Why Is Unemployment So Stubbornly High?

The recession officially ended in mid-2009 when we halted our economic freefall and slowly started to turn the ship around. But the recovery has progressed more sluggishly than people imagined it would – and slower than previous recoveries – and unemployment currently stands at 8.2%.¹

With the recession officially over for almost three years, what is holding back employment from returning to pre-recession levels?^(a) Economists have a lot of theories but the one that seems to get the most support is that there is a lack of demand.² In the crisis, consumers lost jobs, housing equity, and stock investments they still haven’t recovered. With tight household budgets and uncertainty about the future, people have been keeping their pocketbooks closed.^(b) Businesses don’t want to hire new workers or make other investments in expansion because the consumer demand isn’t there. Yet as long as consumers go without jobs, or without secure ones, they will hesitate to start spending again. This creates a “vicious cycle, ” according to Brookings Institution economist William Gale, which can take a long time to correct itself without some kind of outside intervention.

How do we know the problem is a lack of demand? First, because employers tell us so. Recent surveys of small business owners find that they most commonly identify weak sales as their main business concern. Labor data also support the “lack of demand” hypothesis. Companies are sitting on incredibly large cash reserves, so they have the resources to meet strong demand, if it exists, by increasing production.^(c) This would entail hiring additional people or squeezing more work out of existing employees. We know companies aren’t doing much hiring, but we also know that they aren’t maximizing the workers they already have either. The length of the average workweek is still well below what it was before the recession hit.

The demand problem that is holding back private sector hiring is compounded by a jobs crisis in the public sector. Nearly a third of jobs lost in 2011 were in the public sector. The recession has left state and local governments with reduced tax revenues and shriveled pension funds, leading them to layoff large numbers of workers, particularly teachers.^(d) Recent slow gains in private sector hiring have been offset by ongoing job loss in the public sector, in contrast to previous recessions.

Experts have offered other explanations as to why unemployment remains so stubbornly high through this jobless recovery. Although none seem to have quite as much support among economists as the “weak demand” hypothesis,² here are a few of the most popular alternative theories:

• Structural unemployment. There is a mismatch between the skills employers need and those unemployed workers have. Certain sectors, such as manufacturing and homebuilding, will no longer support as many workers as they once did, and workers in these fields need to be retrained for other jobs. While this may be a factor in some industries or geographic regions, recent research suggests that skills mismatch is responsible for only a small share of current unemployment.
• Housing lock. The weak housing market has left people unable to sell their homes for a decent price, preventing them from moving to areas where they might find better jobs. Sounds logical, but studies have found that interstate migration hasn’t dropped since the recession began and the mobility of unemployed workers isn’t related to the state of the local housing market or whether their homes have lost value.
• Excessive regulation. Existing government regulations are too burdensome and uncertainty about future regulations makes businesses hesitant to expand or hire. 19% of small business owners say government regulations are their biggest challenge, up from around 10% before the recession. Proponents of this theory hone in on one set of recently-enacted regulations in particular: the Democratic healthcare reforms.^(e) While the reforms don’t go into full effect until 2014 and many economists believe they won’t have a significant positive or negative impact on employment, business owners seem to be concerned nonetheless.

In all likelihood, there are numerous factors interacting to hold back job growth, but the most important seems to be low demand. While Democrats and Republicans debate what role, if any, the government should play in boosting demand through further economic stimulus, businesses hope that the holiday season will be the start of robust consumer spending in the coming year.