The Case of the Missing Worker

The missing worker has been a persistent mystery shadowing the economic recovery – evidence of labor market hysteresis induced by the Great Recession.

Hysteresis occurs when many workers are unemployed for a long time, experience a decline in skills, and drift away from the workforce. These frustrated workers are central to President-elect Donald J. Trump’s economic message, and key to understanding what might happen under his stimulus plan.

Federal Reserve Chairwoman Janet Yellen addressed the question of prolonged unemployment and lingering effects during a conference that the Boston Fed held in October.

“If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a ‘high-pressure economy’, with robust aggregate demand and a tight labor market,” Yellen said.

As a presidential candidate, Trump pointed to people who dropped out of the workforce.

“There are now 94.3 million Americans outside of the labor force. It was 80.5 million when President Obama took office. An increase of 14 million people,” he said in an August economic speech.

“We have the lowest labor force participation rates in four decades,” he added.

These discouraged workers factor into any analysis of Trump’s economic policies, and what might happen if he tries to boost growth through major infrastructure investments, tax cuts, and trade protection for manufacturing.

With the headline unemployment rate hovering just below 5 percent for the past eight months, one might question if the labor market is already tight and the economy running at full capacity.

As the economy improves, the Fed is signaling the possibility of future interest rate hikes. Richmond Fed President Jeffrey Lacker suggested interest rates might need to rise faster than expected, in light of the inflationary potential of fiscal stimulus.

Whether Trump can stimulate the economy without triggering inflation hinges on the geographic dimensions of his proposals. Having won with strong support in rural areas, Trump is expected to pursue infrastructure and trade policies that, at least in theory, benefits regions that missed out on growth.

While the metropolitan and coastal regions may be at full employment, there is labor market capacity in interior, Southern U.S., and non-metro areas. If government stimulates regional economies that are under-performing, the investments may encourage workers to return to the labor force.

Thus, many interior regions could absorb an infusion of government spending without a spike in labor costs, since discouraged workers would meet the increased demand. The regions could avoid overheating even as the nation as a whole appears to be at full capacity.

In addition to the regional dimension, there are key distinctions among industries: full employment in professional occupations coincide with slack in manufacturing, transportation, and other sectors that could benefit from Trump’s policies.

In short, stimulus targeted at certain regions or professions could have a reverse hysteresis effect. Many workers in these sectors and regions that dropped out of the workforce during the Great Recession would likely return, supplying the necessary labor to sustain growth without stoking inflation.

So in order to analyze the next administration’s policies, we should pay special attention to the geographic and industrial emphasis. Dynamic regional economic modeling can help understand these nuances.

Perspectives on Obamacare Repeal

As President-elect Donald J. Trump prepares to take office next week, Republicans are weighing options for repealing and replacing the Affordable Care Act. Policy makers and experts are debating the implications of different repeal options.

Two analysts – Leighton Ku of George Washington University and Donald Grimes of University of Michigan – have recently published findings that offer different perspectives on the subject. Both use our economic model, REMI PI+. An article in The Atlantic magazine on the possible economic effects of an Obamacare repeal cited both studies.

Dr. Ku is the lead author on a report released by GWU and the Commonwealth Fund titled “The Economic and Employment Consequences of Repealing Federal Health Reform: A 50 State Analysis”, which estimates the impacts of a repeal-without-replacement scenario. The study has also been cited by NPR, CNBC, and CNN.

Mr. Grimes is co-author of “Economic Effects of Medicaid Expansion in Michigan”, which was published in the New England Journal of Medicine and projects employment and revenue effects of Medicaid expansion in the state.

State Tax Policy: Time for Change?

Regardless of the outcome in next week’s presidential election, governors and state lawmakers will play a significant role in policy innovation – including tax reform.

While state fiscal health has improved since the end of the Great Recession, many states only expect modest growth in revenue. Policy makers in state capitals across the country will continue to look for more efficient ways of collecting taxes.

It’s not just a question of sufficient revenue. Policy makers weigh tax reform as a means of boosting economic growth. Some reform plans emphasize a shift away from taxing wages, salaries and investments, in favor of increased taxation on consumption.

Georgia officials have considered options for cutting state income taxes, increasing sales taxes, and expanding the sales tax base. These changes might encourage savings and lower the cost of capital, producing benefits that offset higher consumer prices.

Georgia State University’s Fiscal Research Center analyzed the potential implications of tax reform. Peter Bluestone, a senior research associate at the center, used REMI PI+ to simulate the potential effects of the proposals.

Clinton vs. Trump: Pocketbook Policies

In 27 days, this year’s bitter and unpredictable presidential election will reach a conclusion, and the winner will shape national economic policy for the next four years.

While angry arguments and raucous rallies often drown out substantive issues, serious economic questions are at stake in this election. The subtext throughout this campaign season is economic growth and income inequality.

Voters are frustrated with the sluggish recovery following the Great Recession, and many policy makers are paying greater attention to the widening disparity in wealth. Hillary Clinton and Donald Trump are zeroing in on voters’ economic anxieties.

Clinton has emphasized positions that she says will increase fairness in the economy – paid family leave, expanded child care, and a higher minimum wage. Trump has criticized trade deals as costing American jobs and promised immigration restriction that he says will boost wages.

Trump also vows to stimulate the economy with major tax cuts, while Clinton would raise taxes on the wealthy. Both candidates have spoken in favor of increased spending on infrastructure.

While their economic prescriptions differ, Clinton and Trump both invoke the electorate’s concerns about growth and economic fairness. We have to ask: Do we live in a stagnant “fixed-pie” economy, where all economic competition is a zero-sum game? Or can we grow the pie, and turn the economy into a positive-sum game?

To evaluate proposals that address these issues, we need a dynamic view of the economy. If we can boost productivity, for example, we can grow the pie and avoid fights over limited opportunities. A dynamic approach to economic analysis can anticipate productivity gains, and lead to policies that lift us out of the zero-sum trap.

Paying It Forward: Targeted Borrowing

When the economy is in the doldrums, the government has a few options in its tool box. One strategy is “priming the pump” by injecting the economy with government stimulus, paid for with borrowed money.

Deficit spending can give a boost to the economy, replacing lost demand whenever consumers and businesses are afraid to spend. Depending on how the money is spent, however, the stimulus may just have a fleeting impact on an economy.

On the other hand, if borrowed money is targeted at much-needed public investments, the spending could eventually pay for itself in improved productivity. Alleviating traffic bottlenecks, ensuring the safety of drinking water, or modernizing air traffic control improves people’s lives and promotes future growth.

For some, additional deficit spending is merited even now at a time of relatively low unemployment, since the needs are urgent and the benefits of key investments could outweigh the costs.

Economist Paul Krugman recently argued in his New York Times column that there are a lot of unmet needs right now, citing the aging Metro system in Washington D.C. as one example. He wrote that “there is an overwhelming case for more government borrowing” – given that interest rates are low, and spending would translate into a larger economy and more tax revenue in the future.

In a Washington Post op-ed, former Treasury Secretary Lawrence Summers made the case for infrastructure investments, saying the return on projects would exceed the cost of borrowing.

The key challenge is how to choose projects. With sound economic impact analysis, policy makers can see which projects will likely result in the greatest gains in productivity, employment, and output, and use this information to prioritize spending.