Macro policy has focused on driving the unemployment rate back down to a desired rate, about 5 percent. That policy is, in large part, misplaced. The reason can be explained with some textbook microeconomics. In the microeconomics texts we drill into students that excess supply is meaningful only in relation to price. For example, there could be excess supply at a price of $10 and excess demand at a price of $8.00. In macro we seem to forget this central notion when we talk about the unemployment rate. Unemployment is excess supply so to talk about unemployment, you have to have some achievable equilibrium wage in mind. But that wage is not part of the discussion in macro policy discussions, where we discuss unemployment as if it were independent of the wage rate. If people are holding out for a job at $30 an hour, they may not be able to find one, but they might easily get a job at $9 an hour. Are they unemployed, or are they choosing not to work? You can’t answer that without specifying the equilibrium wage for a person with that skill set.
Historically, the macroeconomic concept of the unemployment rate was developed in reference to a non-globalized world in which the wage/price relationship was assumed to be relatively constant. In such a world, it is possible to define domestic unemployment independently of the wage rate since the wage was a constant reference point. The only relative wage that mattered in a non-globalized world was the wage relative to price, and that was assumed to be constant. In a globalized world, that is not the case. When a company can locate production globally, wages, unemployment, and hence the unemployment rate has to be defined in relationship to wages in other countries. The global relative wage will largely determine the sustainably achievable unemployment rate. If non-wage productivity advantages are not enough to offset wage differentials, then a person’s reservation wage can be too high for the market conditions.
Unfortunately, for many of the unemployed in the United States that is precisely the case. Their wage is above the globally competitive wage for their skill set. Such unemployment is not solvable with increases in domestic demand, and we should stop pretending that it is. There may be global demand for their work at a lower wage, but not at their current reservation wage. Increased demand will simply create jobs abroad, and worsen the U.S. trade deficit. It won’t lower the U.S. unemployment rate.
What will solve the problem? Lower wages, higher skills, a fall in the exchange rate, or in increase in general advantages in U.S. productivity. None is likely to change soon, so it is time for policy makers to accept this reality and stop trying to achieve the unachievable.
First Published : December 4, 2012