Obama's Speech: What are the Best Policies to Help the Unemployed?

Last Updated Sep 8, 2011 10:40 AM EDT

The recession has thrown labor markets into crisis. There are currently 14 million people looking for jobs, long-term unemployment is extraordinarily high, and the ratio of job seekers to job openings is 4.3 to 1. And, unfortunately, there is little to suggest that businesses are ready to start hiring at the rate needed to make a dent in the unemployment problem any time soon. Even if GDP grows at an average of 3.6 percent beginning in 2013, which is unlikely, employment markets won't fully recover until 2017. If growth is only 3 percent on average, then the full recovery date becomes 2020.

But the length of time it takes for labor markets to recover is not etched in stone. A well-crafted government job-creation strategy can help to shorten the time it takes for labor markets to recover, and also ease the costs along the way.

And unemployment is costly. So far, we have lost $5.1 trillion in output relative to what we would have produced if the economy was operating a full employment. In addition, unemployment takes a personal toll and workers and their families beyond the lost income, and many of the effects of unemployment become larger and more permanent the longer a worker is unemployed. Thus, long-duration unemployment leaves permanent scars on individual workers and collectively lowers our long-run economic growth.

In response to this problem, President Obama is scheduled to give a jobs speech today, and though the politics are stacked against it, let's hope the speech begins to move Washington toward action on the unemployment problem.

What can be done? The first step in answering this question is to recognize the nature of the problem we face. Recessions can be caused by different things, e.g. oil price shocks, monetary contractions, and financial meltdowns to name a few, and much like a sick patient, the cure depends upon the nature of the disease. We are having what is known as a balance sheet recession. This type of recession comes about when a financial crash wipes out asset values, in this case stock and home values, leaving households with far fewer assets than before the crash (and no fewer debts). It takes a long time for households to rebuild what they lose when this happens, and these recessions are notoriously persistent. Thus, if there were no political constraints, the very first thing I would do would be debt (mortgage) relief for households. That would help households escape the hole they are in. The sooner that happens, the sooner households will start spending on goods and services instead of paying off bills, and the resulting increase in sales would cause businesses to hire more workers.

But that's not going to happen, the politics won't allow it, and it takes quite a bit of time to put such a program in place in any case, and even longer to feel its effects. So what can be done to create jobs that might have some chance of success in this political climate? Here are four additional steps the president could take:

Infrastructure Spending: Infrastructure spending has a dual benefit. The construction spending stimulates demand relatively quickly and helps to get the economy going, and infrastructure itself improves out long-run growth prospects. Our infrastructure needs to be repaired, and this would be my first choice for creating jobs. In addition, I would choose projects with an eye toward those that have a high labor component. However, while there may be some chance of a small program along these lines, $100 to $200 billion, that's not going to be enough to make large inroads into the employment problem.

Aid for State and Local Governments: States have experienced severe budget problems due to declining tax revenue, increased demand for social services, and balanced budget requirements. The result has been falling employment at the state and local government levels. Schools, for example, have had to lay off substantial numbers of teachers. Helping state and local governments avoid further layoffs would be very helpful. Going further, federal aid for new state and local infrastructure construction would also help to offset the fall in state and local government employment.

Payroll Tax Cut: This or something similar is likely to be one of the president's proposals, and it may have a chance politically since it is a tax cut rather than an increase in spending. However, I don't think it would have as much impact per dollar as the first two options. First, if it's on the employer side, how much incentive will businesses have to hire new workers even if they are a bit cheaper? The problem is lack of demand, and if there's no prospect of an increase in the demand for the goods they produce, hiring workers would be unlikely to be profitable even if payroll taxes are cut. Second, if the tax cut is on the employee side, it will have a larger impact on demand -- it gives workers more money to spend -- and the increased demand for goods and services would translate into an increased demand for workers. One drawback is that some of the tax cut might be saved or used to pay down debt instead of being used to purchase goods and services making the tax cut less effective, and this type of spending doesn't create infrastructure that enhances future growth, but it's better than doing nothing at all.

Investment Tax Credit: Another option is an investment tax credit. The idea is to induce firms to expand their operations or replace worn out equipment. Just as with public infrastructure, this stimulates demand as the new facilities are constructed, and it also expands the productive base for the future. However, there is no guarantee that firms will be induced to expand given the poor outlook for the economy, so the power of this type of tax cut could be relatively small. And it's hard to sort the investments that firms would have made anyway from those that are truly new, so the tax break tends to go to lots of firms who would have made the investment anyway. However, it's a tax cut so it might be politically feasible, and there is some evidence suggesting these types of programs can work.

I am not very confident that anything will make it through Congress in this political climate. So the final recommendation is for the White House to take whatever steps it can on its own, and to view this as the first step in a much longer battle to provide help to the unemployed.