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Some observations perfectly at home in economics textbooks can be so beastly in practice that nobody is willing to mention them.
Ignoring the facts, though, leads to bad policies, and with the U.S. unemployment rate at a stubborn 9.6 percent, we don’t need more of those.
So here comes the leap into ice-cold water: The biggest problem with the labor market right now is that wages are too high. As Washington again turns to government spending as a cure for unemployment, some against-the-grain thinking is in order.
Economics teaches that full employment would be reached if wages adjust downward, to a level that better reflects current circumstances. At lower wages, employers would desire more workers. Labor markets generate persistent unemployment only if wages are sticky, failing to fall as demand declines.
A number of reasons help explain why wages don’t and won’t drop, beginning with federal and state minimum-wage laws.
Second, because union contracts generally cover multiple years, adjusting wages in response to economic circumstances would require a return to the bargaining table, which rarely happens.
Third, the natural reluctance of workers to accept lower pay is amplified by how their wage helps define their identity. A $60,000-a-year office worker might have an extra-hard time coming to terms with becoming a $40,000-a-year worker.
Finally, workers and jobs might be mismatched, either geographically or occupationally. Workers might be needed in places they don’t want to move to, or can’t afford to live.
There are ample signs that these obstacles to lower wages are helping drive high unemployment today.
In an example of poor policy timing, Democrats chose to lift the minimum wage during the worst possible time, just as wages should have been reduced.
Since 2007, the year the recession began, the federal minimum wage has risen to $7.25 an hour from $5.15–an increase of 41 percent. Democrats in Congress proposed the three-stage increase, and Republican President George W. Bush enacted it, as part of a spending measure that focused mainly on financing the war in Iraq.
Increasing labor costs via higher minimum wages at any time poses a risk of higher unemployment; doing so during a recessionary labor market is policy negligence. It would be nice, and perhaps fanciful, to think that had Democrats seen the recession coming in 2007, they might have cut back on their minimum-wage blowout.
Hard on Teens
Teenage workers, who as a group fill many minimum-wage jobs, have been hit disproportionately hard by the recession. The teen unemployment rate has increased to 26.3 percent from 16.9 percent in December 2007.
In a similar vein, evidence shows that union workers are harmed, in terms of employment rates, by their generally higher wages. In 2009, the percentage of union members among the employed dropped to 7.2 percent–the lowest rate in postwar history.
That Americans in large numbers aren’t pulling up their roots to follow jobs is made clear by the disparity in state unemployment rates. Nevada suffers the highest unemployment at 14.3 percent, while North Dakota weighs in at a surprisingly low 3.6 percent, a rate any state would be bragging about even in the best of economic times.
So why isn’t there a traffic jam of job-seekers trekking from Las Vegas to Fargo, and from other high-unemployment areas to high-employment ones?
One reason is unemployment insurance. State unemployment insurance programs usually limit benefits to 26 weeks. However, between various state and federal programs to extend benefits during the recession, unemployment benefits can continue up to a total of 99 weeks, giving people less incentive to pick up and move on when they lose their jobs.
Another complication is the American culture of homeownership. In today’s market, lots of people couldn’t sell their house and relocate even if they wanted to. So chalk one up for renting.
If, as we’ve seen, wage stickiness is driving unemployment higher, the challenge is to enact the public-policy equivalent of Goo Gone. A few ideas come to mind.
First, the minimum wage should be scaled back to $5.85, its level when the recession began in December 2007. There were about 980,000 minimum-wage workers in 2009, half of them more than 24 years of age. This change could have a big impact on aggregate employment.
Second, government policies should induce workers to take the plunge and accept lower wages. These policies could include carrots–tax credits that offset large wage declines, for example–and sticks, such as a reduction in the duration of unemployment insurance benefits.
Finally, unions should be willing to reopen collective bargaining agreements and accept lower wages.
While painful, and perilous for a politician even to discuss, these measures would do a lot to move the economy back toward full employment.
Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.
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