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A Cure For Unemployment

Lee E. Ohanian, 11.18.09, 12:01 AM EST

Forget short-term fixes. Good long-run policies will create jobs.

President Obama recently announced that he will convene a White House summit next month to address the issue of unemployment, which rose to 10.2% in October, the highest rate in over 25 years. But perhaps even more concerning to policymakers is that employment continues to shrink substantially despite the worst of the financial crisis--extremely high risk spreads, the breakdown of interbank lending--being over.

For several months, the Fed has been winding down at least some of the measures it took last fall to stabilize financial markets. And as more than 2 million jobs have been lost since the roughest patch of the financial crisis ended late last winter, a growing number of policymakers are now calling for more short-run economic fixes. The tendency to grasp for short-run fixes during economic crises is all too common, reflecting the demands from at least some political constituents that policymakers "do something." This short-run "fix-it" mentality is particularly dangerous now because some proposals to deal with continuing job loss have deficient economic underpinnings.

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These proposals include an additional round of federal spending along the lines of February's $787 billion American Recovery and Reinvestment Act. I, and some other economists, expressed considerable reservations about the usefulness of this policy and predicted that it would not help the economy. While it is difficult to say how much employment would have changed in the absence of this program, the fact that more than 2 million jobs have been lost since the ARRA was announced raises questions about the efficacy of this policy and will make it politically challenging within Congress to pursue another major spending plan.

If large increases in federal spending are unlikely, other ideas that relate more directly to the labor market may receive attention, including the view that we should consider some European labor market programs, which are designed to share work among employees and stem job loss. But the long-run impact of European labor market policies--including employment protection policies, which penalize employers for laying off workers; work sharing, such as France's 35-hour week; and high tax rates in conjunction with large government transfers--is truly abysmal.

Let's begin with France. Would you be surprised to know that France has had virtually no net job creation--measured by total hours worked--for more than 50 years? Total hours worked in France today is lower than it was in 1950, despite significant population growth. And similar pictures emerge for many other Western and Northern European countries, including Austria, Belgium, Finland, Germany, Italy and Norway. This means that the standard measure of labor utilization--market hours worked per capita--has declined around 25% or more for a number of European countries. Many economists conclude that European labor market policies, including some that are being recommend today, are at least partially to blame for Europe's enormous drop in labor and output.

But even if economists generally agree on the long-run consequences of these labor market distortions, could they still offer some benefit in the short run? This is harder to say, because it has received much less research attention, but recent data from France is not promising. France adopted the 35-hour week in 2000. After this time, the pattern in total hours worked did not change, but productivity, which had been growing at more than 2% per year, faster than the average of other European countries, fell to about 1% per year, slower than the European average. Recent research by economists Victoria Osuna and Jose Victor Rios-Rull explains why at least some of this drop in productivity growth may be the consequence of work-sharing.

Jobs take some time to come back from recessions, but severe downturns tend to have faster recoveries. Typically, severe recessions are followed by recoveries in which about half of all job loss is restored within the first three quarters after he recession trough. But many economists do not expect a vigorous jobs recovery now and in fact worry that there will not be significant job growth until late next year. I agree that recovery may be slower this time, because policymaking over the last year--including enormous bailouts of financial institutions and automakers and an enormous expansion of the federal debt--has created substantial uncertainty about the future course of taxes and economic regulations and restrictions. Because there are significant costs associated with taking on new workers and adding new plant and equipment, business will tend to be cautious in adding new workers until they have a better sense of what economic policy will look like. Economists Nick Bloom and Nir Jaimovich of Stanford have conducted new research that shows economic uncertainty can have large depressing effects on the economy.

The impact of uncertainty is recognized by some in Congress, including Rep. Eric Cantor of Virginia, who when asked about job creation by the Los Angeles Times noted, "What we need to do is to lower the price of risk to increase the confidence of those investors and small-business people who are going to be the job creators. We also have to address the very real sense that small businesses are very nervous about committing capital right now."

If the president and Congress choose to eschew further short-run fixes and instead focus on sensible long-run policies for which there is broad support, then we should ultimately expect a vigorous jobs recovery. But if policy continues to focus on various short-run band-aids without improving long-run incentives and clarifying the policy environment, a significant jobs recovery may well elude us. This means that the best short-run policy for creating jobs is a good long-run policy.

Lee E. Ohanian is professor of economics and director, Ettinger Family Program in Macroeconomic Research, UCLA.

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