‘Great Recession’ Will Redefine Full Employment as Jobs Vanish

(Bloomberg) -- Post-recession America may be saddled with high unemployment even after good times finally return.

Hundreds of thousands of jobs have vanished forever in industries such as auto manufacturing and financial services. Millions of people who were fired or laid off will find it harder to get hired again and for years may have to accept lower earnings than they enjoyed before the slump.

This restructuring -- in what former Federal Reserve Chairman Paul Volcker calls “the Great Recession” -- is causing some economists to reconsider what might be the “natural” rate of unemployment: a level that neither accelerates nor decelerates inflation. This state of equilibrium is often described as “full” employment.

Fallout from the recession implies a “markedly higher” natural rate of unemployment, says Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. “It was 5.5 percent; maybe it will be 6.5 percent, maybe 7 percent.”

That has implications for policy makers as well as workers. The Obama administration and the Federal Reserve are counting on the jobless rate to fall to a medium-term equilibrium of about 5 percent as the economy recovers. A natural rate significantly above that would drive up the annual budget deficit -- which will top $1 trillion for the first time this year -- by reducing tax revenue and pushing up spending on unemployment benefits.

A higher rate would also require the Fed to make a choice: Accept an economy with more Americans permanently out of work, or try to boost employment at the risk of heating up inflation.

Unemployment Report

The government may report May 8 that the jobless rate jumped to 8.9 percent in April, the highest since 1983, from 8.5 percent in March, according to economists surveyed by Bloomberg.

Laurence Ball, an economics professor at Johns Hopkins University in Baltimore, says unemployment may peak at 10 percent, and “it will be a long time before we see 5 percent” again.

The more time workers spend without a job, the less attractive they become to potential employers, Ball says. That in itself helps keep the unemployment rate elevated.

“If you’re unemployed” for an extended period, “you’re not keeping up with new technology,” he says. “You become discouraged and you change your lifestyle.”

A burst of productivity growth starting in the mid 1990s helped lower the natural rate of unemployment to around 5 percent from 6 percent, as profit-flush companies took on more workers. Now the fear is that will be reversed as industries downsize.

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