There is no doubt that the job market is depressed. But it is not so depressed as a 10.1 percent unemployment rate suggests, and its condition has far less to do with the current recession than many people imagine.
In fact, the unemployment rate has risen less since the beginning of this recession than it rose in four of our seven previous postwar recessions (1948-49, 1953-54, 1957-58, and 1973-75). Despite the fact that the unemployment rate is at its highest level in 40 years, on the basis of the increase so far, this recession does not qualify as the worst since the Great Depression.
Nor is the economy appreciably farther from "full employment" now than in some past recessions. When President Kennedy's Council of Economic Advisers first defined full employment as 4 percent unemployment, it chose a rate that the economy had been able to achieve without a war and with little inflation in the mid- 1950s. Since then, a number of demographic and institutional changes have pushed up the unemployment rate and made the economy prone to rapid inflation at higher rates of unemployment than 4 percent. Changes in the age-sex composition of the labor force, greater availability and generosity of unemployment benefits, extension of minimum-wage coverage to a larger segment of the economy and the inclusion of work registration requirements in some welfare programs have probably been the most important factors.
Economists have recognized for some time that the "full-employment unemployment rate" was rising. The Council of Economic Advisers judged that the economy was at full employment in 1973 when the unemployment rate was just under 5 percent. Today, many, if not most, economists would agree that an unemployment rate around 6.5 percent represents full employment.
If that is about right, we are no more distant from full employment now than in two earlier recessions. In the 1957-58 recession, when 4 percent unemployment represented full employment, the unemployment rate hit a peak of 7.5 percent. In the 1973-75 recession, when full employment was about 5 percent, the peak unemployment rate was 9 percent.
Even the increase in unemployment that has occurred during the present recession is not all due to the recession. From the beginning of the recession until this spring, the unemployment rate rose because employment declined. Since this spring, however, most of the increase in unemployment has come about because of a rise in the labor force participation rate -- the percentage of the working-age population that is either employed or actively looking for jobs. Without this increase in the participation rate, unemployment would have risen only from 9.4 percent in April to 9.5 percent in September.
The rise in labor force participation seems to have occurred in spite of the recession, not because of it. The participation rate is usually quite sensitive to changing job market conditions. In recessions, when employment declines, the participation rate usually falls. Some of the unemployed abandon their job search and leave the labor force, and some would-be job-seekers decide to postpone their search until the market improves.
What has happened in this recession is altogether different. Having shown only a slightly rising trend since 1979, the labor force participation rate was unchanged between July of last year and this April. Then, without any discernible evidence that the job market was improving, it took a sudden leap this spring, and from May through September has been at a new high level for the postwar period. Had the participation rate declined as in earlier recessions, the September unemployment rate would have been about a full percentage point lower than it was.
The puzzle is why more people have been entering or staying in the labor force under conditions that normally should have caused them to leave or stay out. Inflation caused large increases in labor force participation in the 1970s, but in the past year inflation has declined sharply.
One possible explanation is the unusual amount of uncertainty in recent months about when and how strongly the economy will recover. The unemployed may have been reluctant to give up their job search and leave the labor force at the same rate as in past recessions, and would-be job-seekers may have decided to start looking sooner, anticipating that a successful search would take longer than usual.
Another possibility is that the participation rate increase is a response to reductions in benefits from transfer programs and uncertainty about the availability of benefits in the future. Social Security, welfare, housing subsidies, grants and low-interest loans to students and similar benefits enable recipients and their families to maintain a certain standard of living with less work effort than would otherwise be required. The growth of transfers acted as a drag on labor force participation in the 1970s, when benefit levels were rising and payments or subsidies were being made available to a larger portion of the population. Reductions could be expected to have the opposite effect.
Also, the publicity given the escalating federal budget deficit this spring -- combined with publicity about the impending problems in the Social Security system -- may have convinced people that future benefits are uncertain and that they will have to rely more heavily on their own earnings.
If the labor force participation rate has increased mainly because of uncertainty about the economic recovery, it may fall somewhat once the recovery begins. That should help speed up the drop in unemployment.
On the other hand, if the participation rate has risen because of real and anticipated reductions in transfers,,it will probably stay high. If the economy and the job market eventually do enjoy a strong recovery, the higher participation rate may be a positive thing. There will be a larger labor supply available for economic growth. And, to the extent that people have anticipated reductions in transfer programs and been able to find jobs that make it possible for them to replace benefits with their own earnings, it should be easier to make real cuts in government spending.