Do We Have a Structural Unemployment Problem?

That was the question that economists Peter Diamond, Dean Baker and Kevin Hassett debated yesterday afternoon in a panel discussion at the American Enterprise Institute (AEI). Moderated by AEI’s Michael Strain, the panel did not disagree on much, particularly its emphasis on the need for government programs to help the long-term unemployed.

Nobel Prize winning economist Peter Diamond, now professor emeritus at MIT, kicked off the debate by arguing against the oft-repeated claim that the current unemployment problem is not just cyclical, but is structural as well. He focused on the Beveridge Curve, which graphs the unemployment rate compared to the job vacancy rate. It’s shown below:Beveridge Curve

When the unemployment rate is high, the vacancy is rate is low as that generally coincides with recessions when employers aren’t hiring. As you can see from the graph above, the concern amongst economists is that there are now more job vacancies for higher levels of unemployment in the past few years compared with the recent decade. However, Diamond was dismissive of this, nothing that over the long-term, the Beveridge Curve fluctuates dramatically and often crosses back above itself after recessions.

“This is not a tight, technical relationship,” he said. “This is a curve that moves all over the place, in part for reasons we could identify, in part not.

“The path back being above it has happened a number of times before and sometimes after that you stay above,” he added. “Sometimes after that when you get back toward full employment, you’re back to the old curve or even below it. So the issue of thinking about how to interpret the path we’re seeing is something that really calls for digging underneath these aggregates.”

Diamond emphasized that a couple other economic points indicate that this is a cyclical unemployment problem. In particular, the lack of wage growth in any major industry is very surprising if the structural unemployment theory is true. If there was a structural unemployment problem, firms would be unable to find workers with the adequate skills and would have to increase wages to fight for the scarce talent. But that hasn’t been the case, Diamond said. Wages have been stagnant.

He also examined the construction industry in particular to see if the change in long-term unemployed construction workers’ employment has been any different than changes for long-term unemployed workers in other industries. When he looked at the data, he found few differences. This rebukes the idea that long-term unemployed construction workers have been unable to reenter the labor force due to a mismatch in skills.

Dean Baker, the Co-Director of the Center for Economic and Policy Research, added an additional layer to Diamond’s argument, noting that the Beveridge Curve has shifted upwards only for the long-term unemployed, not for the short-term unemployed. This is evidence that there was not a structural employment problem for the long-term unemployed when they were part of the short-term unemployed. The issue began when they became part of the long-term unemployed.

The final panelist, AEI’s Kevin Hassett, focused almost entirely on the problems of those workers.

“When you create a stock of folks who have been unemployed for a long time, then it makes it uniquely difficult to reattach them to the labor market,” he said. “There’s been insufficient attention to the emergency of the long-term unemployed.”

Hassett joked that he’d received a surprising amount of praise from liberal organizations recently for his promotion of government jobs programs to help those workers. Yet, even Hassett in conjunction with liberal economists has been unable to convince policymakers to implement such a program. This, he noted, is devastating to those workers, who see significant negative effects on health and wages due to their long-term unemployment. For those reasons, this is a problem that Congress cannot kick down the road.

The longer we wait to confront this pressing issue, the worse it will become. Unfortunately, the lack of interest from Congress may mean it will get much worse.

How Can I Trust AEI?

I meant to write this a few days ago, but never got around to it:

I want there to be a respectable conservative think tank. I want there to be good research out of the right. I want there to be policy analysis that constructively analyzes both the right and left’s proposals. Right now, there are a number of left organizations that do that. The Citizens for Tax Justice leans leftward but produces good, quality work.

It would be nice if the right could actually attempt to put out an unbalanced report. The Heritage Foundation long ago lost credibility in my eyes. But I’ve always tried to give the American Enterprise Institute (AEI) a chance. For instance, its response to the Tax Policy Center’s analysis of Romney’s tax plan is something I can at least respect and debate:

Now I don’t have a problem with the general analytical approach here, nor am I surprised by the findings given that approach. The U.S. has an extremely progressive income tax system where the top 1% pay 40% of the income taxes, while the bottom 50% pay just 2%. Across-the-board tax cuts will favor upper-income folks and “paying for them” will make the system less progressive in terms of the tax burden.

But I do have some issues with the study, as well as an observation or two.

First, the study assumes that Romney’s corporate income tax will be paid for by eliminating about $100 billion in business tax breaks. Yet an AEI study suggests that the U.S. corporate tax rate is deeply on the wrong side of the Laffer Curve and a cut to 25% might well pay for itself. So that $100 billion could help pay for individual income tax reductions.

Second, the study offers one scenario that assumes the tax plan produces greater economic growth than the TPC baseline scenario with a revenue loss of around $300 billion instead of $360 billion. Apply that $100 billion in corporate savings, and the revenue loss — before scaling back individual tax breaks — would be around $200 billion. At that point, the supposed tax hike for those making under $200,000 would likely be much less than 1%.

Third, I would guess the Romney campaign is betting on even higher GDP growth estimates than Brookings-TPC, assuming the economy might get a confidence bounce from business, investors and consumers after a Romney win, especially if he is able to produce major tax and entitlement reform.

I haven’t seen any other study on the correct Laffer curve rate for the corporate tax rate than AEI’s. It’s great that AEI has done that research. And while I don’t necessarily agree with their points (corporate tax revenue isn’t just related to the Laffer curve, it also has to do with the international system), I think that reasonable people can disagree over them. And on top of that, the authors agree that “across-the-board tax cuts will favor upper-income folks and “paying for them” will make the system less progressive in terms of the tax burden.” It’s good stuff.

But then the President of AEI, Arthur Brooks, comes out with a trash column in the Wall Street Journal. It mainly focuses on the Administration’s decision to issue welfare waivers. This has been thoroughly debunked all week so I’m not going to go into it. What I do want to point out is how Brooks opens the op-ed:

Within the space of just two weeks, Americans have witnessed two radically different philosophies about the free enterprise system from President Obama. In his notorious Roanoke, Va., speech of July 13, he said “If you’ve got a business—you didn’t build that. Somebody else made that happen.” That is, Americans have not fully earned their success. (bolding mine)

Are you kidding me?! It’s dishonest and slimy for Romney to slice Obama’s words like that. For a supposedly respectable head of a conservative think tank to do so is disgraceful and despicable. Honestly, Brooks 100% knows what he is doing here. His entire goal is to trick the American public. How can I trust anything AEI produces when its president writes such garbage?