Jobless Recoveries
As we have seen, job growth in the United States from the trough of postwar recessions has typically been rapid. Thus even though the unemployment benefits are of short duration, in previous downturns they were enough to support most of the unemployed until they found a job. In contrast to the situation in continental European countries, long-term unemployment has been rare, perhaps because the short duration of benefits forced the unemployed to search harder and settle for less.
Economists are still arguing over why the 1990–91 and 2001 recessions in the United States were different. One theory is that unlike in past recessions, in which factories laid off workers temporarily when demand was low and rehired them when demand recovered, the economy at these times was undergoing deep structural change.5 Resources were moving from mature old industries to new young ones—from steel to software, so to speak. As a result, laid-off workers had to search much harder and also retrain themselves for the available jobs—hence the jobless recovery. Although this argument is plausible, the evidence that there was much more mobility of workers between industries during these recessions is weak.
Another explanation has to do with the “cleansing” role of recessions. In the same way as regular small fires rid forests of undergrowth that could contribute to a greater and more devastating conflagration, recessions force firms to think hard about their resources and compel them to reallocate resources ruthlessly in a way that would not occur in more normal times. In the process they help the economy avoid deeper long-term damage. For example, supervisors accumulate all sorts of unproductive employees and positions over the course of expansions. Not only is it personally painful for a supervisor to fire an incompetent employee, it also damages morale among the rest of the staff, so the natural tendency is to avoid harsh actions. A recession offers supervisors an excuse to cut the dead wood: “We have to cut jobs in order to remain competitive.” Furthermore, the anxiety of surviving employees is limited to the duration of the recession. Firms therefore use recessions to clean house effectively.6
What was different about the 1990–91 and 2001 recessions is that each came after nearly a decade of growth. According to this view, firms had acquired far more “undergrowth” during the long expansion: thus more cleansing was necessary and its effects more prolonged. Put differently, the longer the years of plenty, the longer the famine. But because we have not had many postwar recessions following long expansions, the evidence for this explanation is not overwhelming either.
Yet another hypothesis has to do with improvements in the hiring process. In earlier recoveries, firms would put out advertisements for positions, people would reply by mail, be screened, and then be called for interviews, all of which took time. Long lead times in hiring meant that firms had to worry that they might not have enough employees to meet the growing demand and could lose sales if they did not start hiring early enough. With the advent of the Internet, it is easier for firms with positions and candidates with the right qualifications to find a match. The Internet also makes it easier for firms to wait and watch their order books, hiring just in time to meet demand.7 Of course, when every firm does this, it diminishes the incentive to hire: not only does unemployment persist, depressing demand, but the pool of available candidates is also likely to remain large, so there is no urgency to move quickly to hire the best candidates.
One piece of evidence in support of the “just-in-time” hiring theory is the greater dependence of firms on temporary workers in the two most recent recoveries, which suggests a reluctance on the part of firms to create permanent jobs. As temporary jobs grow in the current recovery also, William Dennis of the National Federation of Independent Business reaffirmed this view, saying: “When a job comes open now, our members fill it with a temp, or they extend a part-timer’s hours, or they bring in a freelancer—and then they wait to see what will happen next.”8
Regardless of which of the theories is right, if most or all future recoveries are likely to be jobless, the United States, with its weak safety net, is singularly unprepared for them.
Why Is the Safety Net Weak?
Why are unemployment benefits so much more limited in the United States? Americans are not necessarily less caring or generous than the citizens of other rich countries. In fact, Americans typically give more to charity than people in many other industrial countries. According to one study in 2000, the average American gave $691 to charity, while the average for the United Kingdom was $141 and for Europe as a whole $57.9 If the explanation is not stinginess, what is it? There is no single answer to this question, but understanding the genesis of this policy is critical to figuring out why the United States has not been able to reform its system easily, and why so much of a burden has fallen on policy stimulus in recent times.
The Economic Answers
Caricatures are useful because they can draw out the essential nature of the object being caricatured. If I had to caricature U.S. firms (or more broadly, Anglo-American firms, encompassing firms from Australia, Canada, New Zealand, the United Kingdom, and the United States), I would describe them broadly as operating at arm’s length with their suppliers, lenders, customers, and employees, innovative and radical in thought and action, and ruthless in assigning both blame and rewards. Contrast these attributes with firms in continental Europe or Japan, which are better described as relying on long-term relationships with suppliers, banks, customers, and employees, incremental in thought and action, and more willing to share pain and gain among their associates. The spirit of the long-term relationship rather than the letter of the legal contract drives interactions.
These characteristics are neither static nor all-encompassing. Firms across the world are changing rapidly. In Japan, a country once famed for long-term employment, a career spent working for one company is no longer the norm, and a large number of young workers occupy temporary positions. Nor would it be difficult to find caring, sharing firms that have strong relationships with suppliers in the United States or ruthless ones in Europe. But I did say these were caricatures, correct in the broad sweep rather than in fine detail.
The point of drawing out these characteristics is to argue that they may belong together and may generate different forms of safety net. Specifically, mature firms in the arm’s-length Anglo-American economies face a market-oriented financial system that depends on transparency and disclosure. Hard information like quarterly sales, earnings, and cash flow can be easily transmitted to investors in the market. But the more up-to-date information that management gets, such as incoming sales numbers or inventory buildup, as well as market rumors, is not easy to transmit widely to investors because it could be inaccurate as well as less concrete. Moreover, soft information such as management character, capabilities, and strength of purpose—which can often be gauged over time through personal meetings—simply cannot be transmitted to the market other than through assessments by investment analysts, whose own views may color their judgment. How, for instance, can investors gauge whether the CEO is in touch with everything that is going on in the firm or simply the talking head delivering the PowerPoint presentation at investor meetings—especially when he is politically astute at choosing which questions to answer?
By contrast, in the continental European and Japanese system, firms have stronger, longer-term, more relationship-based interactions with investors, who are typically institutions like banks and insurance companies. Firms can share tremendous amounts of inside as well as soft information with a banker whom they have interacted with for years. This relationship improves the banker’s ability to make sound lending decisions and shape management actions, and the relationship gives her a greater incentive to help a troubled client firm because she knows the client will not abandon her lightly when good times come around.10
The arm’s-length system applies pressure for hard measurable and communicable results, because this is how the market gauges top management. The pressure travels through the system, and ma
nagers who do not make their numbers are put on notice. In a downturn, the pressure is especially high because earnings become a key indicator of whether a firm is profitable and whether it should be cut off from funding. Firms have little incentive to nurse excess labor through a downturn, preferring instead to lay off redundant workers and hire them back, or hire new ones once the recovery sets in. Similarly, the market ruthlessly cuts off underperforming firms from finance, ensuring that they have to be restructured or liquidated—much as it forced Badri’s employer to close its U.S. operations.
The relationship system allows top management a little more leeway. Because lenders know the management and can look beyond the numbers in a downturn, they can live with lower profitability for a while. The pressure to fire redundant workers is lower, especially if they are considered important and hard to replace in the longer term. Conversely, workers are more loyal and have the incentive to develop skills that make them especially valuable to the firm, even if those skills are not easily marketable elsewhere. Finally, governments tend to be willing to go the extra mile to preserve existing jobs.
A recent example of the differences may be useful.11 In early 2009, as a result of the financial panic and the associated difficulty in securing financing, car demand plummeted around the world. In both North America and Europe, politicians approved billions of dollars of aid to car manufacturers because they felt the millions of jobs tied to the industry made it too big to fail. In the United States, General Motors and Chrysler secured government funding on condition that they take drastic action to restructure their firms, close unviable plants, and sell unprofitable brands. After an initial restructuring plan was rejected by government overseers as too timid, the firms did indeed take drastic action, emerging from bankruptcy significantly shrunken. By contrast, in France, Peugeot and Renault received substantial amounts of government funds on condition that they close no plants and fire no workers over the term of the government loan!
Does this mean the Anglo-American arm’s-length system is all bad? Not necessarily. Resources are reallocated more quickly to profitable uses: perhaps the car industry does need to shrink substantially. Apart from the added efficiency, the willingness to be ruthless helps innovation. Past experience and relationships are of little value in driving radical innovation: indeed, because the natural human tendency is to do more of the same and to serve existing clients and needs well, past relationships can be positively detrimental.12 The arm’s-length approach has advantages here. For one, because new firms can be matched with new financiers, a wider range of matches is possible, and there is greater potential for new ideas to be financed. Also, because bad ideas are not permitted to continue sucking resources, this system can engage in riskier experimentation. The ruthlessness of venture capitalists in killing bad ideas once they are recognized to be unviable is far more important to their success than the ability to identify diamonds in the rough. The arm’s-length system plants a thousand flowers, uproots hundreds when they do not thrive, and nurtures only a few to bloom. New opportunities abound, while old, tired ways of doing business are ruthlessly eliminated. The system’s strength, then, is that it is not heavily biased toward preserving the privileges of incumbent firms and workers.
In the “relationship” system, incremental change comes easily because existing firms are able to develop variations on old themes, and financiers, having developed a deep understanding of the existing business, are willing to finance moderate innovation. But because few new firms can break in, and because the system is not geared toward generating dependable, hard information that would make new investors comfortable, dramatic innovation is harder. And because the system is not geared toward ruthlessly eliminating bad ideas, its willingness to experiment radically is also more limited. Badri’s employer retained its German plant longer than its American plant in large part because of the nature of the system each plant operated in. And the more prolonged death throes of the German plant suggest that more resources were indeed wasted there while trying to maintain an unviable operation.
That U.S. research and development tends to be more innovative is suggested by the following data: in 2008, the United States and the European Union, which are roughly similar in the size of their GDP, accounted for about the same share of journal articles published worldwide in science and engineering (28.1 percent versus 33.1 percent). But the United States had a 51.6 percent share of the most highly cited (and thus typically pathbreaking) articles, while Europe had only a 29.6 percent share.13
The compatibility between the economic system and the nature of unemployment benefits is clear in the United States. The emphasis is on rapid restructuring in the face of distress, terminating dying enterprises, and financing new businesses. Recessions are a time of both destruction and new creation. Not only are jobs destroyed, but a whole set of new ones are created. Short-duration benefits give the laid-off worker the incentive to actively look for a suitable job. Mobility is easy across firms: because of the large number of workers being laid off, there is no stigma attached to unemployment. Entry into employment is also easy because jobs are not clogged up by incumbents; the constant churn frees positions. Badri, forced to find a job quickly, eventually moved to a start-up in the Midwest, earning a fraction of his earlier salary. But he is productively employed doing research on new materials and is acquiring an array of new skills.
The generous and long-duration unemployment benefits of the relationship system may appear less compatible with the relatively secure long-term jobs in that system. After all, greater job security would suggest a lower need for long-duration benefits. The reason that long-duration benefits make sense is the greater degree of specialization of jobs in the system and therefore the diminished mobility. The relationship system tends to be one of insiders and outsiders. Those on the inside—employed in firms or the government—have a fairly comfortable, secure existence. Those on the outside have a hard time breaking in, and the unfortunate few who lose their jobs and join the ranks of the outsiders are damned both because their past specialization may make it much harder to find appropriate jobs and because the system is not geared toward rapid and easy reentry. In such as system, unemployment benefits do little to expedite job searches; rather, they make a prolonged existence on the outside more tolerable and appease the anger of the unemployed.
Thus each system has developed unemployment benefits that are compatible with its underlying economic structure. This is not to say everything is perfect. Badri’s job was clearly highly specialized, yet he was cast adrift overnight, without protection. Moreover, it is hard to say which came first: the benefits or the structure. Indeed, it is also possible that a common third factor, such as ideology or politics, drives both.
The Politics of Benefits
The United States is parsimonious not just with unemployment benefits but with other forms of social welfare also. At the time of writing, it does not have universal health coverage, despite spending a greater fraction of GDP on health care than nearly any other advanced country. And it spends less on many other welfare programs. For instance, the United States spent 7 percent of GDP on old-age pensions and disability payments in 1998, whereas France spent 13.7 percent and Germany 12.8 percent.14 Retirement benefits to people over age 65 were only 19.3 percent of the average worker’s pretax income in the United States, compared to 58.6 percent in France and 37.2 percent in Germany. It is not that Americans have plenty of savings to compensate: the McKinsey Global Institute indicates that two-thirds of the early baby boomers—those born between 1945 and 1954, and among the wealthiest generations in history—do not have enough assets to retire comfortably.15
There may well be special aspects of the U.S. historical experience that drives its antipathy toward all forms of welfare benefits. Among these include the libertarian tradition in politics, the absence of strong nationwide workers’ organizations, the concentration of poverty in segments of the population that are racially different, the large size and ea
sy mobility within the economy, and the existence of competing economic jurisdictions that make centralized legislation difficult.
A number of historians have argued that there is something fundamentally liberal (in the classical or Lockean sense, that is, embracing the freedom of the individual and resisting significant government intervention in ordinary life) embedded in the cultural and political ethos of the United States. Having escaped the tyrannies and feudalism of the Old World, Americans did not have to combat a strong domestic aristocracy.16 As a result, they did not develop a strong class consciousness or the need to use government to overpower oppressive domestic elites. The beliefs that are still expressed by many Americans in surveys—that the United States has virtually unlimited opportunities, that everyone has the capacity to become rich if they only work hard enough, and that anyone who remains poor probably has not tried hard enough—sit well with a desire for limited government and welfare. And although American opportunity and mobility may be a myth for the immobile and poor underclass and increasingly for much of the middle class, the reality of their experience has not yet altered the national ethos.17
Fault Lines: How Hidden Fractures Still Threaten the World Economy Page 13