Eurosclerosis Comes to the U.S.

Why the U.S. job market is beginning to look like Europe's.
The U.S. job market is beginning to look like Europe's.

This is a fourth post about VoxEU's new e-book on secular stagnation. The first gave an overview of the issue, the second discussed the decline in the equilibrium rate of interest, and the third looked at technology pessimism. This one asks whether the U.S. has contracted Eurosclerosis.

The secular-stagnation theory embraces three main possibilities. Each of them, or none, might be true. First, low inflation has so weakened the effectiveness of monetary policy that the post-crash gap between actual and potential output can't be closed. Second, despite appearances to the contrary, growth in output has slowed because of faltering technological progress. Third, the recession has forced a lot of people out of the labor market and, regardless of what happens to the output gap and technological progress, they aren't coming back.

This third issue is familiar to Europeans. Their rigid labor markets, they've long believed, made it harder than in the U.S. for the unemployed to find new jobs. If unemployment went up, it tended to stay up. The U.S. jobs market in contrast was famed for its flexibility. In the U.S., economic expansions brought unemployment down fast. For years, Europe's governments talked about making their labor markets more American.

These stereotypes need to be rethought. Edward Glaeser's chapter in the VoxEU collection looks at U.S. trends in male working-age nonemployment -- meaning not just the officially measured unemployed, but all men not working. Before the 1970s, the rate of nonemployment varied between 5 percent and 8 percent, but it's trended higher since. The crash pushed it to almost 20 percent, and six years on it's still more than 16 percent.

Glaeser, citing research on European unemployment by Olivier Blanchard and Justin Wolfers, blames an interaction of macroeconomic and microeconomic forces: Shortfalls of aggregate demand drive unemployment higher, and institutions unfriendly to employment keep it elevated. Which "institutions" exactly? Glaeser:

While the US social welfare system remains less generous than many European safety nets, it has become substantially more generous over time. The US has a bevy of social programs -- including Medicaid, the Supplemental Nutrition Assistance Program (food stamps), Temporary Aid to Needy Family, Section 8 Housing vouchers and insurance for both disability and unemployment -- that have generally increased in generosity over time, often for quite laudable reasons. These programs also sharply reduce the incentives to work, often by directly taxing earnings (both food stamps and Section 8 vouchers carry an independent 30% tax on earnings) and by making joblessness less miserable.

Perhaps the most important program connected to long-term joblessness is disability insurance. In 2010, 16.6% of Americans between 21 and 64 reported being disabled, and 11.4% reported a severe disability (Brault 2012). In 1970, 1.5 million Americans were receiving Federal disability insurance; in 2013, 8.9 million Americans received such aid (Social Security Administration 2014). This increase in disability is particularly startling given the general increase in US health over the same time period, and surely institutional changes, including those meant to reduce unemployment, have played some role in this dramatic increase (Autor and Duggan 2003).

This mostly accidental redesign of the U.S. social safety net needs to be revisited, Glaeser says. The disability-insurance system should be changed so that disabled workers don't need to quit the labor force entirely to qualify for help. Those who are capable of working -- as many are -- might qualify instead for, say, two years of help with rehabilitation, work placements and wage support. The authors of one such proposal estimate that this could keep between 1 million and 1.5 million extra workers in the labor force, at little or no net cost.

Another priority, Glaeser says, should be to fix the U.S.'s seriously inadequate education system. (Less than 40 percent of high school dropouts have a job.) This is an endlessly repeated suggestion, but no less valid for that. Better vocational training and support for apprenticeship programs, which Germany has used to good effect, are also worth exploring. Glaeser prefers raising the earned income tax credit (which subsidizes low-wage labor) to raising the minimum wage (which may discourage hiring). Perhaps eliminate Social Security taxes for the low-paid, as well.

All of those might sound like excellent ideas, but there's a problem. Different aspects of the secular-stagnation scenario can interact in confounding ways -- and these so-called structural remedies for long-term joblessness are a disturbing example.

How could it be a bad thing to move jobless people back into the labor force? Other things equal, you'd expect it to lower wages and hence prices -- which, ordinarily, would be fine, because the Federal Reserve would move to cut interest rates and stimulate demand. That way, you'd end up with higher output, employment and living standards. But if the interest rate is stuck at zero -- as under the output-gap variant of secular stagnation -- you can't stimulate demand that way. Adding to the labor supply might then worsen the deflationary pressure. In fact, under these circumstances, a increase in the labor supply could actually reduce aggregate employment, a perversity that's been called the "paradox of toil."

Secular stagnation in its various forms deserves to be taken most seriously. It's a complicated set of speculations with startling implications, including traps that turn good policy into bad policy. The easiest thing, for sure, is not to think about it and hope it goes away -- as, in the U.S. at least, it still might. Problem is, what if it doesn't?

Look at it this way: The demands of basic economic literacy have just increased. You need to grasp the rudiments of secular stagnation -- and, to repeat, there's no better way to do that than by reading VoxEU's e-book.

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