How High Will the Unemployment Rate Go?
Another dismal jobs report for December, with 34,000 more jobs gone (71,000Â full-time losses) and the unemployment rate jumping a third of a point in a single month, has got everyone now wondering:Â How high will the unemployment rate go in this recession?
The “consensus” view of the mainstream economics world is something like this: unemployment will climb to perhaps 8% over the coming year, then the “recovery” will start (everyone thinks in the second half of 2009).
But this story is incomplete, and misses an important aspect of the dynamics of the unemployment rate in a recessionary cycle.Â The recovery in GDP (that is, the point at which is stops falling and starts growing again — which, by the way,Â is not how most individual Canadians would experience “recovery”) is not at all coincident with the eventual, subsequent decline in unemployment.Â With population growth of something close to 1.5% per year, and ongoing trend productivity growth (abysmally low in Canada, but still positive), real GDP needs to grow at 2.5% per year just to maintain a stable unemployment rate.Â I do not necessarily disagree with the prediction that real GDP will stop falling (and presumably start growing again) sometime in the second half of this year (although even that may be optimistic).Â But when will the recovery gain enough speed to surpass that 2.5% threshold, and start the long hard job of bringing the unemployment rate back down again?
Given the nature of this crisis (and the role of balance-sheet problems in both the financial and the household sector in causing the decline in credit, spending, and hence production), I am with those who see an L-shape to this downturn (rather than the classic V-shape or U-shape).Â Real GDP will fall, and then likely stagnate for some time until the conditions are recreated (through a painful process of write-offs, bankruptcies, and value-destruction) for eventual recovery and expansion.Â Hopefully this trek to recovery will be aided by pro-active government measures to supplement demand: with public-sector invetsment, transfer payments to low-income Canadians, and other measures.Â But even with an appropriate counter-cyclical response by government, this will not be a quick recovery.
In that case, the quick rise in unemployment over the next year will be just the beginning of a longer, more painful story.Â In a scenario in which real GDP stagnates or grows very slowly (1-2%) from 2010 onward, then the unemployment rate will continue to grow by a full percentage point or more for another two or three years.Â That could easily put the unemployment rate back into double-digit terrain for an extended period of time early in the next decade.
This trend will be buffered somewhat by two normal cyclical responses in the labour market: a likely decline in labour force participation (as discouraged job-seekers give up looking), and a likely decline in productivity growth below its trend.Â In the former case, while the decline in participation is “helpful” in bringing down the official unemployment rate, it has no benefit (and is actually harmful) for the economic well-being and social engagement of Canadians.Â In the latter case, it’s hard to imagine productivity growth getting any slower in Canada, but it likely will (for the familiar reasons that companies reduce payrolls more slowly than their sales fall, and encounter indivisibilities in capacity which produce a decline in capacity utilization and hence efficiency).Â But again, while this helps suppress the rise in official unemployment, this is hardly helpful to our actual economic goals.
I have assembled an ultra-simple forecasting spreadsheet which starts out from the December 2008 labour force aggregates: working age population (27.1 million), labour force of 18.3 million (implying a participation rate of 67.6 percent), total employment of 17.1 million, and unemployment of 1.2 million (now 6.6 percent of the labour force).
Now apply whatever assumptions you wish regarding the decline in GDP (my illustrative case has a 1% decline for annual GDP in 2009, 0 in 2010, 1% in 2011, and 2% in 2012), productivity growth (I cut it in half for two years, to 0.5% per year, then recovering to 1% per year), population growth (1.5%), and participation (let’s assume it declines by 0.2 percentage points a year for the next four years).Â I don’t think this is unduly pessimistic (in fact, on most counts it’s likely optimistic — although participation could certainly fall faster than I have assumed if Canadians abandon hope of work).Â Yet it generates an unemployment rate above 9% by the end of 2009.Â More worrisome, unemployment then continues to grow throughout the next three years — reaching almost 12% by the end of 2012. This isn’t dissimilar from what actually happened to Canada’s unemployment rate during the early 1990s.
(Just to clarify: this scenario is not my personal prediction: it’s just an illustrative example of how the various factors that determine the unemployment rate fit together, and how double-digit unemployment rates are certainly possible in the years ahead.)
Changes in any of these assumptions, obviously, change the forecast.Â Play around with it yourself: it’s always instructive to see the interactions of economic growth, population growth, productivity, and participation that are the complex drivers of unemployment dynamics.Â (You can assemble your own spreadsheet like this in 5 minutes — but if anyone wants a copy of mine, just e-mail me at email@example.com).
The key conclusions from this analysis are worrisome:
- The rise in unemployment during the recession “proper” in coming months is just the beginning of the labour market damage resulting from this crisis.
- Unemployment will likely continue to rise for at least 2 or 3 years after the onset of official “recovery” — and the increase in the unemployment rate during this “recovery” will likely be larger than the increasae in unemployment during the technical recession.
- This will have an incredibly negative impact on household incomes and well-being for many, many Canadians.
- The fiscal stresses on Canada’s EI system are going to be much, much larger than is anticipated in the Conservative government’s counter-productive new EI funding system (which allows only a $2 billion cushion, and then requires premiums to be altered annually to balance each year’s forecast expenses).Â It is obvious that this system is going to result in successive EI premium increases beginning in 2010 — the last thing the labour market needs as it is trying to claw itself back from recession.Â Instead, the government, with a stroke of a pen, should restore the former accumulated EI surplus (in excess of $50 billion) and allow the EI system to experience (appropriate) deficits during the coming tough years.
- Better yet would be to improve access to EI (relaxing admission requirements, and extending benefits to cover longer-term layoffs) in order to cushion the blow of the weak labour market on Canadian households — not to mention sustain spending in these households and reduce the knock-on contractionary effect of unemployment on aggregate demand.
In short, I don’t think that the economics mainstream (expecting only a moderate and temporary bump in unemployment) has yet to grasp the likely scale of the rockin’ and rollin’ that we’re heading into.