Stimulus Provides Growth, Can't Attack Structural Unemployment

Yesterday, Paul Krugman wrote that the stimulus is working in textbook fashion, but is too small to tackle the employment challenge:

Not that long ago the U.S. economy was in free fall. Without the recovery act, the free fall would probably have continued, as unemployed workers slashed their spending, cash-strapped state and local governments engaged in mass layoffs, and more.

The stimulus didn’t completely eliminate these effects, but it was enough to break the vicious circle of economic decline. Aid to the unemployed and help for state and local governments were probably the most important factors. If you want to see the recovery act in action, visit a classroom: your local school probably would have had to fire a lot of teachers if the stimulus hadn’t been enacted.

And the free fall has ended. Last week’s G.D.P. report showed the economy growing again, at a better-than-expected annual rate of 3.5 percent. As Mark Zandi of Moody’s Economy.com put it in recent testimony, “The stimulus is doing what it was supposed to do: short-circuit the recession and spur recovery.”

But it’s not doing enough.

Suppose that the economy were to keep growing at 3.5 percent. If that happened, unemployment would eventually start falling — but very, very slowly. The experience of the Clinton era, when the economy grew at an average rate of 3.7 percent for eight years (did you know that?) suggests that at current growth rates we’d be lucky to see the unemployment rate fall by half a percentage point per year, meaning that it would take a decade to return to something like full employment.

Worse yet, it’s far from clear that growth will continue at this rate. The effects of the stimulus will build over time — it’s still likely to create or save a total of around three million jobs — but its peak impact on the growth of G.D.P. (as opposed to its level) is already behind us. [more on that here] Solid growth will continue only if private spending takes up the baton as the effect of the stimulus fades. And so far there’s no sign that this is happening.

The absolutely massive challenge that Krugman highlights is made even worse by this fact, often cited by Rob Shapiro: In the 2002-2007 expansion, private employment grew at less than half the rate, relative to growth, as it did in the expansions of the 1980s and 1990s. This means that Krugman’s projection of a decade for how long it would take to return to full employment could very well be optimistic.

The reason is that a lot of the unemployment we’re seeing isn’t just a standard lag, it’s structural. Take a look at this graph, posted by Mark Thoma:

What this says is that over 2% of the non-institutional adult population has been unemployed for over six months, an unprecedented number. As Brad DeLong points out, “long-term unemployment has a way of turning into structural unemployment.” America needs a strategy to fix this dynamic, or we're looking at a lot of people who are basically out of the workforce permanently.