A Jobless Recovery?

CAMBRIDGE – Who will suffer the longest and the most from the implosion in 2008-2009 of Wall Street and the ensuing world recession?

Not the bankers and financiers who created the disaster. Some financiers, like Bernard Madoff, will go to prison for fraud. But, although Madoff was only the tip of the iceberg of rampant financial malfeasance, most suspect financiers need not fear arrest, either because their behavior merely skirted the law, or because financial impropriety more subtle than outright fraud is often difficult to prove.

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Some bank bosses will retire in shame, but with huge payments to ease their pain – such as the $55 million golden parachute handed to Bank of America’s Ken Lewis, with his, and the £25 million pension bestowed on Royal Bank of Scotland’s Fred Godwin. But, buoyed by government bailout money, guarantees, and low interest rates, many banks have again begun to pay their top managers huge bonuses while fighting vigorously against reforms designed to restrain their risk-taking and compensation.

The big losers from this economic disaster are workers in the advanced countries that bought into the laissez-faire flexibility of American-style capitalism. From 2007 to October 2009, the United States lost nearly eight million jobs, which reduced the employment-population ratio from 63% to 58.5%. The unemployment rate at the end of 2009 was above 10%, duration of joblessness was the longest since the Great Depression, millions had had their working hours cut, and millions more were too discouraged by a lack of jobs to seek work.

Advanced Europe, Canada, and Japan also suffered major job losses that will last for a long time. Spain, which allows for widespread temporary contracts, has had the biggest increase in unemployment, because Spanish workers can be fired as quickly as those in the US. Some countries – for example, Germany, Sweden, and South Korea – have “hidden” their joblessness by paying firms to keep workers on the payroll. This can work in the short term, but it cannot be sustained over time.

From the 1980’s through the mid-2000’s, employment has increasingly lagged GDP in economic recoveries. In the US, there was a jobless recovery under President Bill Clinton until the dot.com boom in the latter part of the 1990’s, and there was a jobless recovery under George W. Bush in the wake of the 2001 slowdown. In the early 1990’s, Sweden suffered a huge recession precipitated by a housing bubble and a banking crisis. Its unemployment rate rose from 1.8% in 1990 to 9.6% in 1994, before bottoming out at 5% in 2001. Sixteen years after the crisis, the unemployment rate was 6.2% – more than triple the rate in 1990.

In 1997, Korea suffered not only from the Asian financial crisis, but also from insistence by the US and the International Monetary Fund that it raise interest rates and undertake “Washington Consensus”-style reforms to receive aid. Employment recovered, but primarily in “non-regular” jobs with limited benefits, low wages, and little job security. Inequality in Korea rose from moderate levels to second highest (behind the US) among advanced OECD countries.

Weakness in the job market takes a huge toll on economic and personal well-being. Young people seeking their first jobs and experienced workers who lose jobs in a weak job market suffer economic losses that will last their entire lives. Studies of happiness show that unemployment reduces happiness by as much as the loss of a family member.

It is difficult to see the US re-attaining full employment anytime soon. From 1993 to 1998, the US created millions of jobs, which raised the employment rate by 5.4 percentage points. If employment began rising at this rate in 2010, it would take until 2015 before it reached its pre-recession level. And slow recovery in the US will drag down recovery in other advanced countries, reducing their employment as well.

A long, painful period of high unemployment runs counter to what most experts believed the flexible US economic model would ever produce. From the early 1990’s on, many analysts viewed America’s weak unionization, at-will employment, limited legal job protection, and high job turnover as major factors in achieving a lower unemployment rate than most EU countries. Many OECD countries initiated various kinds of flexibility reforms in the hope of improving their economies along US lines.

The view that flexibility is the key factor in employment is no longer tenable. In its 2009 Employment Outlook , the OECD took a hard look at its favored policy reforms and found them deficient in helping countries adjust to a finance-driven recession. According to the OECD, “there does not appear to be any strong reason to expect that recent structural reforms mean that OECD labor markets are now substantially less sensitive to severe economic downturns.”

So the lesson from the recession is clear. The weak reed in capitalism is not the labor market, but the financial market. At worst, labor-market failures impose modest inefficiency costs on society, whereas capital-market failures harm society greatly, with workers, rather than the perpetrators of financial disaster, suffering the most. Moreover, globalization means that the US capital market’s failure spreads misery around the world.

We owe it to workers victimized by this recession to reinvent finance so that it works to enrich the real economy, instead of enriching only the financiers. This means changing the incentives and rules that govern the financial sector. Since other countries’ economies and jobs are also at stake, they owe it to their citizens to press the US to deliver meaningful financial reforms.