The Little Book of Economics

That was what the world looked like in 1982 when Howard Schultz told his mother he was quitting his job as a well-paid salesman to join a five-store chain of coffee shops. No wonder she tried to change his mind. “You have a future,” she pleaded. “Don’t give it up for a small company nobody’s ever heard of.” Schultz ignored her, and millions of caffeine addicts are glad he did: he went on to turn Starbucks into a multinational franchise with more than 16,000 stores and well over 100,000 employees around the world while introducing a new job title into the American lexicon: barista.

Say It Ain’t So

Two centuries ago, Jean-Baptiste Say, a French economist, elegantly argued that there can never be too little work to go around. If a waiter earns $25 by working two hours longer, he’ll spend the $25 on something, or put it in the bank which then lends it to someone to spend. That $25 in extra demand is exactly enough to pay for the extra labor he supplied. Say’s Law dictates that “Supply creates its own demand.” Some economists go so far as to argue that anyone who is unemployed must therefore not really want to work, at least for the wages available.

Clearly, this isn’t true during and right after recessions, when the problem is that no work is available at any wage. Companies aren’t going to hire workers, even at a pittance, if there’s nothing for them to do. But over time a healthy economy should always create enough jobs to employ the people available to work. Since 1982, the number of working-age Americans who want to work has grown 39 percent, or about 43 million. Back in 1982, who could imagine what all those people would do? Yet they found jobs, injecting enough money back into the economy to maintain the demand for their labor. In the same period, the number of jobs has grown an almost identical 42 million, or 47 percent.

Diving into the Employment Petri Dish

Assessing the health of the labor market starts with figuring out just how big it is. Some of the working-age population, those aged 16 to 65, are in school, at home raising children, in prison, in the military, have retired, or have been unemployed so long they have given up looking for work. The share of the working-age population actually participating in the labor force, either by working or looking for work, averages about 65 percent.

But participation fluctuates a lot from month to month, often depending on business conditions. In recessions, some people lose jobs, and others decide not to look for work—they stay home or go back to college, so they’re not counted as unemployed. This can cause the level of employment and the unemployment rate to drop in the same month. During booms, the opposite happens: The economy draws people into the labor force who might otherwise stay at home or stay in college.

The monthly change in jobs garners huge headlines but it is just the tip of the iceberg. The job market is a wonderfully chaotic Petri dish in which new jobs are constantly being created or destroyed as new firms grow and old firms die. In 2007, when the economy was humming, about 2 million people were fired or laid off each month and almost 3 million more quit their jobs. This loss of jobs was just offset by almost 5 million people hired each month, and so on net, employment rose.

So, who does the hiring and firing? Small companies destroy just as many jobs as they create; they aren’t disproportionate job creators. By contrast, new companies do create a surprisingly large share of new jobs. A 2009 study by Dane Stangler and Robert Litan of the Kauffman Foundation found that if you took out firms that were five years old or younger, employment would contract most months. So job creation tends to be primarily the product of entrepreneurs who have a crazy idea for starting a new company. But it’s a mug’s game trying to figure out which of the hundreds of thousands of start-ups each year will grow to be the big employer. In 1968, would you have bet on Fairchild Semiconductor, the giant, innovative Silicon Valley pioneer, or the two executives who left to start Intel?

Payday

Real pay, that is, after inflation, ultimately depends on productivity. The more a worker produces for his employer, the more he’ll earn. Over time, as companies have equipped their workers with more and better equipment, their pay has risen. Someone with a power paint sprayer can paint a lot more of a building in an hour than if he only had a brush, so he should earn more.

But this is not an iron law. When a worker becomes more productive, he may not be the one who benefits. If he doesn’t have much bargaining power, his employer may leave his salary alone while racking up higher profits. More often, the customer benefits. Newspaper reporters are a lot more productive now because an article they once wrote just for the newspaper now also reaches thousands of more readers on the Web. The problem is that most newspapers can’t persuade online readers to pay for the articles. So the benefit of the reporter’s increased productivity goes entirely to readers who get news for free, while the reporter may have to take a pay cut!

Wages have become a lot more unequal in recent decades. This isn’t because of racial or sexual discrimination. In fact, while white men do earn more than women and minority men, the gap has been closing. The disparity these days is based on education and skills. Imagine everyone standing on a 10-rung ladder, with the lowest paid on the bottom rung and the best paid on the top. The ladder has gotten a lot taller—those one rung from the top earn 35 percent more than they did 30 years earlier. But the distance between the rungs has grown, with the result that the middle rung is only 11 percent higher and the bottom rung is just as close to the ground.

It turns out that the rung you stand on depends a lot on how much education you have received. In the 1950s, the average high school graduate could find a job in manufacturing, railroads, construction, and other industries that were highly productive, didn’t face much foreign competition, and paid well. Over the decades, though, machines and software replaced many of those jobs. As international trade grew, U.S. workers faced competition from lower-paid workers in other countries. Services grew rapidly, and many of those jobs required either almost no skills (operating a cash register in a fast-food restaurant) or a great deal of skill (performing a heart transplant or teaching autistic children). In 1973, a person with a graduate degree earned an average 75 percent more than another person with just a high school diploma. By 2007, that premium had leapt to 125 percent.

Education, though, can’t fully explain why those at the very top have gotten so fabulously rich. According to Emmanuel Saez, an economist at the University of California, Berkeley, the 1 percent richest households reaped 24 percent of all income in 2007, the highest share since 1928. Technology and globalization have enabled celebrity athletes, singers, and corporate executives to multiply their earning power astronomically. Susan Boyle got her start singing in church and at karaoke pubs. When she sang the same songs on Britain’s Got Talent and on best-selling CDs, her income skyrocketed.

Unemployment, Naturally

No single number better captures the health of the economy than the unemployment rate. It represents the share of the labor force that is looking for work but cannot find it. To keep the unemployment rate from rising, employment must do more than just stay the same; it has to grow as fast as the labor force. For the unemployment rate to drop, employment must grow faster than the labor force.

According to the Congressional Budget Office (CBO), the labor force grew 1 percent per year in the United States during the 2000s. Since people are always joining and quitting the labor force, some months it would grow by half a million and other months it would fall by as much. But, on average, the labor force grew by 120,000 people per month. That meant employment had to grow by more than that for unemployment to fall. If, instead, it grew just 80,000, then unemployment would rise by 40,000 and the unemployment rate would rise.

Some people also struggle to find work even in a healthy economy because of a disability, poor English, or too little education. Many people are simply victims of creative destruction. A mainframe computer programmer laid off after 20 years first looks for another job programming mainframes. If the entire world has moved to personal computers, he may be out of work a long time unless he retrains or changes careers.

For all these reasons, even in an economy running at full-tilt, unemployment won’t drop below a natural rate. Since it seems cruel to label something like unemployment as natural, economists also call this the nonaccelerating inflation rate of unemployment, or NAIRU, because below this level, firms have to jack up pay to attract qualified workers. Those higher wages eventually lead to higher prices and inflation.

The natural rate of unemployment is to economics what black holes are to physics: we know it’s there but we can’t really see it. It’s hard to know if someone is unemployed because no one is hiring or because he simply doesn’t have the necessary skills. The natural rate also moves around as the economy changes. In the early 1970s, lots of young baby boomers entered the labor force. They had less skill and experience than their parents, so they took longer to find work, which raised the natural unemployment rate.

In 1982, France cut the official work week from 40 hours to 39 hours in the hope that employers would hire more people to do the extra hour of work. But since affected workers’ wages stayed the same, their hourly pay went up and many lost their jobs, according to Francis Kramarz, a French economist. A decade ago, France prodded companies to cut the work week further, to 35 hours. This was a bit more successful at creating jobs but many firms still went out of business.

Into the Weeds

Job growth and unemployment are central to diagnosing an economy’s health so a lot of attention is focused on how they’re measured. On the first Friday of every month, investors and politicians hold their breath, waiting for the federal Bureau of Labor Statistics (BLS) to report how the job market performed the previous month. The numbers can send stocks and bonds soaring or plunging, and unleash a torrent of press releases in Washington as the president grabs credit if it’s good news and his opponents heap blame on him if it’s bad.

1. In the payroll survey, the BLS surveys private and government employers in order to estimate the total number of workers on nonfarm payrolls, their hourly wages, and hours they worked. Its initial sample covers 30 percent of all U.S. workers; it estimates the rest. The BLS revises those estimates over the following months as it gets data from more of its sample. Those revisions can be big. A new restaurant may open, then close six months later without the BLS knowing it existed. The BLS tries to estimate the jobs created and lost at new firms with a special birth-death model. Once a year, it finally has enough information to replace all those estimates with actual data for almost every job.

2. In the household survey, the BLS surveys 60,000 households across the country (barely 0.1 percent of the total) about their age, education, race, and whether they are working, and if not, why not. From that sample it estimates the unemployment rate, the participation rate, and the total number of people employed and unemployed for the whole country. Except for technical changes once a year these numbers are not revised.

You may think unemployment is a simple concept, but the official definition is quite precise: you have to be available and have looked for work in the four weeks before the government takes it survey. You do not, however, have to be collecting unemployment insurance. By that measure, there were 15.3 million unemployed people in November 2009, for an unemployment rate of 10 percent.

There are alternative measures of unemployment. That same month (November 2009), 2.3 million more people were available but hadn’t looked for work in the last four weeks; almost a million more had simply given up looking because they concluded no work was available, and 9.2 million were working part time because they couldn’t find full-time work. Including all these people produces an underemployment rate, or as the pros call it, the U-6 unemployment rate, of 17.2 percent.

The employment report can leave you scratching your head. For instance, you may hear that in one month employment fell, which is bad, but so did the unemployment rate, which is good. Why might this happen? There are two main reasons.

1. Participation Bounces Around. Some people counted as unemployed (and therefore part of the labor force) one month may not be in the next, because they gave up looking for work, went back to school, or retired. When unemployment falls because of a drop in participation, it is usually a bad sign. Conversely, if unemployment rises because of higher participation, it is a good sign.

2. Sometimes the Two Surveys Diverge. The payroll report may find fewer jobs while the household report finds more people employed. This can happen because employment surveys, like opinion polls, have margins of error, and different results are normal, statistical noise. Or it may also result from the fact that the two surveys define employment differently. Someone working two jobs is counted twice in the payroll survey but just once in the household survey. Nannies, farm workers, and the self-employed are counted in the household survey but not in the payroll survey.

If the two surveys go in different directions, which should you trust? Usually, the payroll survey because its sample is much larger, and its job count is constantly revised as more complete information is received. But the payroll survey doesn’t tell you anything about the unemployed or the characteristics of workers themselves. For that, you have to turn to the household survey. If the two reports show a persistent divergence in employment levels, it’s a clue one is missing something important.

Another important job market indicator is the number of new claims that states receive for unemployment insurance. Because the U.S. Labor Department reports total new claims each Thursday, this number is one of the earliest indicators of a shift in the health of the economy. The numbers are volatile, though. Holidays and bad weather can play havoc with the trend.

The Job Market of Tomorrow

Many of the jobs lost in 2007-2009 are never coming back. In 1982, about 22 percent of the unemployed were on temporary layoff, and businesses called many back to work when sales recovered. In 2009, though, only 11 percent were on temporary layoff; for two-thirds of the unemployed, the job they lost was gone permanently. What explains those permanent losses? Well, many of the now-unemployed owed their jobs to the housing boom—construction workers, tradesmen, mortgage brokers, and so on. Even when the housing market recovers, a lot of those people won’t be needed.

The future structure of the workforce is changing as people tend to work later into their lives. For decades, a growing share of workers over the age of 55 retired before reaching 65; now, however, more are staying in the labor force. Incentives in Social Security and company pensions to retire early have now reversed, and people need to work longer to keep the lifestyle they want. It’s also because work itself has changed. Someone who inhaled noxious vapors on a factory floor often couldn’t work much past age 55, much less want to. But nowadays we teach or consult, we don’t plough fields or mine coal, and we stay healthy longer. Not only can many of us work longer, many of us want to.

The Bottom Line

• In the short run, the number of jobs rises and falls with the business cycle. In the long run, though, the growth in jobs usually tracks almost perfectly the growth in the number of people who want jobs.

• The unemployment rate is the single best signpost of the economy’s health. When the economy reaches full strength, the unemployment reaches its so-called natural rate.

• Pay usually tracks productivity, which is why, over the years, workers have gotten richer. In recent decades, however, the best-paid workers have seen their salaries grow much more rapidly than the rest of the work force has, because of the premium on skills, weaker unions, and superstar salaries, whether for lawyers or for athletes.

Employment, Unemployment, and Wages

Say It Ain’t So

Diving into the Employment Petri Dish

Payday

Unemployment, Naturally

Into the Weeds

The Job Market of Tomorrow