Series: CCF Briefs

Getting Back to Full Employment

Dean Baker and Jared Bernstein

Based on conventional estimates of the lowest unemployment rate consistent with stable inflation, the job market has been slack for much of the past three decades. This persistent excess supply of labor has created myriad problems, all of which remain with us to this day. High unemployment, particularly for the long-term unemployed, remains a central problem. But one of the most important, if often underappreciated, aspects of slack labor markets is the extent to which they also hurt job holders through the reduced rate of real wage growth, especially for minorities, low-, and middle-wage workers. In this regard, persistently high un- and underemployment are also implicated in the long-term problem of growing inequality.

When the job market is operating below full employment, fiscal outcomes also take a hit as fewer people are working, either at all or for their desired number of hours. The result is less tax revenue, more spending on safety net programs, and all else equal, higher budget deficits. The last time the budget hit surplus, in the latter 1990s, full employment was the main factor behind the swing from deficit to surplus.

Another serious problem associated with persistent periods of slack labor markets is “hysteresis”: when large shares of the workforce are un- or underemployed for a long time, their skills can deteriorate and they can lose their connection to the labor market. At the same time, economic slack typically leads to diminished capital investment. Together, these dynamics can lower the long-term growth rates of the labor force and the broader economy, i.e., they can lower the economy’s potential growth rate.

Finally, those unfortunate enough to begin their careers in slack labor markets have often been found to have permanent lower career trajectories, in terms of occupational and compensation advancement.
Conversely, we argue that every one of these problems can be ameliorated by tight labor markets. By facilitating a dynamic wherein employers need to bid up compensation to get and keep the workers they need, full employment raises both the pay and hours worked of low- and middle-wage workers relative to those at the top of the pay scale. In other words, it pushes back against the long-term trend of wage and income inequality.

Moving towards full employment is clearly associated with higher tax revenues, due to more people working and thus paying taxes, and at the same time putting less pressure on safety net programs. Our analysis of the last time the federal budget was in surplus (1998-2001) shows these employment dynamics clearly dominated the more commonly told tale of those years: the fiscal rectitude of the Clinton budgets (which did play a role, but a quantitatively minor one relative to growth).

A very important benefit of full employment is its capacity to reverse some of the damage of hysteresis, as defined above. When people are unemployed for too long—and long-term unemployment has been a particularly pernicious problem of late in the U.S. labor market—their skills and general employability can atrophy in ways that make them less attractive to employers. Recent research has revealed, for example, that simply being unemployed for many months is (not unexpectedly) perceived by employers as a negative attribute. This dynamic has played a potentially damaging role in lowering the share of the working-age population participating in the labor force, which in turn slows the rate of potential G.D.P. growth. We argue that full employment, by fully utilizing available labor resources, including some of those currently sitting out of the labor market, can reverse some of the damage and raise the economy’s “speed limit.” Note also that if we are correct, then tolerating slack labor markets, say, through wrongly timed austere fiscal policies, is a very expensive mistake indeed.

In other words, if policymakers have the tools to move the economy to full employment, as we believe they do, then not taking action against slack job markets does permanent damage to the rate of economic growth, the rate of job growth, federal and state budgets, career trajectories, and living standards, particularly of the least advantaged.