By Hao Li: Subscribe to Hao's RSS feed
September 9, 2010 2:36 PM EDT
The U.S. unemployment rate remains close to 10 percent despite the massive monetary and fiscal stimulus policies of the government.
These policies perhaps averted a repeat of the Great Depression and the even higher unemployment rates that accompany it. However, their effectiveness may be limited because they focus on the demand side and largely ignore the concept of labor market flexibility, said Timothy Hatton, an Australian economist.
The duration and severity of national unemployment is a function of "shocks" and "institutions," using Hatton's terminology. "Shocks" are economic downturns that cause a drop in aggregate demand, which causes employers to slash workers. "Institutions" is the constellation of structures and rules in the labor market that determine how flexible it is in the face of "shocks."
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A flexible labor market is one that is relatively unhampered by rules regarding compensation, hiring and firing. It lets employers and employees negotiate these terms based on market conditions. Compared to rigid labor markets, fluid ones are characterized by a higher turnover rate, a shorter duration of unemployment, and a lower unemployment rate.
The problem of rigid labor markets is that during recessions, if regulations make the cost of employees too unfavorable to employers, they will not hire. Policy makers influence this cost through taxes, restrictions about firing and requirements in benefits like minimum wage, health care and pension plans.
So far, U.S. government policy has not really improved labor market flexibility. In fact, policies aimed at ameliorating the effects of unemployment -- while certainly helpful for the unemployed in the short term -- actually reduce labor market flexibility. The extensions of unemployment insurance is an example of this. The new health care bill, while it may have social benefits, also adds burden to employers.
This lack of flexibility is at least partially responsible for the high unemployment rate, which, among other damages, puts pressure on consumer spending and residential real estate. Long-term unemployed individuals are also in danger of skill erosion.
History seems to support the correlation between labor market rigidity and slow recovery in the jobs market from "shocks," according to Hatton's research.
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