Government Jobs Have Been Cut in This Recession: This Has Hurt, Not Helped, the Recovery

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I.  Introduction

A Republican theme in this Presidential campaign, asserted repeatedly by Mitt Romney and other Republican leaders, is that a sharp expansion of government under Barack Obama is the cause of the weak job growth in the recovery from the 2008 collapse.  Romney laid out this theme most clearly in his policy address on economic issues last March (see here for a transcript).  I noted in this blog entry that the address was confused and full of factual errors, but it does represent what Romney said he believes.  More recently, in remarks in Iowa earlier this month, Romney said of Obama that, “he wants another stimulus, he wants to hire more government workers.  He says we need more fireman, more policeman, more teachers.  Did he not get the message of Wisconsin?  The American people did.  It’s time for us to cut back on government and help the American people.”

As I have noted in a number of entries in this blog, government has in fact been contracting rather than expanding during this economic recovery, and that indeed the resulting fiscal drag can account for the weakness of the recovery.  See, for example, the posts on fiscal drag during the recession (here and here); the reduction in total government employment (including state and local) during the period Obama has been in office (here and here), with federal government employment flat and non-defense federal employment falling (here); and on federal government spending that has in fact been close to flat during the Obama term, in contrast to the sharp increases under recent Republicans (here).

Given the importance and centrality of this issue in the weak recovery, it is important to get the facts right.  While the previous blogs have looked at the relationship of government spending in recent US economic downturns to the pace of recovery of GDP, they have not explicitly examined the assertion Romney and his Republican colleagues have now raised that higher government employment accounts for the slow recovery in jobs.

This can be done quickly, through a series of graphs.  The analysis here complements and extends the earlier blog post on fiscal drag as the principal cause of the weak recovery from the 2008 collapse, and the blog post on the path of employment during these downturns.

II.  The Data

First, total employment (both public and private) has fallen more in the current downturn than in any other in the US over the last four decades, and the recovery once it bottomed out has been relatively weak:

Recessions, index of total employment before and after peaks, US, 1970s until 2012

Total employment was falling at a rapid rate when Obama took office (and at that point, had fallen by more than had been the case in any other US downturn of the last four decades).  Actions taken by Obama at the start of his administration (as well as aggressive actions by the Fed) started right away to bend this curve, and within a year it had bottomed out.  Since then there has been positive and remarkably steady employment growth, but at too slow a pace given the depth to which employment had fallen to make up for the initial decline.  The path has been the weakest seen in any of the recoveries from the downturns the US has faced over the last four decades.

(Note:  The figure above, and the ones below on employment, go out for 18 quarters.  This carries the data to the second quarter for 2012 for the downturn that began in December 2007.  The employment figures are the averages for the periods, and the June 2012 figure, not yet published by the BLS, was estimated based on the April and May figures.)

The graph for total private employment is similar, although with a somewhat stronger fall initially, until it bottoms out following the measures early in Obama’s term, and then a somewhat stronger recovery.  Private employment is now above where it was when Obama took office, but it still has not made up for the sharp fall in the last year of the Bush administration:

Recessions, index of total private employment before and after peaks, US, 1970s until 2012

In contrast, total government employment (including state and local, as well as federal) has followed a different pattern.  In contrast to private employment, it did not fall initially (during the last year of the Bush administration).  But once Obama took office, it has fallen steadily except for the temporary blip seen in the 10th quarter after the onset of the downturn, due to the temporary hiring for the decennial census in the Spring of 2010:

Recessions, index of total government employment before and after peaks, US, 1970s until 2012

The fall in government employment was particularly sharp once Obama took office, as can be seen more clearly in a graph which re-bases the data to equal 100 in the fifth quarter following the business cycle peak:

Recessions, index of total government employment starting fifth quarter after peaks, US, 1970s until 2012

In no other downturn has the US had such a cut-back in government employment.  Yet Romney and his Republican colleagues are arguing for even greater cut-backs, including for firemen, policemen, and teachers, as Romney stated in the quotation copied above.

Looking closely at the two graphs above on government employment, one might note that while the reductions in government employment were greater under Obama and in the most recent downturn than in any other, the second smallest was in the recovery following the January 1980 downturn.  This period was initially under Carter (for four quarters) and then under Reagan.  Since I have noted before in this blog that had government grown under Obama at the pace seen under Reagan, the economy would now be at close to full employment, is there a contradiction here?

The answer is no.  First, one should note that the “recovery” from the January 1980 downturn merges into that from the July 1981 downturn (but leading by six quarters), as the economy went into a new recession a half year after Reagan took office.  Reagan did cut back on government employment initially, before allowing it to grow.  Hence the paths followed by the green (July 1981) lines in the graphs above are more directly related to Reagan’s policies than those indicated by the blue (January 1980) lines.

Second and more fundamentally, the importance of the government sector to the economy and its recovery is more related to overall government expenditures than to simply the number of government employees.  Romney and his Republican colleagues are simply missing this point when they focus their criticisms on the number of government workers.  Reagan expanded government spending, but the focus was on things like defense expenditures rather than the number of school teachers.  Defense expenditures are done under contract to private companies (much of it to a few giant companies such as Boeing and Lockheed).  Building modern jet fighters and naval ships can be very labor intensive, but these are employees of private contractors, and are not directly classified as government workers.

The paths can be seen in the following graphs, similar to ones presented in the earlier blog, but now with 17 quarters shown rather than 16 (as there is now one quarter of additional GDP data available):

US recessions 1970-2012, total government expenditures before and after business cycle peaks

US recessions 1970-2012, total government expenditures from fifth quarter after business cycle peaks

Growth in government spending during the Reagan periods (the blue and green paths) is the highest of all, especially when one starts five quarters from the cyclical peaks (when Obama took office).

III.  Conclusion

In summary, if there was any basis for the belief of Romney and his Republican colleagues that cut-backs in government employment and spending would lead to strong growth, then the economy would be booming right now.  Government employment and spending in the current downturn, especially once Obama took office in January 2009, have been below the paths followed in each of the other downturns the US has faced over the last four decades.

The recovery has been weak because there has been weak demand for the goods and services that business could produce.  There is no point in hiring a worker to make something if you cannot then sell it.  Government demand has been weak, as seen in the graphs above, due to strong Republican opposition.  Investment demand has been weak, despite record low interest rates and high cash balances on corporate balance sheets, since there is surplus production capacity.  There is little point in investing to build even more capacity when what you have is not being fully utilized.  Consumer demand has been weak, both because of weak incomes (the high unemployment and depressed wages for those who are employed) and because of the collapse of the housing bubble, which wrecked household wealth.  And global demand has been weak, due to crises in Europe (with its own mis-guided policies focussed on austerity) and elsewhere.

The cause of this weak recovery is not that government has grown rapidly, but rather that is hasn’t.

Employment is Deteriorating

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US weekly initial claims for unemployment insurance, June 18, 2011, to June 16, 2012

The Bureau of Labor Statistics released this morning its regular weekly report on the number of American workers who had filed initial claims for unemployment insurance.  Although there is a good deal of noise in this weekly data (so some analysts focus on the four-week moving average rather than on the weekly figures themselves), the report provides a useful early indication of developments in the labor market.

It is now clear that the labor market situation is deteriorating.  The graph above shows the figures (for both the weekly initial claims and for the four-week moving average) for the last year.  The trend was improving (weekly initial claims were falling) until mid to late March of this year.  But it is now clear that there was a turn at that point, with the employment situation since then worsening.  Using the four-week moving average, initial claims for unemployment insurance rose from 363,000 in late March, to 386,250 in the most recent figure.

Keep in mind that with normal churn in the labor market, there will always be initial claims for unemployment insurance.  Even with the economy at full employment, weekly initial claims will be at about 310,000 to 320,000 given the size of and extent of turnover in the US labor force (see the figure below for the numbers in 2006 and early 2007, before the downturn).  And the rise in the weekly rate of initial claims for unemployment insurance could still be consistent with positive net job growth each month.  The labor force is growing over time, although with significant month to month fluctuation in the number of people entering and leaving the labor force.

Nevertheless, the turnaround and sustained increase in the weekly figure on initial claims for unemployment insurance is likely to be a signal that the unemployment rate may now start to rise for a period.  This can be seen by looking at the initial claims figure in a longer term context, and correlating that with the overall unemployment rate.

US weekly initial claims for unemployment insurance, July 1, 2006, to June 16, 2012

US unemployment rate, July 2006 to May 2012

The first figure shows the weekly initial claims figure (four-week moving average) for the period from July 1, 2006, to now.  The second shows the unemployment rate.  The sharp rise in the initial claims figure in the last year of the Bush Administration is clear, with a peak reached just after Obama took office.  With new measures such as the Stimulus Bill (passed in February 2009) and other actions (such as continued aggressive measures by the US Federal Reserve Board), the economy started to turn around, and new claims for unemployment insurance began to diminish.  But while the weekly pace was reduced, it was still high, and the overall rate of unemployment continued to rise for a period before starting to fall.

The recovery has been weak, however.  As noted previously in this blog (such as here, and here), fiscal drag from falling government expenditures (mainly at the state and local level, but also weakness at the federal level) can by itself account for this slow and weak recovery.  And as seen in the figure above, in this weak recovery there have been two periods (between May and August 2010, and between March and June 2011) when initial claims reversed its downward path and began to rise for a period.  In each of these times, the unemployment rate also then started to rise for about half a year (from June to November 2010, and from March to June/July/August 2011).

The blip upwards of the unemployment rate last month to 8.2% from the earlier 8.1%, might therefore not be a fluke, but rather a signal of further weakness to come.  Such a rise in the unemployment rate in the half year before an election should be particularly worrisome to any incumbent seeking re-election.  And all this is unfortunately also consistent with the prediction made in this blog in January (see posting here), that despite what looked like an acceleration of growth in the second half of 2011, growth in 2012 could be weak.  It appears that is what is happening.

The Long-Term Rise in Federal Debt is Due to the Bush Tax Cuts

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US Federal Government Debt to GDP ratio, CBO long-term projection, 2000 to 2037The Congressional Budget Office released yesterday its regular annual report on the long-term budget outlook for the federal government.  Surprisingly, it did not receive much attention in the press (at least not yet).  But the implications of the projections it has made are important:  They basically indicate that were it not for the Bush Tax Cuts passed in 2001 and 2003, we would not be facing a long-term fiscal problem.  That is, if tax rates were allowed to return to those we had during the Clinton years, along with some near term control on spending, federal government debt as a share of GDP would stabilize and then fall.  And since the economy prospered during the Clinton years, there is no support for the argument that such tax rates would stifle long run growth.

The results are consistent with projections made in a posting on this blog on February 11, 2012.  In that blog, results are shown from calculations (based on underlying CBO numbers) which demonstrated that phasing out the Bush Tax Cuts would lead the federal government debt to GDP ratio to start to fall.  The new CBO numbers, with calculations by their staff rather than myself, back this up.

The figure above shows the CBO projections of federal debt (held by the public) as a share of GDP, for the period FY2000 to FY2037, under two scenarios.  Under CBO’s Baseline Scenario, current law is followed in all respects.  This includes that the Bush Tax Cuts would be allowed to expire (as currently provided by law) at the end of 2012, and that the budget cuts mandated by the 2011 Budget Control Act for the period 2013 to 2022 (if Congress failed to make similar cuts before then) would be implemented.  Medical payments to doctors made by Medicare would also be cut (as per a law passed by the then Republican Congress in 1997, but then over-ridden annually since then), while over the longer term, the growth in medical costs would be moderated through the implementation of measures passed in the “ObamaCare” reforms.

Under the Alternative Fiscal Scenario, the Bush Tax Cuts would all be extended permanently, the 2013 to 2022 mandated budget cuts would not be made, after 2022 budget expenditures would be raised further to historical levels (as a share of GDP), medical payments to doctors would not be cut but rather kept at current levels, and the ObamaCare medical cost reforms would not be implemented, so medical costs would rise compared to the costs in the Baseline Scenario.

The CBO also mechanically extrapolated the underlying numbers under the two scenarios all the way to 2087, but wisely focussed on the period to 2037 (the next twenty-five years).  The longer term numbers are subject to much uncertainty.  The diagram above presents the CBO numbers to 2037.

What is striking is that the figure above shows that under the Baseline Scenario, where current law is followed and in particular the Bush Tax Cuts are allowed to expire, the federal government debt to GDP ratio peaks in 2013 and then immediately starts to fall.  Indeed, the long-term numbers extended mechanically to 2085 indicate that the federal government debt would fall to zero in 2069.  In contrast, the debt to GDP ratio grows explosively upwards under the Alternative Fiscal Scenario.

It was noted above that a number of changes are made in the Alternative Fiscal Scenario compared to the Baseline Scenario, affecting both tax revenues and spending.  However, one can calculate from the underlying data released by the CBO along with its report (in spreadsheet form at the CBO site), that 76% of the higher deficits in the Alternative Scenario over the key period 2013 to 2022 would be due to the lower revenues following from the Bush Tax Cuts.  Higher government spending other than on medical expenditures accounted for 18% of the higher deficits, while higher spending on medical costs (principally for doctors over this period) accounted for only 6% of the higher deficits.

That is, lower revenues due to the Bush Tax Cuts account for three-quarters of the difference in the deficits between what one would have under the Baseline Scenario and what one would have under the Alternative Fiscal Scenario.  Given the extent of the decline in the debt to GDP ratio that one sees under the Baseline Scenario, it is likely that allowing the Bush Tax Cuts to expire would alone suffice to lead that ratio to start to fall in these new CBO scenarios.  My February 11 posting on this blog did find this.  But it should be noted that the new CBO scenarios included other factors as well in its projections, which accounted for one-quarter of the reduction in deficits.  The report does not show a scenario focused exclusively on the impact of the Tax Cuts.

It should be emphasized that no one, and certainly not myself, is arguing that the Baseline Scenario should be followed in all respects.  Doctor payments under Medicare should certainly not be allowed to be cut sharply as they would if the annual “Medicare doc fix” were not extended.  Nor, I would strongly stress, should all the crude and across-the-board spending cuts mandated by the 2011 Budget Control Act  be allowed to go through.

The basic point, rather, is that drastic cuts in entitlement programs such as Social Security and Medicare are not absolutely necessary for the US to achieve budget balance, despite what Mitt Romney, Congressman Paul Ryan, and other Republicans have asserted.  What the CBO scenarios show is that the Bush Tax Cuts have led to the US fiscal debt problem, and that simply allowing these Tax Cuts to expire would likely suffice to fix that problem.  The US debt spirals out of control due to the Bush Tax Cuts.

To fix a problem, it is important to know the source.  The CBO scenarios make clear that the primary source of the exploding federal government debt is the Bush Tax Cuts.  And while I would not advocate an immediate re-instatement of tax rates to their previous levels, since the economy remains weak, phasing out the Bush Tax Cuts over the next few years would suffice to resolve the fiscal problems we face.