Can Private Equity Firms Like Bain Do Whatever They Want With the Companies They Buy?

May 22, 2012Mike Konczal

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Three critiques of the notion that private equity's actions are above public concern.

The question of Romney's tenure at private equity firm Bain Capital will stay in the headlines as the Obama team releases ads on the subject and Romney continues to run on that record. But what can we take away from this debate?

Ezra Klein argues that running a leveraged buyout company ought to give one some sense of solidarity with those left behind. As LBO/private equity creates winners and losers, winners should be in favor of an expanded social safety net that helps those who lose in the layoffs get back on their feet with minimial disruptions. Since LBO overall creates more wealth, part of that wealth should be taxed for the benefit of those who need help adjusting to their new economic reality afterwards - such as providing continuous health care coverage, job training, etc.

One thing I'm noticing in these debates is an almost tautological idea that since shareholders own the firm, anything shareholders do with their firm is legitimate and outside the boundaries of public concern or critique. It was in the background of what Karl Smith was discussing on Sunday's "Up With Chris Hayes," and Josh Barro made it more explicit this morning on twitter.

A Stick

Let's imagine that I buy a stick. Under a idea of general, everyday libertarianism, since I own the stick I can do anything I want with it. I can break it in half, burn it in a fireplace, carve it into something else, turn it into woodchips, attach a kite to it, exclude people from using it, etc. I can't hit people with it, or use it to set their stuff on fire, or attach duct tape to it in order to steal their stuff - but that's a function of general prohibitions against force and fraud. Short of that, it would be weird to say that I shouldn't do whatever I want to my stick of wood - that something I do with it could be illegitimate - as long as I enjoy it.

But does a private equity firm own its portfolio businesses in the same exact way that I own my stick? Is it weird to even think, outside general prohibitions against force and fraud (which I'll treat as unproblematic as it relates to the question at hand), that their actions could be illegitimate? There are many references to increasing profits, or making firms more dynamic, or "creative destruction," but those are side effects of shareholders doing whatever they want with its portfolio. The core issue is that there could be nothing illegitimate in terms of how a private equity firm runs those businesses in the sense there's nothing illegitimate I could do with a stick I own.

Three Critiques

Starting from this baseline, the critiques as far as I read them (which will draw on two previous posts) break down along three lines:

1. Tax/regulatory loopholes. I did an interview with Josh Kosman, author of The Buyout of America, where he argued that the whole point of the enterprise is to game tax law loopholes. Private equity "saw that you could buy a company through a leveraged buyout and radically reduce its tax rate. The company then could use those savings to pay off the increase in its debt loads. For every dollar that the company paid off in debt, your equity value rises by that same dollar, as long as the value of the company remains the same."

A recent paper from the University of Chicago looking at private equity found that “a reasonable estimate of the value of lower taxes due to increased leverage for the 1980s might be 10 to 20 percent of firm value,” which is value that comes from taxpayers to private equity as a result of the tax code.

That's one thing in an industry with large and predictable cash flows. But after those low-hanging fruits were picked, as Kosman explained, "firms are taken over in very volatile industries. And they are taking on debts where they have to pay 15 times their cash flow over seven years — they are way over-levered."

This critique has power as far as it goes. But let's combine it with another issue.

2. Risk-shifting among parts of the firm. Traditional "creative destruction" is about putting rivals out of business with better products and techniques. Leveraged buyouts and private equity are about something different, something that exists within a single firm. This is often described as putting new techniques into place, firing people and divisions that are not performing, and generally making the firm more efficient.

The critique here is that, instead of making the firm more efficient, it often simply shifts the risks into different places. As Peter Róna, head of the IBJ Schroder Bank & Trust in New York, described it in 1989:

The very foundation of the LBO is the current actual distribution of hypothetical future cash flows. If the hypothesis (including the author’s net present value discounted at the relevant cost of capital) tums out to be wrong, the shareholders have the cash and everyone else is left with a carcass. “Creating shareholder value” and “unlocking billions” consists of shifting the risk of future uncertainty to others, namely, the corporation and its current creditors, customers, and employees…
 
The notion that underleveraging a corporation can cause problems is neither new nor unfounded. What is new is the assertion that shareholders shouid set the proper leverage because, motivated by maximizing the return on their investment, they will ensure efficiency of all factors of production. This hypothesis requires much more rigorous proof than Jensen’s episodic arguments… although Jensen denies it, the maximization of shareholder returns must take place, at least in part, at someone else’s expense.
Shareholders gain, but at the expense of other stakeholders in the firm. This isn't the normal winner/loser dynamic, where some suffer in the short-term to do what's best for the long-term. Here the long-term suffers to create short-term winners. Once again, this issue becomes problematic when combined with another critique.
 
3. Dividend looting. The theory behind private equity, as Róna caught above, is that it requires shareholders to be the proper and most efficient group to set the leverage ratio. But what if, instead of setting leverage for the long term to make the firm more efficient, shareholders simply use additional debt to pay themselves, regardless of the health of the firm? As Josh Kosman put it:
If you look at the dividends stuff that private equity firms do, and Bain is one of the worst offenders, if you increase the short-term earnings of a company you then use those new earnings to borrow more money. That money goes right back to the private equity firm in dividends, making it quite a quick profit. More importantly, most companies can’t handle that debt load twice. Just as they are in a position to reduce debt, they are getting hit with maximum leverage again. It’s very hard for companies to take that hit twice...
 
The initial private equity model was that you would make money by reselling your company or taking it public, not by levering it a second time...Right after this goes on for a few years, you’ve starved your firm of human and operating capital. Five years later, when the private equity leaves, the company will collapse — you can’t starve a company for that long. This is what the history of private equity shows.

This runup in dividend payouts is feature of the post 1980 financial markets more broadly, one that LBO had a hand in creating:

The blue line is profits, the solid red line is payouts. As Josh Mason noted (my bold), "In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they’ve paid out more than all of them...It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises."

Versions of these three arguments form the core of the private equity critique. Instead of simply carving a figurine or starting a BBQ, private equity uses its stick to game tax law while cashing out short-term value, leaving others in the firm worse off and the firm itself more prone to collapse and less able to produce long-term value. Do you find this critique convincing? What else is missing?

Mike Konczal is a Fellow at the Roosevelt Institute.

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Cyclicalists/Structuralist Divide, Redux

May 18, 2012Mike Konczal

Karl Smith has had some great posts lately, both about Noah Smith and the cyclicalists/structuralist divide and about Rajan's Foreign Affairs article (I, II). I'm going to add my own thoughts on each topic here.

Karl Smith has had some great posts lately, both about Noah Smith and the cyclicalists/structuralist divide and about Rajan's Foreign Affairs article (I, II). I'm going to add my own thoughts on each topic here.

Noah Smith has a blog post arguing that cyclicalists should start talking about structural issues too. Using David Brooks' recent terms, he says "I do not mean that cyclicalists should stop recommending things like quantitative easing. I mean that they should start also throwing out ideas about how to improve our economic performance in the long run."

There's two issues here worth bringing up. The first is that Obama is in a ton of trouble, because all he's done in the past two years is talk about long-term problems (remember Winning the Future?) while dancing around the short-term unemployment crisis. His big achievement, health-care reform, wasn't about how in a rich, modern society like ours everyone has a right to health care. Instead it was explained as a way of "bending the cost curve." Bending the long-term cost curve is about as much of a "structuralist" way of pitching expanding health care as possible.

The second is that blurring these two items as an economic matter has been a major problem for both the Obama economics team and for a certain variety of centrist, deficit-hawks in their view of our economic situation. This is the "two deficits" problem. In this argument our short-term deficit isn't large enough, but our long-term deficit is too large. Fine as far as it goes. But in this theory, in order to fix the first you have to make progress on the second at the same time.

Maybe there are political reasons why this is the case, but the economic ones don't jump out. There are good short-term ideas and good long-term ideas. If they are each good ideas, why not do each on their own? Why do they have to move together? The explanation most give, as a Treasury official told Noam Scheiber, is that the government needs to show “some signal to US bondholders that it takes the deficit seriously” and that “spending more money now [on stimulus] could actually raise long-term [government] rates, thereby offsetting its stimulative effect.” I think this is dead wrong, and if Obama loses this argument will be one of the major reasons why. It is what kept him trying to kick Lucy's football negoitate with Republicans in 2011. If both need to move, they throwing a roadblock in front of one stops the other - and given that Republicans won't budge on tax increases, it takes away the case for more stimulus in the short-term. Meanwhile interest rates continue to stay at record lows.

As for the Rajan piece in Foreign Affairs, I think there are two big problems with it beyond what Karl mentions ("the piece had little to do with the recession and nothing to do with borrowing and spending for recovery"). The first is the crux of his argument, which is that 2007 featured "artificially inflated GDP numbers." It is no doubt impressive to people who haven't thought about it hard to state that we had a GDP bubble in 2007 alongside a housing bubble. But what does that even mean? What else would be true about the world if US GDP was unsustainably high in 2007?

Jim Bullard made this argument recently and even then the justification for the argument switched completely within days, once it came under the critical scrunity of the econoblogosphere. In one version the case was about how the collapse of the housing bubble represents a technology loss. In the second argument it was pure wealth effect: we feel poorer, and the only solution is to beg policymakers to “please reinflate the bubble."

The second issue is that the manitude of numbers are completely off. Subprime mortgages were about refinancing, not about new home construction. As Karl Smith noted, to the extent subprime encouraged single-family home construction, it came at the expense of multi-family home construction. Residential building construction is off about 400,000 workers - even if those jobs are gone completely, we have 5 million more workers unemployed right now than we did in 2007 (12.5m versus 7.5m). I'd be happy to say that the NAIRU is up 400,000 people if we can end these so-called structural arguments here.

[Also: Rajan's GSE argument has been debunked in several places. It is hard to argue that Congress is pro-consumer-debt and pro-debtor/easy credit policies in the past 30 years when it passed the 2005 bankruptcy reform act. It is not controversial to argue that the 2005 bill was significantly harder on debtors looking to file bankruptcy. Instead of Congress, the major thing that changed the consumer debt markets came from the Supreme Court. In 1978's Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp, the Supreme Court interpreted the word “located” in the National Bank Act of 1863 as meaning the location of the business and not the location of the customer, which completely changed how credit cards would work in the following decades.

Also, the conservatives' publically-stated calculus is off. There is a sense in which there are short-term things we can do, or long-term things we can do, and we have limited time and energy, so better to focus on the long-term things. But there's reason to believe that conservatives are purposely ignoring the short-term things, because weak economies are the perfect time to be able to achieve their preferred long-term agenda ideas.

We know from the explanations for dissenting votes on the Federal Reserve that those dissenting from more demand now believe that this higher demand through monetary policy gets in the way of making "hard choices" on entitlements and tax reform. The Wall Street Journal has Federal Reserve Bank of Dallas President Richard Fisher saying “The more we offer accommodative monetary policy, the less incentive they have to pull their socks up and do what’s right for the American people.” (This is also currently going on in Europe.)

If you view the Great Society, the New Deal, and the whole regulatory/Keynesian/welfare state as a form of tyranny, well, destroying most forms of tryanny requires bloodshed. If a conservative revolution happens in the next Congress, and the only cost was 4 years of mass unemployment, wouldn't it be worth it to experience liberty in our lives? I fear this explanation drives more conservative commentary on economics than we realize.]

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Demand, Deficit, and Denial: A Simplified Case Against Austerity

May 17, 2012Robert Leighninger

President Roosevelt's legacy of public works programs offers insight into the importance of increased government spending to create jobs and restore the economy.

President Roosevelt's legacy of public works programs offers insight into the importance of increased government spending to create jobs and restore the economy.

It’s good to hear more economists talking about the foolishness of austerity in Europe and the United States. Some, including Joe Stiglitz and Paul Krugman, have been saying it for a long time, but the chorus has gotten louder recently. Still, I have yet to hear anyone put the argument in terms simple enough for the average citizen (including the average Republican not too tied in ideological knots) to understand. I’d therefore like to take a shot.

To reignite the economy, we need more people to buy things. For that to happen, we need to keep people in their present jobs, re-employ people who have lost jobs, and employ those just entering the job market. Once people are buying things, those who make the goods and services being bought will have reason to invest, hiring new workers and buying new machines that make things. They have no reason to invest now; there is no likely return on their investment.

Republicans have things backwards. They assume that investors will invest if we give them more money. But they already have lots of money. Why assume that giving them more will change their behavior? They’re not stupid (at least most of them aren’t). What they need is a prospect of profit.

Tax breaks aren’t any incentive. What good are lower taxes on income that you don’t have? What’s the point of hiring another worker if he or she will have nothing to do? Fewer regulations are equally irrelevant. This is why “uncertainty” and “confidence” (the claim that investors won't invest because they are uncertain what their taxes might be in the future or what new regulations they may face) are smokescreens.

What do you suppose investors would do if there were customers pouring through their doors? If goods and services were in demand and inventory was disappearing? They would not say, “No, I don’t think I’ll take advantage of this. I’ll forgo making a profit now because I don’t know what my taxes and regulations will be next year.”  More likely, the response would be, “Wow, we can sell more widgets now; let’s crank up production!”  

In the language of economists, this is a demand-side problem, not a supply-side problem. Republicans have been looking at the world through supply-side lenses for over 30 years and can’t see the total economy. They are blind to common sense.

So how do we get people to buy things? We can save good middle class jobs by aiding states so they can stop laying off teachers, police officers, firefighters, and other public workers. We can create new jobs with large infrastructure projects. There are so many things on the landscape in need of repair or replacement that it shouldn’t be hard to employ or re-employ millions of people. In 1933, the Civil Works Administration (CWA) put 4 million people to work in two months. 

But good heavens, this will cost money! Yes, it will drive the deficit to new heights, and deficits are worth worrying about. But a stagnant economy will not reduce deficits. Putting people out of work through an austerity campaign only decreases revenues and cripples our ability to deal with deficits. A robust economy will handle the problem much more quickly. Restarting the economy will be expensive, but we need to spend the money. If your house is on fire, you don’t tell the fire department, “Don’t use too much water, I want enough for my morning shower.”

If Obama’s $800 billion stimulus package hadn’t been weighed down with so many useless tax cuts, we might not be having this conversation. The experience of the New Deal is relevant here. At its beginning, 25 percent of workers were out of work; when World War II started, it was down to 10 or 12 percent. That is significant progress. And there would have been even greater progress had President Roosevelt not twice stalled the recovery he had created. In March of 1934, after it was only four and a half months old and employing 4 million people, he pulled the plug on the CWA in spite of the fact that even the Wall Street Journal noticed its effect on the economy. He just didn’t want to believe that it was going to cost so much money to end the Depression. 

Once he had replaced the CWA with the Works Progress Administration (WPA), and after his other giant public works programs—the Public Works Administration and the Civilian Conservation Corps—were fueling the recovery, Roosevelt again cut back. Despite the crisis, he still believed in a balanced budget. This return to orthodoxy produced a recession that by early 1938 was looking like 1929. His advisors finally persuaded him to restore the works programs, and thus he ended the recession. Had it not been for these two crises of confidence, the employment rate at the start of the war may have been lower than 10 percent, and we wouldn’t be hearing these claims that it was the war that ended the Depression.

Once demand is stimulated through public jobs, private investment will return and private jobs will increase. A healthy economy can then deal with deficits. It will be costly to regain that economy, but if we don’t, we will have both stagnation and deficits. 

Robert Leighninger is faculty associate in the School of Social Work at Arizona State University, and author of Long Range Public Investment: The Forgotten Legacy of the New Deal.

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On Hysteresis Hysterics

May 14, 2012Mike Konczal

Dean Baker and Kevin Hassett have a great editorial in the weekend's New York Times, "The Human Disaster of Unemployment." They correctly identlfy the many long-term psychological and social problems of periods of mass unemployment for people, families, communities, and ultimately our nation.

Dean Baker and Kevin Hassett have a great editorial in the weekend's New York Times, "The Human Disaster of Unemployment." They correctly identlfy the many long-term psychological and social problems of periods of mass unemployment for people, families, communities, and ultimately our nation. As is the nature of editorials written by people with cross-ideological committments, the solutions are a bit off, but this weakness is also part of the issue with discussing the urgency of unemployment because of "hysteresis."

Imagine having a fever so bad that it permanently raised your body temperature. Now imagine a period of unemployment so bad that it permanently reduces our economy's ability to produce things and employ people. That's hysteresis -- the long-term scarring of our economy from periods of short-term unemployment. I've discussed this before, and I think the evidence is very convincing it is a major issue. Hysteresis is part of the engine in the recent Brad Delong/Larry Summers paper arguing for self-sustaining stimulus.

Crucially, hysteresis is an intellectual challenge to the so-called structuralists who would argue that we should ignore the short-term economy and just focus on the long-run health of the economy. Beyond us all being dead in the long run, the long run is just a series of short runs right after each other. And hysteresis shows that short-run problems can perpetuate themselves and become embedded in the long-run economy.

Where I become ambivalent about the focus on hysteresis is that it too quickly presumes that special policy is required to combat it. Instead of a weak economy and poor job growth, suddenly hysteresis calls for the assumption that jobs are available and that the long-term unemployed, for whatever individual reasons, can't take them. I think the easiest way to fight hysteresis is just to have a lot of jobs available through strong demand, and employers will be perfectly incentivized to train workers however they need to as they look to expand their workforce. But others would take their eye off the ball of full employment and try to focus on just the long-term unemployed policy-wise, through such things as special job training programs.

Is there data we can use to test this theory one way or the other? I was able to get the people in charge of the flows data at the BLS to send me an update of one of my favorite data sets, flows from unemployment to employment by duration of unemployment. We've talked about this data last year here and here, and now I have it updated through April 2012. The longer you've been unemployed, the less likely it is that you'll find a job over the course of a month.  But how has this changed during the Great Recession and the aftermath?

Thesis: if hysteresis is problematic in that the long-term unemployed have become detached from the labor force in such a way that it requires policy intervention beyond creating jobs - like special job training programs - then we'll see that people who have only been unemployed a short time (low duration) find jobs easiers than a year ago. But we will also see that those that have been unemployed a longer-time will not show any increase in their job finding rate, and maybe their rate of finding a job has even decreased. The unemployed parts of the economy will be bifurcating into a healthy short-term section and a dislodged long-term section.

I'm plotting the chance of the unemployed for the average of the first four months of 2007, 2011 and 2012 each (the data is seasonally unadjusted) by duration of unemployment. How did the last year look?

The purple line for 2012 is pulling away from 2011 across the entire unemployment spectrum. The chances of finding a job are increasing for all unemployment spell lengths, though they aren't anywhere near 2007 levels. Meanwhile, here's a graph of the six month moving average of each duration bucket going back 9 years:

The entire job market is weaker, even for those who have only been unemployed for a few weeks. Though the suffering the long-term unemployed are going through is real, the best policy for them is providing anti-poverty relief through cash and services while pushing on expansionary fiscal, monetary and debt-relief policies to get the economy back on track.

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The High Cost of Unpaid Internships

May 14, 2012Tim Price

Young Americans are doing real work for fake benefits, and it’s causing serious harm to them and our workforce.

Young Americans are doing real work for fake benefits, and it’s causing serious harm to them and our workforce.

Summer is almost upon us and college students across the nation eagerly await vacation and graduation. But once they finish their term papers and pass their final exams, they face a far more daunting challenge: finding a job. That won’t be easy with the unemployment rate for young adults at 13.2 percent, but staring down the barrel of $1 trillion in student debt has them desperate to find an in. As Steven Greenhouse of the New York Times recently reported, undergraduates – and even newly minted baccalaureates – are turning to unpaid internships in droves. Unfortunately, their free labor isn’t doing much good for them or our economic recovery. But there is a solution, and to find it, all we need to do is crack open the history books ourselves and read up on the New Deal.

Greenhouse notes, “experts estimate that undergraduates work in more than one million internships a year, with Intern Bridge, a research firm, finding almost half unpaid.” This represents a steep increase from just a few years earlier. How do all these companies get away with paying their young workers nothing? Federal law lays out clear requirements for such positions, which amount to vocational training opportunities that don’t displace paid employees and from which the employer “derives no immediate advantage.” Moreover, the law states, “on occasion the employer’s operations may actually be impeded” by the intern’s presence.

So take heart, unpaid interns: the next time your boss scolds you for showing up late, transposing the numbers on a spreadsheet, or accidentally jamming the copy machine, just explain that you’re doing your part to help keep your company on good terms with the Department of Labor.

The rules that separate an unpaid intern from an employee who’s being denied a wage are flouted so routinely and enforced so rarely that they might as well not exist. The proof is staring us in the face: if unpaid interns truly provided no benefit to employers, why would companies bother to keep half a million of them around? Eric Glatt, who was hired as an unpaid intern at the age of 40 and wound up doing the job of an accounting clerk, says, “This culture of expecting to be able to get free labor if you slap the title intern on it has become so pervasive that people don’t question whether it’s ethically wrong or legally acceptable.” He and others like him have brought this issue to light recently through a series of lawsuits, but we don’t have to wait for a court ruling to know there are serious practical and moral problems with giving young workers all the responsibilities of a “real” employee with none of the benefits.

The most basic reason that young Americans take these positions is to build their résumés and make connections that will get them a full-time job offer. But unpaid internships fail even on that level. As EPI’s Ross Eisenbrey notes, a 2011 study by the National Association of Colleges and Employers found that “[u]npaid internships… provided no advantage in terms of full-time job offer rates or starting salary” and “in every category were a serious disadvantage in terms of starting salary.” So not only are these interns not getting paid for their work, but they’re actively harming their future prospects. In other words, they would literally be better off doing nothing at all than taking an unpaid internship.

If unpaid interns were just wasting their own time and not harming anyone else, this might seem unfortunate but relatively unimportant in the grand scheme of things. However, unpaid internships create much broader problems in the workforce with ripple effects throughout our society. For one thing, as useless as they may be in general, unpaid internships are nevertheless a luxury. Not everyone can afford to work for free, so when that risk does pay off and lead to a steady job it privileges young workers whose families have the financial resources to support them while they’re biding their time. Given America’s soaring inequality and deepening class divisions, the last thing we need is to have our so-called job creators running rich kid recruitment programs. (Besides, we already have Ivy League schools for that.)

While giving the privileged a boost, unpaid internships also hold other workers down. As Generation Debt author Anya Kamenetz has pointed out, unpaid interns “create an oversupply of people willing to work for…literally nothing,” allowing companies to eliminate low-level paid positions and reduce the bargaining power of their paid employees. On the flip side of the coin, these positions inculcate a mindset that may stay with young workers for the rest of their lives: don’t demand what you deserve; just settle for whatever you can get. Kamenetz writes that they also “promote overidentification with employers: I make sacrifices to work free, therefore I must love my work.” Together, this adds up to a power dynamic in which employers hold all the cards and lowly workers feel lucky just to be doing something, no matter how little it benefits them. Fostering these beliefs harms the labor movement and efforts to bargain for more equitable pay and working conditions.

The question is: if we eliminate unpaid internships while the economy remains too weak to provide college students and recent grads with real job opportunities, what do we expect them to do with their lives? They could stay in school longer, but that’s not an affordable or particularly useful option for everyone, and it only delays reckoning with the real problem. They could also take shelter in their parents’ basement and wait for the economy to pick up on its own, but there’s no telling how long that will take, and unless future employers place a lot more value on Mario Kart skills, we’ll be allowing an entire generation to atrophy and deal a permanent setback to their future earning potential.

Luckily, as with many other challenges we face today, FDR already figured this one out for us. With New Deal programs like the Civilian Conservation Corps, he put millions of young people to work on projects that had a lasting impact on our country. Describing his plans to Congress, Roosevelt explained that the CCC would “take a vast army of these unemployed out into healthful surroundings” and help to eliminate the threat of “enforced idleness.” That last phrase, “enforced idleness,” is a perfect description of what policymakers are subjecting Americans to today as a result of their failure to fund more stimulus and public works projects. As Roosevelt Institute Senior Fellow David Woolner has argued, launching a modern-day CCC would “provide the millions of young people trapped in the despair of poverty with meaningful employment, a chance to further education, and the one thing that FDR was determined to provide above all else: hope for the future.” If we help to make sure their imaginary jobs go the way of their imaginary friends, our young workers may be able to bring about a real recovery.

Tim Price is Deputy Editor of Next New Deal. You can follow him on Twitter @txprice.

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Vitters and Shelby Blocking of Federal Reserve Nominees and Previous Conservative Candidates

May 10, 2012Mike Konczal

Chris Hayes, guest-hosting for Rachel Maddow, had a great segment on the hold Senator David Vitters placed on President Obama's Federal Reserve nominees where he talks with economist Betsey Stevenson.

Chris Hayes, guest-hosting for Rachel Maddow, had a great segment on the hold Senator David Vitters placed on President Obama's Federal Reserve nominees where he talks with economist Betsey Stevenson.  The nominees, Jay Powell and Jeremy Stein, were nominated as a bi-partisan move after Peter Diamond was blocked by the Senate (records have Powell donating to the Romney and Hunstman campaigns in 2011).






Vitters' reasoning? "I refuse to provide Chairman Bernanke with two more rubber stamps who approve of the Fed's activist policies."  This is consistent with Richard Shelby, who blocked Nobel Prize award winning economist Peter Diamond for the Federal Reserve because of “Dr. Diamond’s policy preferences…He supports QE2…He supported bailing out big banks during the financial crisis.”  Republican Senators are giving themselves a de facto seat on the FOMC, and they are casting multiple votes against further monetary easing, without being held accountable for their logic or the subsequent results.

Here's an important point on how far to the right conservatives have moved on monetary policy.  The natural way reporters cover this is to note that the back-and-forth blocking of Federal Reserve nominees have been escalating for several years, especially since Democrats blocked Republican-nominee Randy Kroszner.  Indeed Shelby notes in his letter that "For those who say that policy preference should not be considered, I will only point out that the re-nomination of Dr. Randy Kroszner to the Fed was blocked by the majority party because he was viewed as being too free market."  Democrats blocked conservative, free-market Randy Kroszner's nomination to the Federal Reserve, and so the Republicans are going to block those who support QE2.

But here's the funny part (and I'm cannablizing one of my posts, which lays out the case in more detail): Randy Kroszner supported QE2.  He urges people to seriously consider QE3.  To give you a sense of how off-center the Republican Party has gone in terms of the economy, if Kroszner was to show up as a nominee from President Obama for the Federal Reserve tomorrow the conservatives in the Senate would block him because of his policy preferences.

Here's Kroszner, in January 2011, saying: ”I think [QE2] was the right policy when they put it forward. I think the right policy now, and I think the data has been very much supportive of what the Fed’s been doing...It depends on where we are four or five months from now. If the unemployment rate has not ticked down at all, if we haven’t seen a little bit more job creation, then of course the Fed will have to see if it needs to do more support [with QE3].”  That now appears to be sufficient to get blocked by the conservatives in the Senate.

Even better, Kroszner spent March 2011 arguing not only that inflation wasn't spinning out of control but the real threat was Japanese-style deflation.  Bloomberg TV, March 2011: “It’s hard to see a lot of inflation pressures right now. If you look at the recent numbers that came out on inflation just earlier this week, the core rate, stripping out food and energy, is less than 1%. That’s dangerously close to Japan-style deflation problems. An even the headline rate, which includes food and energy is less than 2%. So we aren’t seeing enormous inflation pressures right now…inflation is well-anchored."  The real threat is not inflation but Japan-style deflation...it's like you are reading a Krugman column.

(For fun, here's Kroszner saying that even glancing at the evidence shows that the Community Reinvestment Act didn't cause subprime lending: "the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.”  Given how important that the "CRA -> Crisis" argument is to think-tank based conservative intellectuals, Kroszner is practically a socialist in the political landscape.)

There is no neutral in monetary policy.  If Republicans in the Senate think that the Federal Reserve is doing too much, then they think the Federal Reserve can't accomplish anything, or that unemployment is too low or they think that unemployment should not come down because it would get in the way of other political projects - from passing the Ryan plan to taking the Senate as a result of a weak economy.  Some people on the right are explicit about the third - “The more we offer accommodative monetary policy, the less incentive they have to pull their socks up and do what’s right for the American people,” was the argument Richard Fisher used for dissenting.  I wish more would just come out and say that.

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A Visual Guide to the Conflicting Theories About How to Fix the Economy

May 10, 2012Mike Konczal

A map of the contrasts between 2012's different theories of what's ailing our economy and how we can fix it.

A map of the contrasts between 2012's different theories of what's ailing our economy and how we can fix it.

Since there's so much renewed focus on debates between those with a demand-side approach and those with a supply-side approach to what is wrong with the economy, I think it's a useful time to redraw my mapping of all the explanations of our crisis. I did this exercise in 2011, with a focus on different explanations of what is wrong with the economy and ways certain policies overlapped between them. I'm going to redraw this to emphasize the policy as it exists on a spectrum of options and give some new links.

Demand

The first approach is to say that we have a lack of demand in the economy. Those who believe this usually have three sets of policies for dealing with the weak economy: fiscal policy, monetary policy, or (mortgage) debt policy. Here are the three circles with a policy response spectrum for each of the issues. In general, the response on the right side of the arrow is more aggressive.

For those who want an explanation of how the three link together, some explanations include "Debt, Deleveraging, and the Liquidity Trap" and "Sam, Janet and Fiscal Policy," both by Paul Krugman, as well as "Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery," by Atif Mian and Amir Sufi.

Some people put more of an emphasis on one circle versus another. Some think one will be the major factor, and some think another has no traction in the economy. In my humble opinion, it is useful to think of this as a three-legged stool. They all hang together, and contraction on any specific part of the three policies will require more expansion on another part to offset it. They are also all different battlefields policy-wise, requiring different agents and different arguments.

Fiscal Policy

For those who would like to see the government run a larger deficit to increase spending, the big question is whether to just give people money (particularly in the form of tax cuts, but also through other means like food stamps and unemployment insurance) or to use the money to invest, hiring people to work on infrastructure and other public works. The multipler is believed to be larger when it comes to hiring people, plus it results in public works and other investments in our economy -- things like roads, bridges, schools, etc. That takes time, though. This debate goes back to the composition of the ARRA stimulus and continues today.

Chrstina Romer has an overview about what we know on fiscal stimulus. Dylan Matthews reviewed nine studies about the effects of the ARRA stimulus bill that was passed in 2009. On the other hand, as Karl Smith would say,  "Why is the US government still collecting taxes when borrowing is cheaper than free?"

Monetary Policy

For monetary policy, the big debate is whether the Federal Reserve should engage in unconventional monetary policy through monetary instruments or by setting more aggressive targets. Paul Krugman gave a nice overview of the debate between these two approaches here.

Joe Gagnon wrote "The World Needs Further Monetary Ease, Not an Early Exit," justifying further action using monetary instruments. The larger case is that Bernanke can do more by guiding short-term interest rates than he could with the blowback he'd get from doing more aggressive targeting.

For the NGDP target group, Scott Sumner has been the best writer on this: see "Re-Targeting The Fed" and "The Case for NGDP Targeting: Lessons from the Great Recession." (A nice background on this movement is Lars Christensen's "Market Monetarism: The Second Monetarist Counter-revolution.") Brad Delong argues that a 2 percent inflation target is too low. Charles Evans's conditional higher inflation target is first alluded to in this speech of his; Yglesias covers his Brookings paper on his approach versus the instruments/guidance approach here.

Mortgage Debt Policy

For debt relief policy, the godfather of the "balance-sheet recession" view is Richard Koo -- see his "U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005." To understand how mortgage debt and a balance-sheet recession is different than the wealth effect of people just feeling poorer from losing their housing value, see this interview with Amir Sufi. Adam Levitin has testimony about how to adjust bankruptcy to prevent housing foreclosures and better assign losses. Atif Mian, Amir Sufi, and Francesco Trebbi make the case that foreclosures are having a major real, negative economic impact in "Foreclosures, house prices, and the real economy." R. Glenn Hubbard and Chris Mayer argue for economic stimulus through refinancing here.

Supply

Meanwhile, on the supply side, there tends to be another three sets of policy arguments. One is that government policy is the issue, another is that governement budgets are the issue, and the third is that the labor force is the issue. Again, the issue on the right side of the spectrum should be considered the more aggressive approach in understanding the topic.

Government Budget/Debt

The first major cluster of supply-side arguments focus on the government budget and the deficits the government is running. These usually argue that private capital and job creators are sitting on the sidelines due to worries about government spending, future tax burdens, and/or a potential debt/solvency crisis. "Growth in a Time of Debt" by Carmen Reinhart and Kenneth Rogoff, as well as "Spend and Save" by Noam Scheiber, are places to start. These often go hand-in-hand with philosophical defenses of a program like the Ryan Plan and assaults on the social safety net (e.g. Yuval Levin's "Beyond the Welfare State").

At their most aggressive, these arguments say that short-term consolidation would expand the economy instead of shrink the economy. This "expansionary austerity" is less popular than it was in 2010-2011 (see David Brooks, "Prune and Grow") due to what is happening in Europe, though it still shows up. "A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked" by AEI and "Large changes in fiscal policy: taxes versus spending" by Alesina and Ardagna are places to start.

Another aggressive argument is that any increased government spending would have to come at the expense of private capital, crowding out investment by definition. This "Treasury View" was a very common Chicago School argument against expansion in 2009, though is mentioned less now -- see Brad Delong's "The Modern Revival of the 'Treasury View.'"

Goverment Policy

Government policy arguments usually rely on the idea that economic performace is weak because of regulatory decisions made under the Obama administration, especially the passage of health care and financial reforms as well as regulatory decisions by the EPA. Suzy Khimm gives an overview of this argument and its political impact. Alan Greenspan is the most prominent advocate of this argument (see his paper "Activism"). Robert Lucas argues that Obama may have turned America into a social democratic country, which could explain the weak economy, in "The classical view of the global recession."

At the more aggressive end of this argument is the idea that the unemployment rate is high because the government is encouraging the unemployed to go on vacation (i.e. it's not a Great Recession but a Great Vacation). Instead of adding to background uncertainty, the government's policies are actively creating the unemployment they are trying to fix. See "Compassionate, But Inefficient" by Casey Mulligan and "The Dirty Secret of Unemployment" by Reihan Salam.

The other argument at the aggressive end is the idea that the level of GDP in 2007 was in a bubble, unsustainably high as a result of debt and/or bad sectoral allocations to finance and housing (caused solely by government policy, of course). A related argument is that the collapse of the housing bubble has permanently reduced U.S. potential output. See the arguments of James Bullard in the links here or here; it is also part of the main thesis of Raghuram Rajan's Foreign Affairs article.

Labor Productivity

The last cluster of arguments are centered around labor productivity. Some argue that we have an issue of labor mismatch. Our workers lack the skills necessary for high-tech 21st century jobs, or the recession has tossed the lowest productivity workers out of the labor force, or there are geographic and related issues that weaken our ability to match unemployed workers to job openings. See David Brooks here and Narayana Kocherlakota here for job openings, and Tyler Cowen's "10 Percent Unemployment Forever?" for the productivity argument.

The more aggressive version of this argument is that our problems are related to a lack of producitivty gains from so-called "protected" sectors of the economy, and without labor market reforms our economy cannot grow. Usually this is code for public sector workers; sometimes it means various growth-related government policy decisions (immigration, copyright/patents). This should properly be thought of as a long-term growth issue, though it is being folded into our current short-term economy by those who would make these arguments. David Brooks makes the case here; Raghuram Rajan makes a similar case in Foreign Affairs.

In general, the supply arguments have not held up well (remember when U.S. debt rallied on a ratings downgrade? good times), but here they are. Did I miss anything?

Mike Konczal is a Fellow at the Roosevelt Institute.

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Live at the Financial Times: Monetary Policy Response Op-Ed

May 9, 2012Mike Konczal

I have an editorial at the Financial Times online here on monetary policy. It responds to Raghuram Rajan's editorial against "progressive economists" calling for the Federal Reserve to do more (same link, unguarded here.)  The essay is reprinted here, but go check it out at the FT's webpage.  Enjoy!

I have an editorial at the Financial Times online here on monetary policy. It responds to Raghuram Rajan's editorial against "progressive economists" calling for the Federal Reserve to do more (same link, unguarded here.)  The essay is reprinted here, but go check it out at the FT's webpage.  Enjoy!

In 1926, John Maynard Keynes attacked socialist ideas for being “little better than a dusty survival of a plan to meet the problems of fifty years ago, based on a misunderstanding of what someone [Karl Marx] said a hundred years ago.” Right now the monetary policy debate in the US is centered on answering the problems of 30 years ago – when inflation and unemployment were both at high levels – based on a misunderstanding of what someone said 50 years ago: Milton Friedman.

The problem at the core of the US economy is that interest rates have been too high since the recession started. However, the Fed is not in a straightjacket. It has the tools to get the economy going again and must put them to use. The absence of pressure on the Fed, which has received only one dissenting vote demanding more stimulus but several to tighten earlier, to do more to reduce unemployment speaks to an intellectual paralysis as challenging as the orthodoxy of the gold standard and balanced budgets in the Great Depression.

The Fed uses monetary policy to balance unemployment and inflation. It has typically done this with an inflation “target”. But the target metaphor is inaccurate; it functions far more like a “ceiling.” People aim for targets but can go over them. Yet what we’ve seen over the last five years is that rather than a balance between its two goals, the Federal Reserve supports the economy up until the point where it is near the inflation target, and thereafter backs down from monetary stimulus. The market understands this and output remains equivalently depressed.

The Fed is fighting the last war: against 1970s stagflation. It is of course essential that the Fed maintains its hard-won credibility against runaway inflation. But the best way to do so isn’t to keep the economy in a perpetual state of high unemployment. It is to be explicit in what it wants to see accomplished and what it is willing to tolerate in order to get it. As Charles Evans, President of the Chicago Federal Reserve, recently pointed out, the Fed could “make a simple conditional statement of policy accommodation relative to our dual mandate responsibilities.” An “Evans Rule” would mean the Fed would agree to keep interest rates at zero and tolerate 3 per cent average inflation until unemployment went down to 7 per cent, setting market expectations in such a way that would allow aggregate demand to surge.

If conventional monetary policy was available – if interest rates were at 1 per cent instead of zero per cent – Mr Rajan’s argument suggests he wouldn’t lower interest rates further. Even though inflation has been lower than the target for several years, and unemployment is significantly higher than it should be, his editorial suggests he believes interest rates are already too low. Lower rates will not help the unemployed, since unemployment is localised. As he puts it, people are out of work in Las Vegas, but lower interest rates will increase demand in New York. So we won’t see increased employment, just savers “coerced” into buying risky bonds.

Contrary to Mr Rajan’s argument, the crisis is a national one. The median state’s unemployment rate is 1.65 times higher than it was before the recession began. New York has an unemployment rate of 8.5 per cent, up from its pre-recession rate of 4.7 per cent. Meanwhile, as Edward Luce wrote in the Financial Times yesterday, “risk capital is far harder to come by”. If lower rates would, as Mr Rajan says, increase demand for riskier assets, that’s exactly what the economy needs.

This would help with our current dilemma, but the Fed must also change its future approach to monetary policy. It has failed to balance inflation and growth, especially in periods of low inflation. Our low inflation target doesn’t work precisely at the moment when we most need it. Changing the target to inflation and growth added together, or what economists call NGDP (nominal gross domestic product), would better balance these goals. Alternatively, moving to a higher inflation target, say 4 per cent a year, would give the Fed much more room to fight recessions. Four per cent was the average annual rate during much of the past 30 years. The costs of a higher target would be minimal. Given that the cost of the current recession is in the trillions of dollars, this demands serious reconsideration.

It seems like a radical statement to some to note that the Fed has the ability to bring us closer to full employment with little risk and is simply choosing not to do it. They believe the Fed is full of disinterested technocrats doing the best they can. No doubt those at the Fed believe they are trying hard, but if the situation was reversed, with unemployment at ultra-low rates and inflation well above what anybody could possibly want, they would be working overtime to try and fix the problem. Chairman Bernanke, when he was a scholar of Japan, understood that a central bank could end up in a situation of “self-induced paralysis,” like where our current Federal Reserve is. And Milton Friedman himself, who people arguing against looser monetary policy would like to invoke, also understood that the Bank of Japan had “no limit” on closing output gaps if “it wishes to do so.”

Commentators would like to argue that monetary policy rewards some people over others, forgetting that mass unemployment is the most regressive policy imaginable. But beyond that, monetary policy is not a morality play, and it’s not about rewarding the good people and punishing the bad ones. It’s about stabilising growth, prices and maximum employment without overheating the system or letting it choke to death from a lack of oxygen. Now, more than ever, a commitment to both goals is necessary for the good of our economy.

 

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Assessing Yet Another Round of the Structural Unemployment Arguments

May 8, 2012Mike Konczal

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

No matter how much elites insist that our unemployment problem is structural, they don't have the data on their side.

David Brooks has the 2012 version of the structural unemployment argument in his editorial today, "The Structural Revolution." Here's rooting for this one, as the previous arguments haven't held up all that well.

The 2010 version of the argument had to do with an increase in JOLTS "job opening" data, data that turned out to be incorrectly estimated by the BLS (as we learned in 2011). The 2011 version focused either on the idea that the unemployed had bifuricated into a normal unemployment market and a long-term, zero-marginal productivity market (it hadn't) or that the "regulatory uncertainty" of the Obama administration was holding back the economy (which, as Larry Mishel found, wasn't backed by the data).

There's been a ton of situations where these structural unemployment arguments came charging down the runway only to hit a cement wall of data. One "oops" moment was Raghuram Rajan citing Erik Hurst in claiming that unemployment would be three points lower if it wasn't for "structural" reasons, and Hurst having to publicly point out his preliminary research said nothing of the sort. Another was Rajan arguing, in June of 2011, against monetary policy. Why? Because "one view is that corporate investment is held back by labor-market rigidities (wages are stubbornly too high)....There is, however, scant evidence that the real problem holding back investment is excessively high wages (many corporations reduced overtime and benefit contributions, and even cut wages during the recession)." Empirically that means that there shouldn't be any bunching of wage changes at the zero mark. Here's what the San Francisco Fed found early this year:

Whoops.

Apparently none of that changed anything for anyone. So what do we have now? I want to address three specific points in Brooks's essay which I think are wrong in a very useful way. First, Brooks argues that "Running up huge deficits without fixing the underlying structure will not restore growth." The argument here is that a larger deficit will not help with short-term growth. I'll outsource this to Josh Bivens, addressing a similar argument from Adam Davidson:

This is the reverse of the truth – there is wide agreement that debt-financed fiscal support in a depressed economy will lower unemployment. Now, it’s true that there are holdouts from this position. And others who think the benefits of lower unemployment are swamped by the downsides of higher public debt (they’re wrong, by the way). But, the agreement is much more widespread – ask literally any economic forecaster, in the public or private sector, that a casual reader of the Financial Times has heard of if, say, the Recovery Act boosted economic growth. They will all tell you “yes.”

You won’t find anywhere near such a consensus on long-run tax or education or health care policy. In fact, public finance economists can’t get unanimous agreement on if, in the long run, income accruing to holders of wealth should be taxed at all (it should, by the way). In short, anybody waiting for the current unpleasantness to pass and for economists to unite in harmony in future policy debates shouldn’t hold their breath...

Lastly, Davidson notes that there is a rump of economists (he calls them, reasonably enough, the Chicago School) that argue that debt-financed fiscal support cannot help economies recover from recessions. But, it’s important to note that there is pretty simple evidence that can be brought to bear on this Keynesian versus Chicago debate. Nobody denies, for example, that the government could borrow money and just hire lots of people – hence creating jobs. What the Chicago school argues is that this borrowing will raise interest rates (new demand for loans will increase their “price,” or interest rates) and this increase in interest rates will dampen private-sector demand. But interest rates have not risen at all since the Recovery Act was passed and private investment has risen, a lot.

Second, Brooks argues that "there are the structural issues surrounding the decline in human capital. The United States, once the world’s educational leader, is falling back in the pack." If this is the case -- that our problems are a lack of education and investment in human capital -- then recent college graduates would have significantly lower unemployment rates than most, or they would be the same, or if they were higher then they'd come down even faster. Also from EPI, Heidi Shierholz, Natalie Sabadish, and Hilary Wething, "The Class of 2012":

Young people with recent college degrees have high unemployment rates. That's not good, either for Brooks's argument or for the huge number of young people being devastated by the weak economy and the weak response of elites.

Third, we have Brooks arguing that there are issues "surrounding globalization and technological change. Hyperefficient globalized companies need fewer workers. As a result, unemployment rises, superstar salaries surge while lower-skilled wages stagnate, the middle gets hollowed out and inequality grows." Some occupations require high skills and have sufficient demand, but some occupations require mid-skills and are disappearing. (Low-skill jobs should be fine on unemployment, but low on wage growth, in most versions of this "job polarization" theory.)

Let's take BLS CPS unemployment data by occupation, March 2007 and March 2012, and see if you can tell me which occupations require these high-end skills from their low 2012 unemployment rates:

I'm having trouble seeing them in the data.

So here's the important thing about the demand-side recessions: If I wanted to come up with a "supply" theory for Brooks, I'd say, looking, at the data above, that we have too many college graduates and too many business and professional workers. I'd also say we have too many non-college graduates and too many service workers. I'd also say we have too many of all ages, all educations, and all occupations. Something is weak at a fundamental level in the economy, which is impacting everything, even before we get to the pressing issues related to job polarization or education. That weakness is demand, and that is where the policy response should be. Don't tackle it, and the longer-term problems are even harder to manage.

As David Beckworth noted, "[t]his evidence in conjunction with that of downward wage rigidity excess money demand, and the Fed handling the housing recession just fine for two years should remove any doubt about there an aggregate demand problem. The real debate is how best to respond to this problem." The evidence he referred to was the SF data noted above along with the tracking he found between sales being reported as the "single most important problem" by small businesses and the unemployment rate:

Mike Konczal is a Fellow at the Roosevelt Institute.

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Getting Our Arms Around Labor Force Participation With Two Fed Studies

May 7, 2012Mike Konczal

The short answer is: half, U-5 probably tells you everything you need to know, and women are going to play the most interesting role as it evolves.  Now for the question and longer answer....

The short answer is: half, U-5 probably tells you everything you need to know, and women are going to play the most interesting role as it evolves.  Now for the question and longer answer....

The average labor force participation rate went from an average of 66% in 2007 to a 2011 average of 64.1%.  Last month it was 63.6%.  As a reminder, the labor force is the employed and the unemployed (those without a job who are actively looking for one) added together.  When this number decreases it means that there are less people working, though it doesn't increase the unemployment rate (because, by definition, those leaving the labor force are no longer looking for a job).  Let's try to get our arms around the latest econoblogosphere debate: how much is the decrease in labor force participation a type of shadow unemployment?

To recap, there's a handful of longer-term trends to watch in the economy. When Ben Bernanke was asked about labor force participation at his most recent press conference, he responded that labor force participation was dropping because the economy was (my bold) "no longer getting increased participation from women... society ages and also, for other reasons, male participation has been declining over time."  However a lot of it "represent cyclical factors, much of it is young people, for example, who presumably are not out of the labor force indefinitely, but given the, uh, weak job market, they are going to school or doing something else, rather than, than working."

But how to get a good estimate of what is cyclical - related to the economic downturn - and what is structural and the result of longer-term trends - what would have happened without the Great Recession?  First off, what's the largest number possible?  Evan Soltas (a new blogging superstar you should be reading) takes the labor force participation rate of 2007 and projects it to now, and finds 5.8 million people missing.  This would give us an unemployment rate of around 11.4 percent, but would also exclude the longer-term trends.  Greg Ip, looking at CBO numbers, finds 5 million people missing.

At the other end of the spectrum are those who would think that the unemployment rate is capturing all we need to know.  If someone really wants a job, they would look for one, and there's nothing interesting policy-wise in this information.  At 8.1% unemployment there's still plenty of slack in the labor market. (There's an unemployment crisis at 8.1% unemployment!)  The answer of the "true" unemployment rate should be somewhere in the middle.

Chicago, Kansas City

Daniel Aaronson, Jonathan Davis, and Luojia Hu of the Federal Reserve Bank of Chicago just put out a paper - Explaining the decline in the U.S. labor force participation rate - that shows:
the current LFPR [Labor Force Participation Rate] is roughly 1 percentage point lower than our estimated trend rate (the LFPR consistent with the contemporaneous composition of the work force and an economy growing at its potential)....As of late 2011, the actual LFPR for 16–79 year olds is 1.1 percentage points below trend LFPR...Indeed, over the 2008–11 period, we find that only one-quarter of the 1.8 percentage point decline in actual LFPR for 16–79 year olds can be attributed to demographic factors.
Labor force participation is 1.1% below the trend of where it is supposed to be.  They concluded this after creating a model of 44 combinations of gender, education and age to estimate projected changes, which is then compared to actual 2011 labor force participation rates.  Two-thirds of the long-term decline in LFPR is from demographics, and the remaining third is due to other effects, especially gender and education.
 
Meanwhile, Willem Van Zandweghe has a paper from the Federal Reserve Bank of Kansas City, published in the first quarter of 2012, titled Interpreting the Recent Decline in Labor Force Participation.  They, strikingly, come to the same conclusion as the Chicago researchers.
 
Zandweghe breaks out a decomposition technique to seperate out the cylical from the long-term elements of labor force participation movement.  He finds that that "[t]he Beveridge-Nelson decomposition attributes 1.1 percentage points of this decline (58 percent) to the cyclical downturn. Long-term trend factors, such as demographics, account for the remaining 0.8 percentage point of the decline (42 percent)."  1.1% percent is cyclical. That 1.9 percentage point overall drop reflects the drop from the 66% average in 2007 to the 64.1% average in 2011.
 
Gender plays a role in this analysis as well.  A slight majority of men's decline in labor force participation is due to long-term trends; virtually all of women's decline is the result of the cyclical downturn in the recession.  "The average annual LFPR of men fell 2.8 percentage points from 2007 to 2011, of which 60 percent was due to a decline in trend participation...Women’s average annual LFPR fell 1.2 percentage points from 2007 to 2011. The decomposition attributes essentially all of this decline to the cyclical downturn in the labor market."
 
1.1% Means...
 
To lose 1.1% of the labor force means that we are missing roughly 2.7 million people.  Since around half of the total loss is cylical, the 2.7 million matches half of the total 5 - 5.8 million that Soltas and Ip found above, which is a good sanity check.  If we add 2.7 million people to the unemployed, that gives us a current unemployment rate of 9.7%.
 
The number of people the BLS lists as "not in the labor force" but also lists as "persons who currently want a job" has increased by 1.7 million.  Indeed U-5 unemployment, which takes normal unemployment and adds in "discouraged workers, plus all other persons marginally attached to the labor force," sits at 9.5%.  Discouraged and marginally attached workers, and the U-5 unemployment rate that incorporates them, are designed to give us a measure of those not in the labor force who want to come back into the workforce but have given up looking.  Perhaps this will be our best measure going forward of this phenomenon?
 
Here's a chart from the Kansas City paper of how the unemployment rate looks forecasted:

Since so much of the cylical elements of the labor force participation is driven by female labor choices, those will be key in understanding how this evolves.  Catherine Rampell wrote last December about how young women dropping out of the labor force "are not dropping out forever; instead, these young women seem to be postponing their working lives to get more education."  We could see a wave of much more highly educated women enter the labor force further down the road.  And the New York Fed's blog argued that "a key factor for future aggregate labor force participation is the behavior of married women," and whether or not they look to re-enter the labor force. In general, and likely for men, as both the Kansas City paper and Ryan Avent note, many of these workers are going into disability.

Overall I agree with what Ryan Avent argues here.  If we were hitting constraints, we'd see job openings and prices, especially labor costs, shooting upwards, which we do not see.  I'm not sure what policy lessons people are drawing from these missing workers, but they amplify the case that expansionary policies, from fiscal to monetary to debt workouts, are necessary and urgent.

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