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The Global Unemployment Crisis: Costs, Causes, Cures

How to fight the misery index effectively, especially double-digit unemployment rates?

November 15, 2010

How to fight the misery index effectively, especially double-digit unemployment rates?

Of all the aspects of social misery, nothing is so heartbreaking as unemployment …"
— Jane Addams (1910), “Twenty Years at Hull-House”

You know times are tough when the Wall Street Journal looks into the link between unemployment and suicide. In 2009, the paper reported that suicides in the United States had "crept up during the worst recession in decades." And it noted that "suicide rates have historically risen during tough economic times, when unemployment is high."

The misery index — the sum of the inflation and unemployment rates — gained popularity as an indicator of tough times during the U.S. presidential election of 1980. Double-digit inflation in the United States and around the globe was the big problem then.

Today, the misery index is nearly back to the level it was in the 1980s. However, the source of the misery is now not inflation — but the near double-digit rates of unemployment.

Across the globe, an estimated 210 million people are unemployed, an increase of over 30 million since the start of the Great Recession of 2007. Three-fourths of this increase occurred in the advanced economies.

The problem is particularly severe in the United States — the epicenter of the Great Recession — and the country with the highest increase in the number of unemployed: an increase of 7.5 million unemployed people since 2007.

Costs, Causes, Cures: The Take-Away

  • What are the costs of this increase in job loss? A loss of earnings is the immediate cost, but research documents far-reaching impacts on earnings potential, life expectancy and families.
  • What are the underlying causes of the increase in unemployment? It is self-evident that the main cause is the fall in demand. But near-term structural factors, such as the effects of housing busts and sectoral mismatches, are also at play. And some new research investigates whether deeper causes, such as increases in income inequality, are behind severe financial crises and the unemployment that ensues.
  • What is the cure? The single best tonic for labor markets in the near-term is for government policies to support the recovery in demand. That is easier said than done, of course.
  • More targeted policies may be needed to cure pockets of structural unemployment. And looking further down the road, do we need to increase the attention given to the jobs dimension in economic policymaking? Are targets for employment growth and for balanced growth in incomes needed, the way countries often have targets for inflation and fiscal deficits?

    Human Costs of Job Loss

    While the link between unemployment and suicides rates suggested by the Wall Street Journal remains unproven, careful studies — many of them co-authored by Till von Wachter of Columbia University — have now established the terrible human toll of job loss.

    From these studies, we know that the loss in earnings when people lose their jobs persists far into the future. Even 15-20 years after the initial episode of job loss, people who were displaced make on average 20% less than comparable workers who kept their jobs.

    The hardship of job loss also has serious negative impacts on health. In the short run, layoffs are associated with higher risk of heart attacks and other stress-related illnesses. Over the longer term, the increased mortality rate due to unemployment can persist up to 20 years after the job loss — and lead to an average loss of life expectancy of one to 1.5 years.

    Children of laid-off parents also suffer. In the short-run, parental job loss increases the probability that a child repeats a grade in school by nearly 15%. And one study found that children whose fathers were displaced from their jobs had annual earnings nearly 10% lower than similar children whose fathers did not experience job loss.

    Long-term unemployment is particularly costly, not only for the earnings losses — but because it affects a person's morale and self-confidence and how the person is viewed by companies.

    The odds of finding a job decline the longer a person has been unemployed. In the United States, a person unemployed for over six months has less than a one in ten chance of finding a job in the coming month, compared with a one in three chance for someone unemployed less than a month.

    John Irons of the Economic Policy Institute notes that "high unemployment, falling incomes and reduced economic activity can have lasting consequences. For example, job loss and falling incomes can force families to delay or forgo a college education for their children.

    “Frozen credit markets and depressed consumer spending can stop the creation of otherwise vibrant small businesses. Larger companies may delay or reduce spending on R&D. In each of these cases, an economic recession can lead to ‘scarring’ — that is, long-lasting damage to individuals' economic situations and the economy more broadly."

    Unemployment: Cyclical or Structural?

    What are the causes behind the increase in unemployment and its persistence? Evidently, the main reason for the sharp increase in unemployment is the fall in demand. When there is less demand, companies need less labor input, which they accomplish by cutting hours of work or laying people off — or some combination of the two.

    Analysis of cross-country differences in unemployment rates during the Great Recession shows that fall in demand is an important, but not the sole, factor behind unemployment increases.

    What is also important is the co-incidence of the demand decline with acute stresses in other sectors, such as the financial and housing sectors. For instance, countries which experienced a substantial house price decline during the crisis suffered on average a larger increase in unemployment, for any given drop in demand.

    The fact that unemployment is persisting at high levels despite some recovery in GDP has triggered a controversy, particularly in the United States, about whether the unemployment is cyclical or structural. The U.S. blogosphere resounds with claims that it's one or the other.

    The evidence suggests that the increase is largely cyclical — as convincingly argued by Mike Konczal of the Roosevelt Institute — but there are also indications of some increase in structural unemployment. One indication is the increase in skill mismatches at the U.S. state level. IMF economists Marcello Estevao and Evridiki Tsounta find that in many states, the gap between the skills of the state's population and the skills needed in the state's existing jobs is at an all-time high.

    In normal times, in a highly mobile society like the United States, such mismatches would lead to people moving to states where their skills are needed. But, during the Great Recession, the hit to the housing sector means that many people are not able to simply walk away from their homes to where the jobs are.

    The combined effect of skills mismatches and higher foreclosure rates — and the interactions between these two problems — is estimated to have added about 1.5 percentage points to the U.S. unemployment rate.

    Increased dispersion in stock market returns across industries is also signaling an increase in structural unemployment. When the underlying shocks to the economy have disparate impacts on the fortunes of industries, dispersion in stock market returns rises.

    This was the case, for example, in 1974 when the oil price shock altered patterns of comparative advantage across industries, and in 2000 with the bursting of the dot com bubble.

    During the Great Recession, the index reached historic highs, partly reflecting the hits to the financial and construction sectors. About a quarter to a third of the increase in U.S. long-term unemployment can be attributed to the structural changes reflected in increased stock market dispersion.

    Raghu Rajan and Robert Reich have suggested deeper causes of severe financial crises and the sharp unemployment that ensues. They suggest that sustained increases in income inequality and stagnation in median wages lead to periods of excessive borrowing by the poor- and middle-classes, and this build-up in leverage ultimately triggers a financial crisis.

    IMF economists Michael Kumhof and Romain Ranciere have put together an economic model that is able to replicate key features of the linkages between inequality, debt and financial crises.

    Between 1983 and 2007, the income share of the richest 5% of U.S. households increased from 22% to 34%, and the ratio of household debt to income doubled. However, as Kumhof and Ranciere point out, consumption inequality increased much more moderately than income inequality.

    The only way in which high consumption could be sustained in the face of stagnant incomes was for poor- and middle-class households to become much more indebted. In other words, the increase in the ratios of debt to income must have been concentrated among poor- and middle-class households.

    That indeed is what the data show. In 1983, the richest 5% of households had a debt-to-income ratio of 80% and the bottom 95% a ratio of 60%.

    Twenty five years later, the situation was dramatically reversed — with a ratio of 65% for the richest 5% and of 140% for the bottom 95%. In Kumhof and Ranciere's model, this increased indebtedness then increases the risk of a financial crisis, which when it occurs leads to high delinquencies and output losses — and, presumably, increased unemployment.

    No Quick Cure for Unemployment?

    Though the situation in labor markets is dire today, it could have been worse — were it not for policy responses by governments during the Great Recession. At the onset of the recession, most central banks quickly lowered their policy interest rates. Governments also allowed the decline in their tax revenues to show through in increases in their fiscal deficits.

    And to add to that, many countries provided a fiscal stimulus, and one that was internationally coordinated across countries under the auspices of the Group of 20 (G-20) countries. These policy responses may have kept the Great Recession from turning into the next Great Depression.

    Beyond these common macroeconomic policy responses, countries differed in the extent to which they used more policies targeted more directly at the labor market. One of the key policies adopted in Germany, Italy and Japan was to provide government financial assistance to encourage companies to keep workers at their jobs but reduce their working hours and wages.

    Such short-time work programs can spread the burden of the downturn more evenly across workers and employers, reduce future hiring costs and protect workers' human capital until the labor market recovers. While it is too early to undertake a full assessment, these programs are credited with having played a crucial role in dampening the increase in unemployment in many countries.

    They may be the reason that the German unemployment rate barely budged during the Great Recession. In fact, the government recently announced that the number of people unemployed in Germany had dipped below its historical three million threshold.

    What policies are needed over the coming year? Economic downturns accompanied by financial crises have tended to be deeper and longer lasting than other downturns. Thus, financial sector policies are likely to have an important bearing on the recovery.

    Financial repair has not yet fully addressed the legacies of the crisis, including bank funding concerns and the resolution of weak banks, thus keeping credit tight and constraining demand.

    Financial reforms have progressed, but much more needs to be done. The faster that uncertainty about the course of reforms is reduced, the more the financial system will be able to support demand and growth.

    The rising tide of recovery will not raise all boats. With structural unemployment appearing to be on the rise, more targeted policies may be needed to address problems in particular sectors (such as housing) or among some classes of people (such as the long-term unemployed) or in communities where economic distress is particularly acute.

    High inflation in the 1980s evoked a policy response that brought inflation down through sharp recessions and also triggered changes in the policy framework — notably, granting central banks more operational independence — so that inflation remained low in the decades that followed.

    The unemployment crisis needs to be taken just as seriously. With 210 million people unemployed across the globe, a policy response is needed to bring about a quick recovery in jobs. And looking further ahead, we need a policy framework — as the International Labor Organization has long argued — that would keep the unemployment component of the misery index low in the future.


    Today, the misery index is nearly back to the level it was in the 1980s.

    However, the source of the misery is now not inflation — but the near double-digit rates of unemployment.

    As the International Labor Organization has long argued, we need to keep the unemployment component of the misery index low in the future.

    Despite the Great Recession, the number of people unemployed in Germany had dipped below its historical three million threshold.

    Governments' policy responses may have kept the Great Recession from turning into the next Great Depression.