How Low Con Unemployment Be?

FIG. 10-1 Actual g.n.p. has seldom matched our productive potential, even when potential is defined (as here) as involving only 96 per cent of full employment. (Source:Council of Economic Advisers.)

Figure 10-1 sets “high-level employment” output as that attainable with 4 per cent unemployment. But whether 2, 3, 4, or 5 per cent unemployment represents a reasonable goal is a hotly debated issue. Our aspiration levels vary with our achievements. During the early 1950’s, when average unemployment fell to 3 per cent or less, about 3 per cent seemed a reasonable goal for stabilization policy to shoot at. With the discouraging results of the late 1950’s and early l960’s, many people lowered their aspirations to 4 per cent, or even to 5 per cent, unemployment.

The fear that inflation may result from larger aggregate demand to fight unemployment bulks large in modem controversy. Some observers argue that most of the unemployed below 4 or 5 per cent are unemployables, ne’er-do-wells, and the structurally unemployed who could be drawn into other jobs through rising aggregate demand only at the cost of substantial inflation. But their opponents point to earlier prosperities when unemployment fell to 3 per cent or even less, both during the decade after World War II and during the 1920’s. They argue that this shows that such unemployment rates are indeed feasible in a prosperous, free economy like ours if aggregate demand is adequate.

Clearly there is some unavoidable minimum of unemployment. In a large, free economy like ours, hundreds of thousands of people are always on the move. In 1966, for example, some 10 million people changed jobs. It takes time for people to move from one job to another. In seasonal industries such as agriculture and construction, there is sure to be some unemployment in the slack season. Such unemployment is often called “frictional” unemployment. Moreover, there are always some essentially “unemployable” people looking for jobs—individuals with very poor health, with very low mental capacities, with no training, and the like. Still others are potentially employable, but their skills and locations are badly out of line with job openings or their wage demands are unrealistically high for what they can offer; these are the “structurally” unemployed. There is some level of aggregate demand that will put all such individuals to work in short order, but it is very high indeed, and it would surely generate widespread inflation before it provided jobs for all.

How large is the unavoidable minimum unemployment? There is no precise answer, because clearly with enough pressure of aggregate demand (as in World War II) unemployment can be reduced to almost zero, and indeed millions of new workers can be drawn into the labor force by high wages. But such policies clearly involve massive inflationary pressures. Careful empirical studies suggest that perhaps 2—3 per cent of the labor force may be taken as a reasonable approximation of frictional unemployment plus job seekers who are, for practical purposes, unemployable under normal conditions.

Other nations set us a goal to shoot at. In all of western Europe, since World War II unemployment rates have been much lower than we have achieved, in most cases varying between 1 and 2 per cent of the labor force over the past decade. But these results have generally been achieved at the cost of somewhat higher inflation than in the United States.

One last general observation on the problem of unemployment rates. If actual unemployment is 6 per cent and the frictional minimum is estimated at 3 per cent, can we conclude that the economy is operating at 3 per cent below capacity? No. More probably, output is 6—8 per cent below the system’s capacity. The reason is partly that with substantial unemployment many workers are on a part-time basis. As demand rises and unemployment falls, these people shift to a fullemployment basis so the number of man-hours of work rises more rapidly than the number of employed. More important, with widespread unemployment many persons drop out of the labor force because they become too discouraged to continue looking for jobs. When aggregate demand and employment opportunities rise, many, especially women and “marginal” workers, return to the labor force. Thus, in unemployment periods there is always a reservoir of potential labor force entrants and of “hidden unemployment,” made up of workers who are not reported as unemployed in the statistics because they are not actually seeking work. We have no accurate figures on the extent of this invisible labor supply, but recent research suggests it may be substantial compared to reported unemployment.