The (Lack of) Recovery in the Employment to Population Ratio: Not the Concern It Might Appear to Be

Employment to Population Ratios, Jan 2007 to July 2014

Unemployment Rates, Ages 25 to 54, Jan 2007 to July 2014A.  Introduction

A critically important policy question is how close the US economy now is to full employment.  The unemployment rate has been falling, albeit slowly, from a peak of 10.0% in October 2009, to a current 6.2% as of mid-July (ticking up from 6.1% in June, but a 0.1% change is not statistically significant).  That is, the unemployment rate has come down by a bit less than 4% points from its peak.

However, some have noted that one does not see such a recovery if one focusses on the employment to population ratio.  Excellent analysts, such as Paul Krugman and Brad DeLong, have argued that one should.  If the unemployment rate has come down by close to 4% points, then the employment to population ratio should have gone by almost the same in percentage points unless people are dropping out of the labor force.  [It will not go up by exactly the same amount in percentage points since the base for the employment to population ratio is population while the unemployment rate is expressed as a share of the labor force.  But, all else equal, they will be close.  One could make the relationship exact by expressing the unemployment rate in terms of the share of population rather than share of the labor force, but this is not how the unemployment rate is normally reported.]

If the employment to population rate has not recovered by the same amount (in percentage points) as the unemployment rate has, then by arithmetic this is only possible if the labor force participation rate has come down.  The concern is that the pool of unemployed is coming down not because people are finding jobs (which would then be seen in a rising employment to population ratio), but rather because they are dropping out of the labor force after trying, but failing, to find a decent job (thus lowering the labor force participation rate).

There are of course demographic factors as well to take into account to explain what might be happening to the labor force participation rate, in particular the increasing share of the baby boom generation that is reaching normal retirement age.  One way to do this is to focus the analysis on the prime working age group of those aged 25 to 54 only.  All the charts in this post therefore do this.  But even with this refinement, the apparent concern remains:  The employment to population ratio does not show the same recovery that one sees in the falling unemployment rate.  What is going on?

B.  Recent Years

The chart at the top of this post shows the employment to population ratios from January 2007 to July 2014, for those aged 25 to 54, and for everyone together as well as for males and females separately.  The chart below it shows the unemployment rates for these same groups.  The data all come from the Bureau of Labor Statistics.  The peak unemployment rate was hit in October 2009, after which there was a fairly steady recovery.  [The month to month fluctuations mostly reflect statistical noise.  The employment, unemployment, and labor force participation figures are all based on surveys of households, and there will be statistical noise in any such surveys.]

For the group as a whole (male and female), the unemployment rate for those aged 25 to 54 rose by about 5% points between late 2007 / early 2008 and its peak in October 2009.  Over this period the employment to population ratio fell by a similar 5% points.

But this relationship then broke down going forward.  Over the two years between October 2009 and October 2011, for example, the unemployment rate for those aged 25 to 54 fell by 1.1 percentage points, dropping to 7.9% from 9.0% at the peak (for this age group).  But the employment to population ratio hardly moved.  And between October 2009 and the most recent figures (for July 2014), the unemployment rate came down 3.8% points, while the employment to population ratio rose by only 1.6% points.

The question for policy makers is whether the 3.8% fall in the unemployment rate is a reasonable measure of how far the economy has recovered from the 2008 collapse, or the 1.6% recovery in the employment to population ratio is.  As noted above, both the unemployment rate and the employment to population ratio deteriorated by 5% points during the 2008 collapse and follow-on into 2009.  If the 3.8% recovery in the unemployment rate is the right indicator, then we would have retraced about three-quarters of the fall (3.8/5.0 = 0.76).  But if the 1.6% recovery in the employment to population ratio is the right indicator, then we are less than one-third of the way (1.6/5.0 = .32) back.  This is a huge difference.

Since the difference between the two measures must be reflected, by arithmetic, in a declining labor force participation rate, one needs to look there to see what is going on.  For the January 2007 to July 2014 period, the picture is:

Labor Force Participation Rates, Jan 2007 to July 2014

The rates are all falling after October 2009, for males and females, and hence for the two combined.  What is interesting is that they appear to be falling at a fairly steady pace throughout the period (aside from the month to month squiggles that are mostly statistical noise).  And for males, the rate appears to be falling at a broadly similar pace before October 2009.  The trend is not so clear for females before October 2009, whose rate may have been rising until a few months before October 2009.  This then leads to little change in the overall rate for males and females combined, but the period is so short that the trends are not clear.

C.  A Longer Term Perspective

When one then takes a longer view, the trends do become clear:

Labor Force Participation Rates, Jan 1948 to July 2014

Going back to 1948 (the first year in the BLS series for all these labor market indicators), one sees a pretty steady fall in the labor force participation rate for males from around the mid-1950s (with the squiggles in the curves due to statistical noise), and a strong rise in the female labor force participation rate from the initial year with data (1948) to around 2000.  There was some acceleration in the rise for females in the 1970s, and then a deceleration from the early 1990s, leading to a leveling off around 2000.  Since then, the labor force participation rate for females has fallen, on a path that appears to parallel the similar fall in the rate for males, but at 14 to 15% points lower.

The data are consistent with the broader socio-economic story we have of the labor market in the post-World War II period.  Male labor force participation rates are quite high, but have fallen some over time.  Female rates started very low but then grew, and grew at an especially rapid rate starting in the 1970s.  Female labor market participation rates then reached maturity and leveled off around 2000, after which the female rates paralleled the downward path of the male rates, but at a certain distance below.

In this longer term perspective, the decline in the labor force participation rates since 2009 therefore does not appear to be unusual, but rather a continuation of the longer term trend.  There have been some small fluctuations around the long term trends in recent years that appear to coincide with the business cycle (in particular for the female rates), but they are small and dominated over time by the long term trends.  There have also been similar fluctuations in the participation rates in the past (such as in the mid-1990s) that did not coincide in the same way with the business cycle, as well as large business cycle changes in the past that did not show such fluctuations (such as during the big downturn in the early 1980s at the start of the Reagan presidency, that did not lead to such fluctuations in the labor force participation rates).

The implication of this analysis is that the reported unemployment rates are a better indicator of the state of the labor market than the employment to population ratio is.  The fall in the labor market participation rates in recent years has not been something new, driven by the 2008 economic downturn, but rather a continuation of the trend seen in these rates over the longer term.

Looking at unemployment rates for this age group going back to 1948 provides a useful perspective on what to expect for it:

Unemployment Rates, Jan 1948 to July 2014

Unemployment rates continue to be high in mid-2014.  Even though they have retraced about three-quarters of the deterioration in 2008/2009 (more for males, less for females), they are, at 5.2% currently (for males and females together) still well above the unemployment rates for this group of about 4% in late 2007 /early 2008, and of only 3 1/2% in late 2006 / early 2007.  And the unemployment rate for this group was only 3.0% in late 2000, at the end of the Clinton years.

There is therefore still a significant distance to go before the economy will have returned to full employment.  But the improvement since October 2009 is substantial, and is real.

D.  Implications of the Long Term Trends for Aggregate GDP

Finally, while the employment to population ratio might not be a good indicator of how much slack there is in the labor market in the short run, there are long term implications of the trends noted above.  Specifically, while the overall labor force participation rate rose steadily from 1948 (the earliest year for which we have this data) to about 2000, this was entirely due to the strong rise in the female rate over this period.  The male rate was falling, steadily but slowly.  Once the female rate peaked in the year 2000 and then began to fall at a rate similar to that for males, the overall rate began to fall.  There is no indication this will be reversed any time soon.  Indeed, the degree to which the female rate is now paralleling the male rate suggests that this really is a “new normal”.

A falling labor force participation rate is not necessarily an indication of something bad in itself.  It might reflect increased prosperity, which is being enjoyed by choosing not to work but to retire early, or to attend university or post-graduate education programs in your 20s, or to stay at home and raise a family.  But to the extent it reflects lack of free choice, such as being fired in your 40s or 50s and then not being able to find a job, or to remain a perpetual student due to lack of job opportunities, or to stay at home due to the unavailability of affordable child care, the implications are different.  But it is well beyond the scope of this blog post to dig into this deeper.

But there will be important long term implications of declining labor force participation rates on long term GDP growth.  With fewer in the labor force, aggregate GDP growth will be less.  Note that this does not imply growth in GDP per capita (or more precisely, GDP per worker) will be less.  GDP per worker is a function of productivity growth.  But with fewer workers than otherwise, aggregate GDP growth will be less.

Two final charts, then, to close this blog post.  The first shows the absolute number of people in the ages 25 to 54 population cohort, who are not in the labor force:

Population Not in Labor Force, Jan 1948 to July 2014

The number of males in this age group not in the labor force has been growing steadily since the late 1960s.  The number of females not in the labor force fell until around 1990, was then flat for a decade, and then began to grow.  Overall, the number aged 25 to 54 not in the labor force started to grow around 1990, and has continued to grow since.

Looking at the numbers of those in the 25 to 54 age group in the labor force:

Labor Force Number, Jan 1948 to July 2014

Due to a growing population in this age group (baby boomers, for example, but others as well), and the growing labor force participation rates of females until 2000, the total labor force in this group rose from the starting year (1948) until 2008.  It grew especially fast in the 1970s, 80s, and 90s.  But the absolute size of the labor force (in the 25 to 54 age group) then started to fall from 2008.  This is a historic change for the US, and based on the fall in labor force participation rates discussed above, as well as slowing population growth, should be expected to continue.  While GDP growth per capita (or per worker) might continue to grow as it has in the past (and it has grown at a remarkably consistent 1.9% a year since 1870 in the US, as discussed in this earlier blog post), one should expect aggregate GDP growth to slow.

E.  Summary and Conclusion

The unemployment rate has fallen substantially since hitting its peak in October 2009, but one does not see a similar recovery in the employment to population ratio.  The labor force participation rate therefore has to have fallen.  However, it does not appear that this fall in the labor force participation rate has been driven by the economic downturn, where high unemployment and poor job prospects led workers to drop out of the labor force on a widespread basis.  Rather it appears largely to be a continuation of longer term trends, that become clear when one separates out the paths for male and female labor force participation rates.

The implication is that the unemployment rate is probably a good indicator of how much slack there is in the labor force.  The unemployment rate has retraced about three-quarters of the rise during the 2008/2009 downturn, but is still high.  And it is substantially higher than what was seen as possible in late 2006 / early 2007, and especially the rate achieved in late 2000.

But there are longer term implications.  The analysis suggests that we should not expect much of a recovery in the labor force participation rate when the economy finally returns to full employment.  Rather, the labor force participation rate is on a downward slope, and has been since the year 2000 (when the female rates reached maturity).  This is likely to continue.  The result is that the absolute size of the labor force in the prime working age years of 25 to 54 should be expected to continue to fall for the foreseeable future.  Japan and most of the European economies have already been facing this.  While GDP per worker, which is driven by productivity change, need not necessarily slow, one should expect growth in aggregate GDP to be less than what one saw in the past.  The ability to adapt to, and manage in, this new economic environment remains to be seen.

Rising Income Inequality: Full Employment Would Have Kept the Bottom 20% From Falling Behind

Real Income Growth of Bottom 20% vs Unemployment Rate, 1968-2012

A.  Introduction

President Obama highlighted in this year’s State of the Union address, as well as in other recent speeches and events, the importance of and concerns about the worsening distribution of income in the US.  As this blog noted in a post two years ago, income distribution has worsened markedly in the US since about 1980, when Reagan was elected.  This deterioration since 1980 is in sharp contrast to the period from the end of World War II until 1980, when incomes of all groups in the US moved upward together.  The paths then diverged sharply after 1980, with large increases in the incomes of the rich (and in particular the extremely rich:  the top 1%, top 0.1%, and especially the top 0.01%), while the real incomes of the bottom 90% were flat or even falling.

An important question, of course, is what to do to achieve more equitable growth, and in particular more rapid growth in the real incomes of those in the lower strata of the population.  Much of the discussion has focussed on measures such as improving our educational and training systems, to prepare workers for better paying jobs.  There is no doubt that such measures are important, and need to be done.  Their impact will, however, only be over the long term – in a generation for measures such as improvements in the educational system.

This blog post will focus on a more immediate action that can be taken:  returning the economy to full employment and keeping it there.  We will find that based on historic patterns, slack in the labor market due to less than full employment has been negatively associated with growth in the real incomes of the bottom 20% of households.  Furthermore, based on statistical regression parameters estimated from the historical data, the greater degree of slack in the US labor market since 1980 compared to that in the thirty years before 1980, largely suffices in itself to account for the relative deterioration of real incomes since 1980 of the bottom 20% of households compared to the top 20%.

This is an important result.  Note that the claim is not that greater slack in the labor market (on average) in the decades since 1980 was the sole cause of the deterioration of relative incomes of the poorest 20% vs. the richest 20%.  There were undoubtedly numerous reasons for this.  But what the finding does indicate is that had the unemployment rate after 1980 matched what it had been in the three decades before 1980, this would have largely sufficed in itself to offset the other factors, and would have led to a rate of growth in the real incomes of the bottom 20% close to what it was for the top 20%.

B.  The Relationship Between Real Income Growth of the Bottom 20% and the Unemployment Rate

The scatter diagram at the top of this post shows the relationship between the annual real income growth of the bottom 20% of households since 1968, and the average rate of unemployment in the same year.  The income data for the bottom 20% comes from the series produced by the US Census Bureau, and measures household cash income before tax and from all cash sources (so it will include Social Security, for example, but not payments under Medicare).  The series starts in 1967 (so 1968 is the first year for which one can compute the growth), and goes to 2012.  The unemployment rate comes from the standard series produced by the US Bureau of Labor Statistics, where the annual rate is the simple average of the monthly rates over the year.

The scatter diagram suggests there is a relationship between slack in the labor market (a higher unemployment rate) and the annual change in the real incomes of the bottom 20% of households, but that it is by no means a tight one.  Other factors matter as well.  But a simple ordinary least squares regression of the annual change in the real incomes of the bottom 20% against the average unemployment rate in that year, does suggest that the unemployment rate is an important and statistically significant factor.

The regression fitted line slopes downward with a coefficient of -0.8228, indicating that on average, a 1% point increase in the unemployment rate in the year will be associated with a 0.8228% point fall in the growth rate that year of the real incomes of the bottom 20%.  The t-statistic on the 0.8228 slope coefficient is 3.3, where any t-statistic greater than about 2.0 is generally seen as statistically significant (with a greater than 95% degree of confidence).  That is, with a greater than 95% degree of confidence, the results suggest that the coefficient is significantly different from zero (where zero would indicate no relationship).

The R-squared of the regression (an indication of correlation) is relatively modest at just 0.1982.  It can vary from zero to one.  This indicates that there is more than just the unemployment rate that accounts for the annual change in the real incomes of the bottom 20%.  But this does not mean that the unemployment rate does not matter.  The t-statistic for it is highly significant.  Rather, the modest R-squared indicates there are other factors as well which have not been identified here.

Similar regressions were run for the changes in the real incomes of the other quintiles of the household income groups.  The estimated coefficients became progressively closer to zero, from -0.82 for the bottom 20%, to -0.62 for the second 20%, to -0.52 for the middle 20%, to -0.47 for the fourth 20%, and then dropping sharply to -0.25 for the top 20%.  This suggests that the link to unemployment as a factor explaining the growth in the real incomes of the group became progressively less important for the richer groups.  And the t-statistic for the coefficient for the top 20% was only 1.0, indicating the estimated coefficient (of -0.25) was statistically not significantly different from zero (and hence that one cannot reject the hypothesis that no relationship is there).  The R-squareds for the regressions similarly fell steadily, from 0.1982 for the bottom 20%, to 0.19 for the second 20%, to 0.16 for the middle 20%, to 0.14 for the fourth 20%, and then dropping sharply to an extremely low 0.02 for the top 20%.

The results suggest that slackness in the labor market, as measured by the unemployment rate, was a significant factor in explaining the annual growth in the real incomes of the bottom 20% (with more unemployment leading to lower or indeed negative growth).  The results also suggest that higher unemployment did not have a statistically significant impact on the growth in real incomes of the top 20%.

C.  The Impact of Less Slack in the Labor Market

From 1950 to 1979, when growth was similar for all income groups (see this earlier blog post), the monthly unemployment rate averaged 5.17% in the US.  But from 1980 to 2012, the monthly rate averaged 6.44%, or 1.27% points higher.  The index of real incomes of the bottom 20% of households (in the US Census data cited above) had risen from 100.0 in 1967 (the earliest year with such data) to an index value of 118.9 in 1980.  But since then it has risen hardly at all, reaching only 119.5 in 2012.  The 1980 to 2012 growth rate was only 0.015% per year (note not 1.5% per year, but rather only one-hundreth of that).

Suppose the labor markets over 1980 to 2012 had been as close to full employment as they had been over the period 1950 to 1979.  Applying the estimated regression coefficient of -0.8228 to the 1.27% point difference in the average unemployment rates, the annual growth rate of the real incomes of the bottom 20% would have been 1.045% points higher (equal to 0.8228 x 1.27% points), and hence would have reached a growth rate of 1.06% a year (equal to 1.045% + 0.015%).  With such a growth rate, the real incomes of the bottom 20% would have reached an index value of 166.5 in 2012  This would have been close to the index value of the real incomes of the top 20% in that year of 169.8 (with 1967 set equal to 100.0).  Relative incomes would have grown similarly since 1967, and inequality (for the bottom 20% compared to the top 20%) would not have grown.

This is an interesting result.  It suggests that the higher unemployment rates we have on average suffered from since 1980 can account both for the stagnation of the real incomes of the bottom 20%, and the increasing inequality when comparing this group to the top 20%.  Note it does not offset all of the increasing inequality seen since Reagan was elected.  The real incomes of the top 1%, top 0.1%, and especially the top 0.01% have grown by far more than the incomes of the top 20%.  But keeping up with the top 20% would still be a major accomplishment.

A return to the economic performance that the US enjoyed in the three decades before Reagan would not be impossible.  To keep the average unemployment rate at the 5.17% rate achieved between 1950 and 1979 would not mean that all recessions need be avoided.  There were a number of recessions in the three decades before 1980.  But the recessions since 1980 (dating from January 1980 at the end of the Carter Administration, from July 1981 at the beginning of Reagan, from July 1990 during Bush I, from March 2001 at the beginning of Bush II and December 2007 at the end of Bush II) have been especially severe.  Avoiding those high peak rates of unemployment would have brought down the average.  Specifically, the average unemployment rate (based on the monthly figures) over 1980 to 2012 would have matched the 1950 to 1979 average if one would have been able to avoid those months since 1980 when the unemployment rate reached 6.4% or more.

D.  Conclusion

There is increasing recognition that the rise in inequality in the decades since 1980, and the stagnation since then in the real incomes of those in the lower strata of the population, cannot go on.  But the solutions commonly proposed, such as better education and training, will take decades to have an impact.

The analysis in this post indicates that the more immediate action of bringing the economy back to full employment and then keeping it close to full employment, would have a major positive impact on the real incomes of those in the bottom 20% of households, and would lead to a more equitable distribution.  The analysis suggests that had the unemployment rate over 1980 to 2012 been at the level achieved over 1950 to 1979, then the rate of income growth of the bottom 20% since 1980 would have been similar to that of the top 20%.  The higher rate of unemployment since 1980, on average, may well explain why growth was broadly equal among income groups in the three decades before 1980, but not in the three decades since.

While there are many factors that underlie income growth and distributional changes, particularly for those at the very top of the income distribution (the top 1% and higher), the results suggest that getting the economy back to full employment should be seen as critically important and valuable.  And there is no mystery in how to do this:  As earlier posts on this blog have noted, the fiscal drag from government cutbacks since 2009 can fully explain why full employment has yet to be achieved in this recovery.  Had government been spending been allowed to grow simply at its historical average rate, the economy would already have returned to full employment by now.  Had government spending been allowed to grow at the higher rate it had under Reagan, the US would likely have been back at full employment in 2011 or early 2012.

Unemployment matters.  Not only is it a direct and personal tragedy for those who have lost a job because of the macro mismanagement of the economy, it is also a waste of resources for the economy.  The evidence reviewed in this post suggests further that the greater degree of slack in the US labor market since 1980 may well explain the stagnation of real incomes of the poorer strata of the population, and the widening degree of inequality of recent decades for those other than in the extreme upper strata.

ObamaCare Has Not Led to a Shift of Employees From Full-Time to Part-Time Work

Part-Time Employment #2 as Share of Total Employment, Jan 2007 to Sept 2013

Conservative media have repeatedly asserted that due to ObamaCare (formally the Affordable Care Act), there has been and will be a big shift of workers from full-time to part-time status.  Publications such as Forbes, the Wall Street Journal, and of course Fox News, have asserted that this is a fact and a necessary consequence of ObamaCare.  The argument is that since ObamaCare will require employers to include health care benefits as part of the wage compensation package to full time employees (defined as those who normally work more than 30 hours a week for the firm), firms will have the incentive, and by competition the necessity, of shifting workers to part-time status.  It is argued that instead of employing three workers for 40 hours each (for 120 employee hours), firms will instead employ four part time workers at just below 30 hours each to obtain the 120 employee hours.

There are a number of problems with this argument.  First, the ObamaCare requirements for health coverage only apply to firms with more than 50 full time employees.  There is no change for firms employing fewer than 50 workers.  Second, almost all of the firms in the US with more than 50 employees, and indeed a majority also of the workers in firms of fewer than 50 employees, are already in firms that provide health insurance coverage for their workers.   Specifically, 97% of the workers in firms with more than 50 employees are in firms offering health insurance coverage as part of their wage compensation package.  ObamaCare will require this (to avoid a per worker penalty) to go from 97% to 100%, which is not a big change.  And even though ObamaCare will not have such a requirement for firms employing fewer than 50 workers, it is already the case that 53% of the workers in such firms are in firms providing health insurance coverage.   Firms provide health insurance coverage as part of the total compensation package they pay their employees both because they have a direct interest in having healthy workers, but also because there are tax and financial advantages to doing so.

Notwithstanding these issues, the conservative media and Republican politicians continue to assert that ObamaCare is leading to a large substitution of part-time for full-time workers.  But as Jason Furman, the Chairman of the Council of Economic Advisors in the White House has recently noted, this is not seen in the data.  The graph at the top of this blog post is one way to look at this data.

The graph shows the share of part-time workers (part time for economic reasons and not part time by choice) in all workers, by month, for the period from January 2007 to September 2013.  The data come from the Bureau of Labor Statistics.  If ObamaCare is leading to a large shift of workers from full-time to part-time status, then this ratio would be rising since ObamaCare was passed or at some more recent date.  But it is not.

The share of part-time workers in all workers rose in the last year of the Bush administration due to the economic crisis, from about 3% before to about 6 1/2% after.  It was rising rapidly as Obama took office, but stabilized soon thereafter as the economy began to stabilize with the passage of Obama’s stimulus package and aggressive actions by the Fed.  Since then the ratio has trended downwards, albeit slowly.  As has been noted previously in this blog, the continued fiscal drag from government expenditure cuts since 2010 has held back the economy and hence the recovery in the job market.  The blog post noted that if government spending had simply been allowed to grow at its long term average rate, we would likely have already returned to full employment (and would have returned to full employment in 2011, if government expenditures had been allowed to rise at the same pace as they had during the Reagan years).

The Affordable Care Act was signed by Obama in March 2010.  As the graph above indicates, there was no sharp change in trend once that act was signed.  If anything, the share of part-time workers in all workers then began to decline from a previous steady level.  Such a response is the opposite of what the conservative media and Republican politicians have asserted has been the result of ObamaCare coming into effect.

To put the figures in perspective, the graph above also shows how high the ratio of part-time workers to all workers would have had to jump, had either just 5% (the square point) or 10% (the round point) of full-time workers been substituted for by an equal number of part-time workers, additional to where the September 2013 ratio in fact was.   An equal number is used between the full-time and part-time workers to be conservative in the estimate.  The argument being made by the critics is in fact that a higher number of part-time workers would have been hired to substitute for the full-time workers let go, to get the same number of working hours.  But even with an equal number being substituted, such a shift of 5% of the workers would have led to rise in the ratio by 74% relative to where it was in September 2013, and a shift of 10% would have led to a rise of 148%.  One does not see anything like this.

It is not known what the paths would have been to reach those 5% or 10% shifts, but the resulting changes in the paths would have been obvious.  Such changes did not occur.  Since one is comparing the figures to what otherwise would have been the case, the conservative critics would need to argue that the ratio of part-time to all workers would have plummeted in the absence of ObamaCare.  There is no reason given on why this would have been so.  Furthermore, for the case of a 10% shift the number of part-time workers would have had to be negative in the absence of ObamaCare, which is of course impossible.

There is simply no evidence to support the assertion in the conservative media that ObamaCare is leading a significant share of firms to shift workers from full-time to part-time status.

The Stagnation Over the Last Half Century of the Real Minimum Wage Is Even Worse Than It Looks: But May Not Be Easy to Solve

Real Min Wage Under Alternative Scenarios, 1950-2012

A.  Introduction

The previous post on this blog looked at whether the periodic increases in the minimum wage since 1950 in the US had led to jumps in unemployment of those workers making the minimum wage.  It concluded that there was no evidence of higher unemployment resulting from the changes of the magnitude observed.  And this was found whether by simply examining what happened to unemployment in the months following those sporadic increases, or in more rigorous econometric studies that have been undertaken over the last two decades.

That blog post noted that despite those sporadic increases in the nominal minimum wage, the minimum wage in real, inflation adjusted, terms had still fallen significantly over the last half century.  The minimum wage, in terms of today’s prices, had averaged about $9 per hour over the 25 years 1956-80 inclusive, and had reached a peak of $10.82 in February 1968.  Yet the minimum wage is only $7.25 today.  President Obama proposed to Congress in his State of the Union address that the minimum wage be raised to $9.00.  This would be a modest goal, as it would bring it back only to a level of a half century ago.  During that half century, US per capita GDP has more than doubled.  Yet even that modest increase has been strongly criticized by Republican leaders and conservatives.

B.  Two Scenarios

Staying flat in real terms is an exceedingly limited goal.  One would expect growth in a growing economy.  And at $9.00 an hour, a full time worker (40 hours a week, 52 weeks a year with no vacation) would still be earning almost 20% less than the poverty line for a family of four.  It is therefore of interest to ask what would the minimum wage be today if it were not simply flat in real terms, but had grown along with the rest of the economy?

The graph above shows two scenarios.  One is where the minimum wage would have grown at the same pace as overall labor productivity growth, and the other is where the minimum wage would have grown at the same pace as real compensation has for all workers.

There are several points worth noting.  First, it is very interesting that over the period 1950 to 1968, one finds that labor productivity, real compensation of all workers, and (with more jumpiness) the real minimum wage, all tracked basically the same path.  This is as one would expect in a normal growing economy.  Productivity grows, real wages grow at a similar rate (implying that profits will also grow at a similar rate), and similar increases in the real minimum wage will not create difficulties.

But the trends then diverged.  The minimum wage, set by government policy, was not allowed to keep up with inflation, leading to a significant fall in real terms.  The deterioration in the real minimum wage was especially sharp and steady during the presidencies of Richard Nixon (1969-74), Reagan (1981-88, and carrying over into 1989) and George W. Bush (2001-2007).  By June 2007, the minimum wage had reached a low of $5.75 (in terms of today’s prices) – lower than at any other point in time since before 1950 (I did not look at earlier data than this).  The real minimum wage was $7.38 in January 1950, during the presidency of Harry Truman.  It was 22% less in 2007, 57 years later.

C.  The Divergence Since the 1980s Between Growth in Labor Productivity and Growth in Labor Compensation

Labor productivity and real compensation of all workers continued to track each other for a few years after 1968.  But then some divergence started to open up in the mid-1970s, and this divergence began to grow sharply from about 1982/83.  It has continued since.

This divergence between productivity growth and real compensation of workers since the 1980s has been noted and discussed before in this blog.  It was noted there that the changes that occurred during the Reagan presidency, while lauded by conservatives, in fact did not lead to overall faster growth in output or productivity (growth in output and in productivity have in fact been slower since the Reagan presidency than it was before).  But the changes that began during the Reagan term did lead to sharply slower growth in real wages, and led as well to a far worse distribution of income.  The rich, and especially the very rich (the top 1%, and even more so the top 0.1% and 0.01%) have done extremely well since 1980.  But as that blog post showed, the real incomes of the bottom 90% have grown only modestly (and almost solely in the second half of the 1990s, during Clinton’s term).

By 2012, the average real compensation of all workers was fully one-third less than what it would have been had it grown after 1968 at the same pace as labor productivity growth.  This is not a small difference.

The causes for this divergence between labor productivity growth and real compensation of workers, largely since 1982/83, are not all known.  Policy was clearly an important part of it.  One policy was that of allowing the minimum wage to fall in real terms, which pulled down the wages of not only those at the minimum wage, but also the wages of those some distance above the minimum wage as the minimum wage affects the whole lower end of the wage structure.  Reagan’s policies to undermine the ability of labor unions to bargain for higher wages were also a factor.  Government policies to keep down the wages of government workers would also have contributed.

But in addition to such policy factors, there were technological and other economic issues that probably contributed.  As Erik Brynjolfsson and Andrew McAfee argue in their recent book, Race Against the Machine, the high rate of change in computer and communications technology, and the accompanying growth in robotics, not only diminished the demand for many middle class jobs such on the automobile production lines, but also for middle class jobs such as accountants, clerks, and other skilled positions where rules are followed which a computer can be programmed to do.  This same technological change in computers and communications also enabled globalization of production.  And the changes made possible by the new technologies led to the development of more and more “winner-take-all” sectors, where a few winners at the top can supply the whole market, leaving little for the rest.

D.  Could the Minimum Wage be Raised to Match?

As the graph above shows, had the minimum wage continued to grow after 1968 at the same pace as overall labor productivity grew (as it had before 1968), it would have reached $24 an hour by 2012.  Had it grown even at the slower pace that overall compensation of workers had grown, it would have reached $16 an hour.  But I would not advocate increasing the minimum wage today to $24 an hour, or even $16 an hour.  While the previous blog post had noted that changes in the minimum wage of a magnitude seen in the past had not led to higher unemployment, I am not so sure this would hold if the current minimum wage ($7.25 an hour) were more than doubled or tripled.  Without more data, I would indeed be wary of a rise in the minimum wage to more than perhaps $11 or $12 an hour.

One possible approach might therefore be as follows.  To start, one would raise the minimum wage to $9.00 an hour now, as Obama has proposed.  Obama has then also proposed to index this rate to inflation, so that one does not again see the regression in real terms observed repeatedly in the past.  But this would be too modest.  One would raise the rate to $9.00 an hour now, then to $10 a year later, then to $11 a year after that, and so on.  At each step, one would observe what the effects are.  If the impact on employment of minimum wage workers is modest, one would continue.  At some point one would start to observe significant adverse impacts, and at that point one would stop or even move back a step.

The fact that raising the minimum wage to $24 an hour now, or even to $16 an hour, is considered unimaginable, and indeed would likely lead to significant adverse employment impacts, is telling.  Something fundamentally flawed has developed in the economy which the US did not see before the 1980s.  And it does such harm for the working poor that even a full time worker at the minimum wage will still earn well less than the poverty line income.  There is a clear need to understand this better, but that should not keep us from following a more active approach, such as the step by step process suggested above, until we do.

The Impact of Increasing the Minimum Wage on Unemployment: No Evidence of Harm

Minimum Wage vs. Unemployment Rates, 1950-Jan 2013

Minimum Wage vs. Ratio of Unemployment Rates, 1950-Jan 2013

A.  Introduction

In his State of the Union speech last month, President Obama called for a rise in the federal minimum wage from the current $7.25 per hour to a new rate of $9.00 per hour.  This would be a 24% increase, but would still mean that someone working full time, 40 hours per week, 52 weeks a year (no vacation), would earn only $18,720 a year.  Such a full time worker would still be earning well less than the current federal poverty line for a family of four of $23,050 per year.  The proposed increase is modest.

Republican leaders nonetheless immediately denounced the proposal, asserting that raising the minimum wage would hurt, not help, the poor, as they would lose their jobs.  They assert that instead of seeing an increase in their wage, the minimum wage workers would be fired.  And unlike in many other areas (such as the impact of fiscal policies) the Republican leadership here is making an argument that one would find in an introductory economics course.  Elementary economics would indeed argue that in perfectly competitive markets, an increase in the minimum wage would lead to such workers losing their jobs rather than being paid more.

B.  Have Increases in the Minimum Wage Led to Higher Unemployment of Such Workers in the Past?

But what is the evidence?  If increases in the minimum wage lead to such workers being fired, one would see higher unemployment among such workers very quickly in the months following each increase in the minimum wage in the past.  The graphs above show what in fact has happened.

The first graph shows the federal mandated minimum wage since 1950, in real inflation adjusted terms (using the CPI), plus the unemployment rates for all workers and separately for workers aged 16 to 24.  The data comes from the Bureau of Labor Statistics, but was downloaded for convenience from FRED, the Federal Reserve Economic Data web site maintained by the Federal Reserve Bank of St. Louis.  The unemployment rate for workers aged 16 to 24 is shown separately as one would expect that increases in the minimum wage would increase unemployment especially sharply in that group, if the assertion is correct that increases in the minimum wage lead to such workers losing their jobs.  Approximately 51% of the hourly wage workers earning the minimum wage are in this 16 to 24 age group.

First of all, it is worth noting that the minimum wage, when adjusted to reflect general inflation, is a good deal lower now than a half century ago.  It reached a high (in prices of January 2013) of $10.82 in February 1968, and lows of $6.02 in March 1990 and $5.75 in June 2007.  It averaged close to $9.00 an hour over the twenty-five years of 1957-81 (inclusive), and is only $7.25 currently (almost 20% less).  The Obama proposal is modest, as he has only asked Congress to bring it back to that $9.00 an hour, the rate of a half century ago.

But does one see in the history that increases in the minimum wage lead to a jump in unemployment rates, particularly of the young (and decreases in the minimum wage leading to lower unemployment rates)?  Actually, no.  Unemployment rates do fluctuate a good deal, as they depend on macro conditions in the economy.  But it is hard to see any obvious jump in unemployment rates in the months following the sporadic increases in the real minimum wage we have had over the last more than 60 years.

It is also worth noting that due to the politics of the minimum wage, and the resistance of conservatives and businessmen to higher rates, increases in the minimum wage have been generally infrequent and then relatively large in percentage terms.  This thus provides good material for a test of whether increases in the minimum wage lead quickly to jumps in the unemployment rate (particularly of the young).  Yet one does not see it.

Any relationship might be hard to recognize in part because of the independent rises and falls in unemployment rates due to macro conditions.  The second graph therefore charts the real minimum wage along with a line that shows the ratio of the unemployment rate of those aged 16 to 24 to the unemployment rate for the entire labor force.  This ratio exploits the fact that a relatively high share (about 51%, as noted above) of minimum wage workers are young.  Thus, if it is in fact true that increases in the minimum wage will lead those making the minimum wage to become unemployed, the higher share of such workers in the ages 16 to 24 category will lead to an increase in that ratio.

But the graph does not show such a relationship.  While the real minimum wage has seen many sudden changes, the ratio of unemployment rates often does not then change, and in fact sometimes moves in a direction that is the opposite of what those opposed to increases in the minimum wage would predict.  The one possible exception appears to be a blip seen following the February 1968 increase in the minimum wage.  But this blip occurs in fact four months later (in June 1968; the time scale is compressed as the chart covers 63 years) and then drops back.  But one also sees that the steady decline in the real minimum wage during the 1980s in the Reagan years was accompanied by a rise in the ratio (the opposite of what they would predict), and that the ratio then declined (instead of rising) when the minimum wage was finally moved up in 1990 and 1991.  Similarly, increases in 2007-09 were accompanied by  a decline in the ratio.  One could pick out other examples, but basically what is shown is that there is no systematic pattern.

C.  More Rigorous Work on the Impact on Employment from Raising the Minimum Wage Also Shows No Harm

Graphs such as these are, however, simplistic.  While looking at the history is of interest, and should show at least some indication that increases in the minimum wage will lead to higher unemployment (especially of the young) if the minimum wage critics were correct, there is much more going on in the economy which should be taken into account.  Fortunately there have been rigorous studies that do this, and they too have found that the impact of increases in the minimum wage (of the magnitude historically seen) on unemployment rate is either non-existent or small.  Some studies have indeed found that increases in the minimum wage have reduced unemployment.

The seminal paper that launched the modern literature on the impact of the minimum wage was co-authored by economists David Card (of University of California, Berkeley) and Alan Krueger (then of Princeton, and now Chairman of the Council of Economic Advisors in the White House).  Card and Krueger controlled for extraneous effects that might be going on in the economy at the time a minimum wage is increased, by exploiting the fact that states may have separate minimum wage requirements from the federal requirements, and that states change their minimum wages at different times.  Specifically, they looked at employment in fast food establishments along the border between New Jersey and Pennsylvania on an occasion when New Jersey raised its minimum wage while there was no change in Pennsylvania.  They found no negative employment impact from New Jersey’s action.  Indeed, there might have been a small positive impact on employment following the increase in New Jersey’s minimum wage.

The Card and Krueger study, while rigorous, was limited as it looked at only one instance of a change in the minimum wage, and the impact on only one industry.  But more recent studies, following a similar approach, have extended the Card-Krueger work to many more cases.  A particularly comprehensive recent example is a paper by the economists Arindrajit Dube, William Lester, and Michael Reich.  Like Card-Krueger, they too found that increases in the minimum wage that have been periodically enacted in the US at the state level have not had a negative impact on employment of minimum wage workers.  And since changes at the state level would presumably have a bigger impact than changes at the national level (as jobs could in principle shift across state lines), there is no reason to believe the impact of a federally mandated change would be negative.

There is of course much more work on this issue, and a paper by John Schmitt issued last month provides a good summary of where the literature stands.  Less technical reviews of the issues and what economists have found are available here and here.  There are, of course, economists who would disagree, but the preponderance of the work done so far has found little or no evidence that increases in the minimum wage that we have seen in the past have led to decreases in employment of such workers.  Indeed, some studies have found that increases in the minimum wage increases employment.

D.  Why Does Standard Economic Theory Get This Wrong?

The real world evidence matters more than the theory.  But why would standard elementary economic theory appear to have gotten this wrong?  The truth is that there are many matters in the real world that do not behave as one might predict based purely on an economic abstraction.  Unemployment exists, for example, even though economic theory would predict that in a world of perfect competition, with full information and no transactions costs, and many other conditions, we should only see full employment.   But the assumptions of abstract economic models might well not apply in critically important ways once one faces the specifics of a particular issue.  That is why real world testing is important, as well as examination of the underlying assumptions and abstractions.

In the case of employment of workers at or close to the minimum wage, there are many reasons why the predictions of pure economic theory might well not apply.  Such labor markets are far from the perfect competition ideal.  There is a different balance of bargaining and other power between the employer and the potential minimum wage employee; the information available to each side of the transaction (on how productive the worker might be, and what his or her alternatives are) will differ; workers once they are in a job gain a good amount of job specific knowledge and abilities (not only on how to do the specific job, but also how best to work in a team with the specific colleagues there, where things are kept, and a million other details); that due to such job specific knowledge and imperfect information on who else might be available in the market, there will be substantial transactions costs incurred when an employee quits a job or is fired and a new one must be hired; and more.  Standard theory predicts that workers (in a perfect market) will be paid the value of their marginal product, but it can be difficult even to know what the marginal product of a specific worker might be when they work, as they typically do, in a team with others.  And one finds in the real world that wages are typically paid according to seniority and according to some hierarchy, rather than according to some strictly measured marginal productivity.

Good economists are therefore not surprised that markets in the real world can act quite differently from how the simple models might predict.  And they therefore accept as quite possible the finding of the real world empirical studies that increases in the minimum wage, such as those observed in the past, might well not have led to jumps in unemployment of workers earning the minimum wage.

E.  Conclusion

Full time workers in minimum wage jobs are poor, despite their evident willingness to work.  Even if the minimum wage is raised to $9.00 an hour from the current $7.25 an hour, as Obama has proposed, these working poor will still be earning well less than poverty line income.  And bringing the minimum wage to $9.00 an hour will only bring it back to where it was more than a half century ago.  Real GDP per capita has more than doubled over this period.  Yet minimum wage workers are currently earning 20% less.

Rigorous empirical studies do not show that increasing the minimum wage by an amount such as this will lead to an increase in unemployment of such workers.  Nor does one see such an increase in unemployment in a more casual examination of the evidence, such as in the graphs above.  While the poor need more assistance than just from this, increasing the minimum wage as Obama has proposed would certainly be an important help.