Recessions have long-lasting consequences for the unemployed, but the U.S. policy response only offers short-term solutions.
Yesterday morning the Next American Economy breakfast seminar hosted guest Till von Wachter, who led a fascinating but disturbing discussion of the long-term effects of unemployment. Till, a professor of economics at Columbia, has become known more and more broadly for his research in this area. You can watch my interview with him below:
When a worker loses a job during a recession and goes through a period of long-term unemployment, both the short- and long-run effects are devastating. We usually think of the short-run reduction of income and the family crises that reduction can cause, but according to Professor von Wachter, the longer-run effects are even greater. Lifetime earnings are reduced by as much as 20 percent, health worsens, mortality rises, divorces increase, children's school performance declines, and the lifetime earnings of the next generation are lower.
It's important to underline that Till's work focuses on the effects of recessions, not unemployment in all periods. Our economy is constantly churning, far more than most recognize, and men and women are constantly changing jobs -- mostly voluntarily, but also involuntarily. In periods of growth, these job changes don't seem to have the same effects.
There are several explanations for the long-term effects of unemployment in a recession. Sometimes workers who have privileged positions because of factors such as long tenure or union membership lose those positions. Once unemployed, workers may lose skills that they have developed while working. Recessions also tend to "reset" all wages for new workers, including those who are rehired. (This also affects graduates who enter the job market during a recession, as their earnings are also lower over a long period of time.)
We have really not developed policy tools to deal with these pervasive effects of unemployment and recessions. Our policy remedies focus almost entirely on short-term income replacement and not much -- or not very effectively -- on the long-run effects.
Another part of Professor von Wachter's work is currently focused on a broader issue in recessions: does "creative destruction" occur? It is sometimes argued that recessions sort of boil away excess and therefore are regrettable but necessary aspects of our system. Till's work here is beginning to suggest that this just isn't so. It's not just marginal workers who lose their jobs, and recessions do not lead to particularly high levels of sectoral change. So it's hard to find positive arguments for recessions that offset the negative effects on workers. (I know that sounds like an obvious point, but economists do have to ask.)
So what? Where does this take us?
It takes me first to Ben Friedman's book The Moral Consequences of Economic Growth. Friedman argues that the consequences of sensible growth are so pervasive and positive that we should focus much more on it. I've long argued that this should be the mantra of the radical center, and even of progressives.
Till's work suggests a corollary: we should focus not simply on growth but on increasing the long-run probability of stable growth by reducing risk, thereby reducing the occurrence of recessions and their severity when they do occur. (Yes, I have in mind our financial system with four major banks all clearly too big too fail providing a huge share of all credit in the U.S.) Good businesses routinely look at – forgive the jargon – risk-adjusted rates of return; macroeconomic policy should, too. A risk-adjusted view of the economy in 2007 might have made a lot of people much more sober about likely future scenarios.
But the punch bowl is always kept out too long at the party, and recessions will occur. What more can we do that might be effective in reducing the long-term effects of unemployment?
I distill three lessons from Till's work. First, short-term income replacement and government work programs are not the answer. Second, the real problem is a loss of job skills and human capital. Third, most job training programs seem to have had at best mediocre success because they are hard to design, hard to manage, aren't routinely evaluated, and can't focus on the truly critical skills that are developed and maintained on the job.
America needs to develop formal mechanisms that keep more workers in their jobs – mechanisms that allow their hours or even wages to adjust rather than have the only real adjustment be the on-off switch of full job loss. We might, for example, look at Germany, which, in the recent Great Recession, avoided the severe rise in unemployment we had here in the U.S. The German experience is complicated, but Germany does have formal approaches to job-sharing and a highly developed program of work-time accounts. These had a substantial and positive effect in Germany, yet we don't have them.
We're in the middle of a big debate about the nature of capitalism. A lot of truly stupid things are going to be said on both sides about capitalism and each other. I've been a proud but fairly minor league capitalist for a long time, and I know its workings can be made better. Long-term unemployment and its effects do not have to be a partisan issue. There are some actual concrete steps we could take that would do real good and make the Next American Economy a better place.
Roosevelt Institute Senior Fellow Bo Cutter is formerly a managing partner of Warburg Pincus, a major global private equity firm. Recently, he served as the leader of President Obama’s Office of Management and Budget (OMB) transition team. He has also served in senior roles in the White Houses of two Democratic presidents.