds that about two-thirds of the increase in unemployment since the beginning of the recession can be attributed to cyclical factors with the remainder the result of structural ones. In due course, academics will fight this out with mountains of evidence subject to sophisticated statistical tests. It’s a good bet that neither side will persuade the other. But some observations seem obvious and might suggest changes in policy. Some make sense regardless of political perspective. Indeed, in an important sense, cyclical and structural factors are inextricably linked and the effort to distinguish between them may only serve to distract from finding solutions.


There is little doubt that the longer a worker is unemployed the more difficult it becomes to find new employment. That’s either because skills deteriorate or prospective employers are instinctively skeptical about the qualifications of applicants who have long failed to find work. The cyclical thus leads to the structural.There is also agreement that a big factor in the slow recovery in employment is the virtual collapse of the residential construction industry. We know this is a result of the housing boom and the subsequent bust which was at the center of the cyclical downturn. But a recovery in residential housing construction is probably far off. Furthermore, there are considerable impediments to construction workers obtaining jobs in an increasingly service-oriented economy.More generally, the rising cost of employer-provided healthcare has raised the cost of adding to payrolls, not only for corporations but for local governments as budgets are constrained by shortfalls in tax revenues and less generous federal subsidies. Certainly, this problem has been deepened by the cyclical downturn, but the long-term solution must confront our deeply rooted practice of tying health insurance for those of working age to employment.Among the most controversial issues regarding high domestic unemployment is the effect of globalization. The structural case is that we have hobbled our labor markets with high costs and regulation, leading to outsourcing and a paucity of domestic investment. But America’s largest multinational companies are also choosing to focus their investments in emerging markets because that is where demand is growing most rapidly. Jeffrey Immelt, GE’s chief executive, has pronounced that the era of “globalization around cheap labor is over… today we go to Brazil… China… India, because that’s where the customers are.” Still, a long-term reduction in the U.S. unemployment rate will surely require both a more competitive, better educated labor force, and a more robust U.S. economy.Barely explored is the effect on consumer demand of widening income disparities. It is well established that higher income households spend a smaller share of their income. If the rewards of a cyclical rebound flow mostly to those in the highest income strata, which has been the case for most of the past generation, will even a powerful recovery support sustainable gains in employment?Looking Ahead

On the positive side, there is now substantial evidence that a sustainable rebound in employment in the long-moribund U.S. manufacturing sector is developing. Cyclical factors like a weaker dollar and global inflation are making U.S. labor costs more competitive in the global marketplace. Also contributing is a long-term trend of rising U.S. labor productivity. Still, one conclusion seems clear. No recovery can be sustained without addressing both cyclical and structural factors. If we fail to address the cyclical downturn today, temporary impediments to an improved job market will become more intractable. If long-brewing structural impediments remain, the long-term prospects for a healthy, prosperous, and globally competitive U.S. labor force will be gloomy indeed.