The Unemployment Rate and State and Local Economic Policy

My friends are telling me I'm an idiot.  I was quoted in the local newspaper last week saying that our high unemployment rate was a bit of a mystery.  Both friends and strangers have told me that it's simple: our state has high unemployment because of bad policy, such as high tax rates and restrictive controls on growth.  Here's why they are wrong and I am right.

Unemployment is a labor market phenomenon, not a general economic phenomenon.  Weak demand for labor may arise from bad policy.  "Businesses won't create jobs if they are taxed too high" is the common theme.  But labor demand is not based solely on public policy.  The number of workers that a business will hire depends also on how much those workers need to be paid.  I would expect poor public policy to lead to weak demand for labor, and thus low wage rates rather than high unemployment.

The price system usually brings supply and demand into balance.
Nobody wants to sit in the middle seat of an airplane on a long trip, but those middle seats are pretty much full.  Why?  The airlines set prices so that the seats sell.  Or consider gasoline.  People drive fewer miles in the winter than in the summer, but we don't see unemployed gasoline in January.  Instead, we see (on average) lower gas prices in winter than in summer.  When we have unemployment, we ask, "Why doesn't the wage rate drop to keep all of the people employed?"

There are both long-run issues and short-run issues.  In the long run, there's a natural level of unemployment that reflects the time it takes for a person to find work.  We have new people coming into the labor force, as well as people quitting and being dismissed, and most of these people would rather take some time looking for a good job than accepting the first job opening they come across.  This natural unemployment rate is higher in states that have a great deal of in-migration (such as Oregon), because the newcomers need time to find jobs.  While they are looking, they are unemployed.

The minimum wage prevents price adjustment for low-skilled workers, so states with higher minimum wage rates experience higher unemployment rates, especially for youth and minorities.  This is an instance where state policy does come into play.

In the short run, recessions bring high unemployment because wage rates are slow to adjust to weak demand, for a wide variety of reasons.  The extent of unemployment in the recession depends on how the state or local area is impacted by the recession.  Those places (such as Oregon) with a greater concentration in manufacturing and construction have a bigger change in labor demand and thus a greater rise in unemployment.

However, aside from the minimum wage, bad long-term public policy does not explain a higher unemployment rate.  It could explain lower wage rates in general, though.

Comments

[kharris]

There are a couple of ways in which bad policy could be part of the explanation for a high jobless rate.

First, if the effect of bad policy is not steady through the course of a business cycle - if it is greater in bad times than in good - then sticky wages could combine with bad policy to lead to a more rapid rise in the jobless rate for bad-policy areas than in the country as a whole. Over time, wages would adjust or the business cycle would turn and straighten things out, but in the short run, you'd see bad-policy areas with a more rapid than average rise in the jobless rate.

Second, a new bad policy could lead to a rise in the jobless rate above where it would otherwise be (higher than in the rest of the country) during the time it takes sticky wages to adjust.

[William Frohnmayer]

The other half of the equation where the unemployment rate is impacted by government policy is when the regulations, fees, and taxes imposed by government begin to impact the decisions of the entrepreneur and business owner. These factors can clearly impact the risk reward/ratio for a business venture to the point where they trump labor cost. The recently passed tax legislation in Oregon which penalizes the entrepreneurs and business owners in the system is clearly an excellent example. For most business the key to success is to get as many people as possible thru the door to purchase their goods and services. To maximize employment rate government needs to provide a business friendly and competitive (with other states) environment for the business owner to operate in. Oregon is currently non competitive so new business (unless bribed by large tax incentives) will hesitate to locate here and existing business’s will relocate where the risk reward ratio is more favorable. Both which can have a major impact on employment rates.