The two gangs of economists warring over the causes of high unemployment.

Commentary about business and finance.
Aug. 24 2010 4:51 PM

Strucs vs. Cycs

The two gangs of economists warring over the causes of high unemployment.

Read more by James Ledbetter on Moneyblog.

Why is unemployment so high? Click image to expand.
Why is unemployment so high?

Here is a proposition: If the Obama administration felt that it had the power to lower the nation's unacceptably high unemployment to a level below where it stands today—11 weeks from a crucial midterm election—then, for moral and political reasons, it would have done so.

If for some reason you don't accept that proposition, you can probably stop reading.

But if you do accept it, at least one of these corollaries also follows: 1) The policies that the Obama administration has pursued to reduce unemployment have so far been inadequate to the task, and 2) The nature of 21st-century unemployment presents policy challenges that the administration did not anticipate, and to date has not been able to surmount.

So why has unemployment been harder to fix than the administration thought? Last week, Narayana Kocherlakota, the president of the Minneapolis Federal Reserve Bank, poked at these issues in a speech that got little attention from non-economists. Noting that job openings in recent months have increased but unemployment had surprisingly also gone up, he invoked the concept of "mismatch" and said: "Firms have jobs, but can't find appropriate workers. The workers want to work, but can't find appropriate jobs."

A handful of economists were quick to disagree, for an unsurprising reason: To state that chronically high unemployment is caused by forces beyond current economic woes is to suggest that government can't do anything to solve it. Instead, these economists insist, the problem is insufficient demand, which the government should do everything to try to stimulate. These critics are the "cyclical" theorists of unemployment (who generally advocate a second stimulus package), while Kocherlakota argues for "structural" causes (representing those who, like the majority of Americans, right now oppose a second stimulus). The question of stimulus is so polarizing that the two camps have practically hardened into street gangs—the Strucs and the Cycs—whose primary interest seems to be assaulting each other.

But what if it's not that simple? The choice between a cyclical theory and a structural theory of unemployment looks increasingly illusory. We should grant the Cycs that government attempts to stimulate demand have been too small. But how many Cycs are willing to refute with confidence that even if stimulus measures had been bigger, they might still only have solved a modest part of the problem?

Let's go back to Kocherlakota's speech. His idea of "mismatch" owes much to the work of Robert Shimer of the University of Chicago (the location alone brands Shimer as a Struc). At the core of Shimer's model of mismatch is the idea that "at any point in time, the skills and geographical location of unemployed workers are poorly matched with the skill requirements and location of job openings." That may sound basic to anyone who's ever tried to make a key hire, but much of the economic modeling of unemployment going back to the 1970s has been even cruder, looking only at the number of vacancies and the number of workers.

Stepping back from America's politicized debate, it is clear that at least some kind of mismatch is present. Torben Andersen, who teaches economics in Denmark, notes that among the 32 countries of the OECD, "the sectors adversely affected by the crisis (building sector, financial sector, export sector) are not necessarily those which would benefit from a more expansionary policy increasing public and/or private demand."

That suggests at least one limit to how effective government stimulus can be right now, and reflects back on our original proposition. For example, the Obama administration's mortgage tax-credit seems to have had some temporary effect on the purchase of homes. But stimulating demand will not alone revive the construction industry and restore the estimated 1.8 million jobs that it's lost in the last two years, certainly not anytime soon. Indeed, some pessimists believe that the construction sector will continue to shed millions more jobs, even as the economy continues its tepid recovery.

Shimer's theory goes deeper. In his September 2007 paper "Mismatch," he claims to be able to explain a large number of variables associated with unemployment and labor markets. His model purports to take into account, for example, why some unemployed people are more likely than others to find a job, and that some jobs and some workers are more likely to disappear than others. Thus, he claims the model can account for what appear to others as mysteries, such as why employers might not be raising wages to fill jobs that they complain they can't fill.

I'm not in a position to verify Shimer's work, though it seems well-argued and surprisingly comprehensive. But even if mismatch is not the fundamental problem we're facing, even if the real problem is primarily a lack of demand, the Cycs could be doing more to explore how and why demand may have changed to the point at which it is at least partially immune to traditional attempts at stimulus.

Mark Thoma of the University of Oregon has taken a couple of steps in this direction: "There are other things fiscal authorities can do to encourage structural transformations, e.g., investment tax credits, incentives to bring new businesses and the unemployed together by moving labor to the jobs or encouraging new businesses to locate where unemployment is highest, retraining programs, etc." Those solutions are a little cookie-cutter—retraining programs, at least as currently implemented, do not seem hugely effective—but at least Thoma is trying to think about real solutions to what may well be structural problems. And we need that, because maybe the Great Recession has done something more than increase the number of unemployed Americans: Maybe it has opened a curtain onto modern unemployment that relative prosperity had kept shut.

So in the interest of peace between the camps—and of lowered unemployment—here's a plea to each. Strucs: You've got to be more specific about exactly how much of current unemployment you think is structural, and explain what those structures are, so that those who believe that government might be able to help fix it can at least offer some ideas. And Cycs: You can start by acknowledging what is different about unemployment in this recession and so-called recovery, and give us targeted policy proposals, instead of vague exhortations to pump up demand.

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