Is-the unemployment problem cyclical or structural?

What’s at stake: One of the big questions right now is whether the advanced economies are suffering, for the most part, from structural or cyclical unemployment. If it's cyclical, then there's a good chance that government intervention can help. If it's structural, i.e. a decline in automobile production and manufacturing more generally, a decline in home construction, and a decline in the financial industry all of which free workers that need to be absorbed elsewhere in the economy, there's less that can be done and some do not think that government can do much at all about this type of problem.

The rationale for an increase in structural unemployment

Natacha Valla and Jérémie Cohen-Setton highlight in VoxEU that significant revisions to structural unemployment rates have been applied by the European Commission without being made clear and discussed in public, while the economic foundations for applying such revisions are questionable. Yet these revisions are key for assessing the macroeconomic stance of different countries and whether they should engage in more or less policy stimulus since these measures are key ingredients for computing potential output and output gap estimates. While there is a broad consensus on the fear that some elements of joblessness could become entrenched, the economic rationale for significantly revising “on the spot” NAIRU estimates during large business-cycle turning points is disputable.

Paul Seabright argues that even in ordinary recessions you expect to see an increase in the mismatch between the types of job available and the types of skill people have to fill them, a mismatch that declines gradually over time as the economy picks up. But this recession, more than most, seems likely to have produced a great increase in the mismatch, due to the unsustainable patterns of consumption and investment induced by the credit boom that preceded the financial crisis. The depth of the recession makes the mismatch worse. Even in the sectors that will have to shrink compared to three years ago (think construction) there are many currently unemployed people who will get jobs back in their old occupations if they are patient; activity levels are down way too far by any reasonable standards and will surely, eventually, pick up again. That encourages many others people to wait longer than they should, instead of retraining in new occupations.

Gilles Saint-Paul writes that there hasn’t been an increase in structural unemployment yet, but there is a risk of "political hysteresis". The crisis will certainly lead to higher unemployment for a while due to the need to reallocate labour away from sectors (such as finance or construction) that were artificially large during the last decades. And persistence of unemployment will be increased because of the reduced employability and job search intensity of the long term unemployed. But to have a really permanent increase in unemployment, we have to ask whether labour market institutions will change. EVEN though Saint-Paul believes that after the crisis the US economy will resume its growth trend at a lower level than before the crisis, he does not think that this per se will lead to a permanent increase in unemployment. The reason is that the unemployment rate essentially depends on labour market institutions, and most notably on those that affect wage-setting. A mechanism through which recessions can lead to permanently higher unemployment is what I call political hysteresis: at the end of a recession, those who have kept their jobs (the insiders) may support tighter labour regulations that would increase their bargaining power in order to take advantage of the recovery to get higher wages, at the expense of new hires.

Beveridge worries

One major source of the newfound concern around structural unemployment is the shift in the relationship between job openings and unemployment – Beveridge curve – that David Altig of the Atlanta Fed has detected. Brad DeLong argues that given the large recent increase in vacancies in the past two quarters, the US unemployment rate ought to have started to fall. It did not. That means that the chances are now very high that our cyclical unemployment is starting to turn into structural unemployment, as businesses that seek to hire and have the cash flow to hire still find that the currently-unemployed applying for jobs don't fit inside their comfort zones. Brad DeLong and Paul Krugman consider the high vacancies to be a sign of a problem which is more persistent and less absurdly easy to deal with than low aggregate demand.

Andy Harless argues that while the shift is unmistakable in Altig’s chart, it does not represent a major increase in structural unemployment. Rather, it represents the normal dynamics of the business cycle in the context of an incipient recovery from a historically severe recession that, in some ways, has not quite ended. Dave Altig has drawn a linear regression line to represent the general relationship between job openings and unemployment. But we should not therefore assume that the true relationship is a linear one. If you ignore the regression line, you can see a distinctly curved pattern to the points. We should expect a curved pattern. In practice, when one of the series gets very low, it becomes less responsive to the other series.

What can governments do?

A speech by Minneapolis Fed President Narayana Kocherlakota suggests that some Federal Reserve voices are taking the potential for structural unemployment very seriously. Firms have jobs, but can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs. Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers. Of course, the key question is: How much of the current unemployment rate is really due to mismatch, as opposed to conditions that the Fed can readily ameliorate? The answer seems to be a lot. Most of the existing unemployment represents mismatch that is not readily amenable to monetary policy.

Mark Thoma argues that even if the problem is mostly structural, the government can help workers during the transition. Second, government can ease the structural problem by making it easier for businesses and individuals to relocate. But no matter how large the structural problem is, cyclical unemployment is also a big problem, so the claim that government is powerless because it's all structural doesn't hold.  And the claim that the existence of a structural problem means there's nothing the government can do is also incorrect.

Scott Summer argues that the danger in searching for structural unemployment explanations for our current malaise is that it takes the pressure off policymakers to deliver adequate NGDP growth. During recent decades the economy has performed best when NGDP grew at a steady rate of about 5%/year. Unless monetary policymakers move more aggressively to boost NGDP growth closer to the pre-2008 trend line, we have no basis for predicting a rapid recovery in jobs. And there is no justification for blaming our current problems on structural unemployment when the AS/AD model can easily explain the difference between the fast recovery of 1983-84 and the anaemic recovery that we are currently experiencing.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.