France Never Recovered from the 1974/1981 Recessions. Will We Recover from This One?

Probably.  Nevertheless it’s worth thinking about the implications of this Robert Barro piece:

To get a rough quantitative estimate of the implications for the unemployment rate, suppose that the expansion of unemployment-insurance coverage to 99 weeks had not occurred and—I assume—the share of long-term unemployment had equaled the peak value of 24.5% observed in July 1983. Then, if the number of unemployed 26 weeks or less in June 2010 had still equaled the observed value of 7.9 million, the total number of unemployed would have been 10.4 million rather than 14.6 million. If the labor force still equaled the observed value (153.7 million), the unemployment rate would have been 6.8% rather than 9.5%.

In contrast, his son Josh Barro points out that most studies suggest extended UI boosted the unemployment rate by only about 0.4% or 0.7%, and then goes on to argue that even those figures may be too high.

…The incentive effects of UI extension must also be weighed against the stimulative effects of paying UI benefits. For some reason it’s become almost taboo to note this on the Right, but UI recipients tend to be highly inclined to spend funds they receive immediately, meaning that more UI payments are likely to increase aggregate demand. UI extension also helps to avoid events like foreclosure, eviction and bankruptcy, which in addition to being personal disasters are also destructive of economic value.

I’d like to sit in on one of those family dinners!

Count me as being somewhere between the two Barros, but closer to Josh.  I think the main difference between 1983 and today is that NGDP growth was nearly three times faster in the initial recovery of 1983-84.  If that’s all I knew about this recession–nothing about the banking/housing fundamentals that triggered it, and nothing about 99 week UI extensions, I’d still predict a very slow recovery, albeit perhaps a tad faster than we are getting.  Robert Barro contrasts the slow recovery to 1983, but better comparisons might be 1992 and 2002, when unemployment actually rose for more than a year after the end of the contraction.

However, I wouldn’t go as far as Josh Barro, who concedes a small adverse effect on the economy’s supply side, but then argues that the program boosts AD.  If extended UI benefits make the labor market more rigid (which seems likely), then it may reduce the equilibrium real rate of interest.  In that case monetary policy will become effectively tighter, even if the Fed continues to target nominal rates at 0.25%.  Many economists overlook the way supply and demand shocks become entangled.  There is a reason why negative demand shocks often follow closely on the heels of negative supply shocks (1974, 2008, etc.)

And although I think it unlikely we end up never recovering, the French experience should teach us some humility.  Recall that in the 1960s most European economies had much lower unemployment than the US, typically around 2% or 3%.  By the 1980s many were stuck with rates close to 10%.  France never really recovered from the 1981 recession, with unemployment fluctuating between 7% and 11% over the past 30 years.  And in 1972 no one in Europe saw this coming.

Why did it happen?  Who knows.  Initially people came up with all sorts of explanations.  Here’s an example from a 1993 paper:

A flow model is used to identify the causes for rising unemployment in France between 1978 and 1990. Two flow equations are estimated as functions of exogenous factors such as aggregate demand, factor costs, structural shifts and long-term factors and then used in simulations for the level of unemployment. It is shown that the main reason for high unemployment in France is a slow down in the demand for labour due to high labour and energy costs in the early 1980s and to tight aggregate demand over the whole period.  Change in the labour supply have had an increasing impact in recent years.

Today it seems silly to cite AD and energy prices, but it’s hard not to sympathize with the author (Dominique Gross).  If the cause was structural (as most now believe) it begs the question of why the natural rate of unemployment suddenly rose from 2% to 9%.  And which structural problem?  For ever suspect, you can find some small European country that has that policy, and yet maintains only 5% unemployment.  Perhaps it is labor market policies interacting with differences in culture and comparative advantage.

An optimist like me would argue that we aren’t about to copy the French statist model; dramatically higher minimum wages, generous UI benefits, national health care, higher taxes, etc.  Oh wait . . .  Seriously, as bad as it looks to conservatives, there is a lot of ruin in a nation.  So I still think there is only a 10% or 20% chance we will experience French-style “ hysteresis” (which refers to a sticky unemployment rate that refuses to fall during “recoveries.”)

One thing that has always annoyed me is economists who do a lot of moral grandstanding, accusing people they disagree with of being evil.  For instance, this is how Robert Reich recently entitled his attack piece on Robert Barro:

A record number of Americans is unemployed for a record length of time. This is a national tragedy. It is to the nation’s credit that many are receiving unemployment benefits. This is good not only for them and their families but also for the economy as a whole, because it allows them to spend and thereby keep others in jobs. That a noted professor would argue against this is obscene.

Regarding obscenity, a Supreme Court justice once said “I know it when I see it.”  With all due respect to Reich, I don’t see it.  Here’s the Barro article he responds to:

The unemployment-insurance program involves a balance between compassion—providing for persons temporarily without work—and efficiency. The loss in efficiency results partly because the program subsidizes unemployment, causing insufficient job-search, job-acceptance and levels of employment. A further inefficiency concerns the distortions from the increases in taxes required to pay for the program.

In a recession, it is more likely that individual unemployment reflects weak economic conditions, rather than individual decisions to choose leisure over work. Therefore, it is reasonable during a recession to adopt a more generous unemployment-insurance program. In the past, this change entailed extensions to perhaps 39 weeks of eligibility from 26 weeks, though sometimes a bit more and typically conditioned on the employment situation in a person’s state of residence. However, we have never experienced anything close to the blanket extension of eligibility to nearly two years. We have shifted toward a welfare program that resembles those in many Western European countries.

Didn’t Reich just say Barro opposed unemployment insurance?  Not only does he favor it, but he favors extended benefits during recessions.

Perhaps he thinks it’s obscene to accuse the unemployed of being lazy.  But then I found this in Reich’s article:

In theory, Barro is correct. If people who lose their jobs receive generous unemployment benefits they might stay unemployed longer than if they got nothing.

So I guess somewhere between the 99 weeks recommended by the virtuous Robert Reich, and the 39 weeks recommended by the evil Robert Barro (and implemented by Bill Clinton), UI extension proposals become obscene.  It all reminds me of the old Winston Churchill joke:

Churchill: “Madam, would you sleep with me for five million pounds?”

Socialite: “My goodness, Mr. Churchill… Well, I suppose… we would have to discuss terms, of course…”

Churchill: “Would you sleep with me for five pounds?”

Socialite: “Mr. Churchill, what kind of woman do you think I am?!”

Churchill: “Madam, we’ve already established that. Now we are haggling about the price.”

PS.  Robert Barro is one of my favorite supply-side economists.  No one is more deserving of a Nobel Prize in Economics.  But I think he has a bit of a blind spot about AD shocks, as do many on the right.

HT: Alex Tabarrok, Mark Thoma

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