Putting Americans Back to Work: Competing Visions for Job Creation

Editor’s note: In remarks to the Senate Democratic Policy Committee, Martin N. Baily stated that it will take seven years to get back down to 5 percent unemployment and the possibility of a double-dip recession means that another stimulus may be needed, particularly to help states and localities.

Chairman Dorgan and members of the Committee, I thank you for inviting me to testify to this hearing on the pressing problem of job creation. My oral testimony will be based on the summary bullet points shown below. My written testimony expands on these points.

Summary

• The steps that have been taken to turn the economy around are succeeding. Unemployment is still too high and the recovery is fragile, but the economy is now moving in the right direction. The rise in unemployment and drop in employment this year have resulted in criticisms of the economic policies used. However, these policies are working and have brought the economy back from the danger of depression.
• If the economy creates 200,000 jobs a month going forward, it will still take seven years to reduce the unemployment rate to 5 percent.
• As we assess the different visions for job creation it is worth looking at what has worked in the past. Job growth from January 1993 to January 2001 averaged 237,000 jobs a month, much higher than in any other recent administration.
• There are a number of policies that are currently being discussed for a new jobs bill and I support such a bill provided the overall budget cost is kept small. I strongly support the extension of emergency assistance to individuals and states and localities. I support efforts to expand SBA-backed lending that is made on a sound and responsible basis. I have been skeptical of proposals to use tax incentives for job creation but, among the possibilities, a refundable tax credit to small businesses to expand hiring looks attractive.
• Budget deficits are constraining choices. Consistent with keeping deficit reduction on track in the longer run, I support increased investments in science and technology, investing in skills as well as education, involving labor in efforts to increase efficiency and productivity, relaxing the constraints on H1B visas, and increasing national saving to keep U.S. manufacturing competitive.
• Whatever mistakes have been made in the past, it is now time for the government to work with business and labor to restore the American economy.

Introduction

With unemployment at 10 percent and payroll employment still falling, I know everyone is aware of the difficult challenge ahead to restore full employment to the U.S. economy. Over seven million payroll jobs have been lost in this recession through November of this year.

There are many factors that caused the financial crisis that precipitated this deep recession, but high on the list are the over-borrowing that pervaded the economy and lax regulatory supervision of financial institutions and mortgage lending standards. The previous administration inherited budget surpluses but quickly turned these into chronic deficits that triggered massive borrowing from overseas. The large federal budget deficits contributed to the climate of over-borrowing. And at the same time, the belief that regulation is always detrimental, encouraged financial regulators to take a hands-off view of financial institutions even when they were taking excessive risks.

The challenge we now face is that job growth in the recovery, once it begins, must substantially exceed the normal rate of labor force growth in order to bring down the rate of unemployment. In fact, using standard forecasts of future labor force growth, suggests that if payroll employment increases were to average 200,000 a month, a pretty good pace of growth based on past history, it would still take seven years to get the unemployment rate down to 5 percent.

The good news to balance this stark picture is that it does seem that the economy is turning around. There was 2.8 percent growth of GDP in the third quarter of this year and it looks as if there will be around 4 percent growth in the fourth quarter, based on data already reported. The pace of job loss is abating quite rapidly and, if the expected GDP growth materializes, that should result in net job creation, possibly by December and likely by the New Year.

A key reason for the recovery is that Treasury and the Federal Reserve were able to stabilize the financial sector, working together with Congress, which allocated the TARP funds that were essential to this process.  Unpopular as they were, the steps taken to restore financial stability have worked, and the Wall Street banks are recovering and in some cases prospering. Another important reason for the recovery is that the President proposed and Congress approved a substantial stimulus package to bolster aggregate demand. While this package was not perfect, it was effective, and has contributed to the recovery.

Unfortunately, however, we are not yet out of the woods. There are likely to be several hundred more failures of small and regional banks in the next year or so. Commercial real estate loan defaults are contributing to the banks’ problems, as is the fact that Fannie and Freddie are asking them to take back many of the residential mortgages that have become delinquent. Even if these smaller banks are taken over by other, stronger banks there is a danger that lending to small and local businesses will be undermined by these failures.  In addition, consumers are still cautious, and with good reason. Their wealth has been diminished by the decline in home prices and equity prices. Their ability to borrow is more limited than before. And as long as the labor market remains weak and unemployment remains high, there is concern about the stability of family incomes. Most economic forecasters have learned humility in the past few years and I am reluctant to take a strong position on where the economy is headed. 

The chances are good that the economy is on the path to a solid recovery, but there is a significant danger that once the bounce-back period ends, growth will be sluggish in 2010 and perhaps 2011. If growth is too sluggish, a second-dip recession is possible.