Monday, August 3, 2009

Stagflation and Its Potential to Derail Economic Recovery


We've previously discussed the fact that the current unemployment rate, while high, is not at the level it was in some previous recessions. We've also discussed that unemployment tends to last longer than recession, and is therefore called a "lagging" indicator.

But that's not the whole story. Further research shows that unemployment may actually be behaving differently than it has in past economic recoveries.

In the statistical measurement called "standard deviation," the US is deviating from the standard behavior of unemployment as measured by Arthur Okun, a prominent economist in the 1960s. The relationship he discovered was that between the degree to which the economy contracted and the concurrent rise in unemployment. This relationship, called Okun's Law, had been reasonably reliable - until now. At the current rate of decline in our economy, his calculations show that we should have a current unemployment rate of 8% - not 9.5%. We have lost almost 5% of all jobs - far surpassing the 3% we lost in the 1980s recession when unemployment last reached over 10%.

We previously discussed the fact that, during a recession, employers tend to keep employees at a level that will accommodate the return of growth after the recession ends. It is that "buffer" that results in a delay in hiring, as these employees increase their productivity during the growth phase, eliminating the necessity to add workers until the economic growth trajectory is well under way.

In this recession, however, further examination of employment patterns show that this "buffer" has not been kept. Does this mean that employers, jarred by inability to obtain credit by the frozen financial system, panicked and cut employment more than usual? Perhaps.

But, that does not explain the additional fact that, since 2001, overall hiring has been contracting. During the 1990s, employment expansion was at a rate of 8 workers for every 100 on staff. That expansion dropped to 7 workers per 100 during the 2001 recession. Hiring, however, stayed at that level after the recession was over, and has now fallen to 6/100.

Perhaps a part of this failure to hire can be attributed to
  • A permanent loss of manufacturing and other jobs "outsourced" to countries who can produce goods at a lower cost than the US

  • Less innovation = fewer new businesses. During war time, technology tends to be focused on the war effort as opposed to innovations in the private sector.

  • As aging baby boomers leaving the work force, the total number of workers lessens and unemployment rates appear larger. As an example, with a total work force of 100, if 5 people are unemployed, the unemployment rate is 5%. With a total work force of 90, if 5 people are unemployed, the unemployment rate is 5.5%

Whatever the explanation, there is a big difference between a sustained decrease in hiring, as there has been since the 2001 recession and thereafter, and job losses due to a recession. Jobs lost in economic downturns have historically returned, but only when confidence that economic recovery was well in force.


Some argue that the unemployment problem is partially addressed by the stimulus program. This is only partially true, because government programs aimed at repairing the infrastructure, e.g., roads, bridges, etc., are temporary in nature.


Jobs lost in economic downturns have historically returned only when economic confidence returned to the private sector. Certainly, no employer wants to add workers unless she feels that a sustained recovery is under way.

Sustainable Jobs

The Obama administration has opined that new job growth be in technological advances in green energy, which will address the national security issues of oil imports, the international need to reduce greenhouse gases, and provide a cost effective alternative to depleting international sources of fossil fuels. With the current lack of emphasis in math and science in the educational system, this goal will be difficult to achieve in the short run. Regardless of the source of so-called sustainable jobs, however, it is crucial that job growth be achieved - and soon.

Falling Wages

One need only look at the economic problems in the State of California and publishers like the Boston Globe to see that we are experiencing a period of falling wages. Wages, expected to be flat during periods of recession, are in danger of falling as businesses and municipalities cut expenditures to the bone.

Additional Stimulus

Should unemployment rates continue to fall precipitously, and wages fall as businesses try to survive, the government may be tempted to provide additional stimulus. That, in my opinion, would result in the disastrous recipe for stagflation. Stagflation = Stagnant (or falling) Wages + Inflation.

But, inflation is very low, you may argue. True, but the national debt, approaching $10 trillion dollars, must be repaid. And, as debt is piled on, higher and higher rates must be paid to borrowers who lend us money. Higher rates mean higher cost of borrowing in the public and private sector, which result in higher costs. Higher costs plus stagnant wages = Stagflation.

What Now

The goal of sustainable job growth is an absolutely critical part of the answer. That means that we will need

  • An immediate retooling of our workforce in skills necessary for sustainable jobs

  • Education emphasis on math and science

  • Accommodative policies to encourage investment in sustainable business

  • Immediate policies enacted to reduce deficits

  • Bi-partisan support for such policies to encourage confidence.

The last issue is critical. Without confidence, business will stay stagnant. It's a tall order, and there's an immense economic outcome at stake. Failure to achieve sustainable job growth will result in a more serious long term economic problem than has faced our country to date. It is up to every one of us to voice our opinion to our representatives and demand that action be taken immediately, or accept a generation of economic decline.

1 comment:

  1. I have two explanations for the loss of jobs and the reluctance of companies to rehire:

    1) Employers realize that despite what statistics that purport to measure productivity seem to indicate, the average worker -- particularly in white-collar jobs -- spends increasingly more time Twittering, Facebooking, and trolling for YouTube videos of cats playing the tuba than actually contributing to the bottom line. Keeping staff numbers lean insures that what workers there are have no choice but to dedicate an increased percentage of their time to doing actual work.

    2) Companies are run by people and people overreact, especially when barraged by "information" about "the greatest downturn since the Great Depression". I'd like to see a survey of the media hype dedicated to this recession as compared to previous downturns. I have a feeling that there's actually a pretty strong correlation between words of press and the rate of unemployment.

    Feel free to call this correlation Belefant's Law, by the way, and tell your friends in Sweden while you're at it.

    Brian Belefant