The unemployment rate in the USA jumped from 5 to 5.5 percent in May. This ten percent jump was the largest monthly increase since the 1980s. There was a net loss of 49,000 jobs, plus many new job seekers who could not find work. The state with the highest unemployment is Michigan, at 6.9 percent, with many workers laid off by car producers. This jump in unemployment is yet another indication of an economy with a decreasing rate of growth.
The Bureau of Labor Statistics in the U.S. Department of Labor measures the “labor force” as those employed, including part time, plus persons over 15 years of age who are seeking work or are about to start work. So if a discouraged person has given up looking for work, he is counted as not in the labor force and not unemployed, even though he would accept a job if offered.
There are various types of unemployment. During a recession or depression, workers get laid off their jobs, and this is called “cyclical unemployment.” Unemployment was down to a low of 4.4% in March 2007, so there is now a cyclical unemployment rate of 1.1 percent of the labor force. Cyclical unemployment rises during a recession, but it also starts to rise before the recession, as the reduction in the rate of growth implies less new investment in construction and other capital goods and so a reduction in the labor force that was making these grow.
Another type of unemployment is called “frictional.” These are workers in between jobs, those who have moved or quit or recently graduated, who are actively seeking work, and who most likely will soon get a job or become self-employed. Usually frictional unemployment consists of about one percent of the labor force.
That leaves 3.5% of the labor force unemployed who are not engaged in short-term job search or have been laid off due to decreasing growth, but are chronically unemployed. Some of these have been laid off from declining industries such as automobile production, but in a thriving economy they would soon find jobs in other industries. There is something in the structure of the economy that keeps some workers unemployed for long periods of time.
To understand chronic unemployment, we need to understand what determines the general level of wages in an economy, the normal wage paid to workers with the least skills. Each worker contributes to the output of a firm, and this addition to the total product is called the “marginal product of labor.” Workers tend to be paid their marginal product. If a worker adds more to output than he is paid, he would be better off quitting and starting his own business where he would pay himself that higher marginal product. Or, another firm will see a profit opportunity in hiring him, since he contributes more to output than he costs.
So competition generally equalizes wages with the marginal product of labor. Suppose there is a person with few skills and bad work habits. He comes to work late and is a slow learner, and he can only do the most simple tasks, and does so slowly. His marginal product is low, but still greater than zero. He would accept a job to pull out weeds in a garden at some low wage. But nobody wants to hire him. Why?
It is illegal to hire a worker at a wage below the legal minimum. The minimum wage prevents the least able workers from being hired. The increase in the federal minimum wage from $5.15 to $5.85 in 2007, which will rise to $6.55 in July 2008, hits teenagers especially hard, as in May, teenage unemployment rate leaped from 15.4 percent 18.7 percent.
The employer also has to pay taxes on the employee, including the income tax, the social security tax, the unemployment compensation tax, the workmen’s compensation for injury tax, and various state and local payroll taxes. Beyond that, taxes on profits or sales or gross receipts reduce the gains from hiring labor. Employers look at the total cost of labor, so if the minimum wage plus taxes is greater than the worker’s marginal product, he does not get hired.
For example, California, with a relatively high state minimum wage of $8.00 and with high state taxes on employment and profits, has an unemployment rate of 6.2 percent, .7 percent higher than the national average. New Hampshire, with low taxes on labor, has an unemployment rate of only 3.8 percent.
Do not blame the high price of oil for unemployment. A high oil price reduces our standard of living, but this by itself does not create unemployment, because it does not prevent workers from being hired at some wage. It is because of labor restrictions and taxes that low-skilled bad-habit workers are chronically unemployed.
The alternative to being an employee of others is to be self-employed, and here restrictions and taxes make it more costly and difficult to be your own boss. You have to get permits, licenses, and badges. To open a shop requires approval by the zoning board and a hearing where chronic complainers will seek to block the new enterprise because it increases traffic.
The urban margin of production is the sidewalk, and in developing countries, peddling goods in the street is a common way to become self-employed, but in the USA, this is verboten unless one gets a license and pays high fees. Typically there is only a small fixed supply of licenses, and the health code of an American city does not allow a peddler to sit in a park and sell cooked corn on the cob. Entrepreneurs who persist then have to confront self-employment taxes and a million and a half regulations to abide by. The self-employed dude abides only with high ability and determination.
The remedy for unemployment should be obvious. Restrictions and taxes prevent workers from being employed, and the remedy is to remove them. Eliminate all taxes and arbitrary restrictions on labor and enterprise. Get public revenue from land value, pollution charges, and user fees instead. True free trade would completely eliminate all involuntary unemployment.
There is one agency actively recruiting applicants for jobs. If you want to join the army and shoot guns in Iraq, you can get that job. Otherwise, more workers will get laid off and have a hard time finding work as we slide down the contracting phase of the business cycle.
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FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.
Foldvary is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.
Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.