THE BLOG
08/23/2009 05:12 am ET Updated May 25, 2011

Solving the Problem with Jobs and Wages

America's vaunted job-creating machine has been breaking down, and the administration is finally noticing.

It was 2003 when I first asked myself whether the dynamics that normally produce lots of new jobs when the economy expands were changing in some fundamental way. I had noticed that job losses during the mild 2001 recession were five to six times as great as expected, given the modest drop in GDP. Then we saw that in 2004, two years after the recession ended, the number of employed Americans was still falling, compared to the two months it took for job creation to turn around after the 1981-82 recession and the 12 months it took after the 1990-1991 downturn. The evidence that America's labor markets were undergoing structural changes of a nasty sort continued to accumulate. Just as employment had fallen several times faster than GDP during the 2001 recession, so once job creation finally picked up in 2004, private employment gains remained weak. Over the same period that saw 14 million new jobs created in the 1980s expansion and 17 million new jobs created in the 1990s expansion, U.S. businesses in the last expansion added just 6 million new jobs. Manufacturing was hit especially hard: From 2001 to 2004, manufacturing lost more jobs than during the entire "deindustrialization" years from the late 1970s through the 1980s, and those losses continued throughout the entire 2002-2007 expansion.

With job losses in the current recession already two to four times greater than seen in the downturns of the early 1980s, 1990s and 2001, these dynamics are finally getting broader attention. Late last week, Larry Summers, the president's chief economic adviser, acknowledged publicly that what's known as Okun's Law has broken down. Arthur Okun, JFK's economic advisor, observed in the 1960s that employment during recessions regularly fell by about half as much as GDP, in percentage terms, which he attributed to the costs employers bear when they fire workers and then have to hire and train again once the downturn ends. Nobel laureate Paul Krugman also weighed in last week, positing that recessions triggered by bursting bubbles -- that would be 2001 and this one -- affect jobs much more than those triggered by tight monetary policies to fight inflation (the 1974-1975 and 1981-82 recessions, for example). It's an intriguing thought, but it doesn't appear to really jive with the evidence. The IT-Internet bubble that burst in 2000 certainly helped trigger the 2001 recession, but the downturn's job losses and the subsequent delayed and slow job creation swamped the direct and indirect declines in demand that followed from the implosion of so many Internet and IT companies.

It's much more complicated than that -- and consequently will be much harder to address. To begin, the changes in the way our labor markets work also have affected everyone's wages. During the 1990s expansion, productivity increased by about 2.5 percent per year, and average wages rose accordingly by nearly 2.0 percent per year. That's the way free labor markets are supposed to work: As workers become more productive, employers become willing to pay them more (and which competition forces them to do). But in the 2002-2007 expansion, even as productivity grew 3 percent per year -- the best record since the 1960s -- the average wage of American workers stagnated. And the most popular political explanation, blaming U.S. multinationals for outsourcing jobs abroad, doesn't hold up here: Over this period, the number of workers abroad employed by those multinationals hardly rose at all.

This change is also getting more official attention. Last week, President Obama reminded everyone that economic expansion isn't enough -- and we're still quite a way from any real expansion -- since most middle-class Americans weren't doing well even before the crisis hit and the economy tanked.

The administration's agenda could go a long way to addressing these structural changes, if it's done right. The most plausible explanation is that American jobs and wages are being squeezed by a combination of fierce competition created by globalization and our own failures to control health care and energy costs, two big fixed cost items for most businesses. The competition has made it much harder for businesses to pass along these higher costs in higher prices -- an important reason why inflation has been so low for more than a decade, here and around the world. But that also means that when companies face higher health care and energy costs that they can't pass along, they have little choice but to cut other costs. And the costs they've been cutting are jobs and wages.

The only way to ensure that the next expansion won't be like the last one, but instead will create more jobs and bring higher wages, is to make medical cost containment the center of health care reform and make the development and broad use of alternative fuels, from biomass to nuclear, the center of energy and climate policy. That's not where Congress seems headed. The House-passed climate bill will do little to drive alternative fuels for at least another decade, when a simple, refundable carbon tax could do the trick. And the most promising aspects of health care reform for cost-containment -- a public insurance option and performance-based reimbursement -- are both under serious congressional attack. If the president hopes to see more job creation and wage gains than under George W. Bush, these are the places where he should take his stand.

Cross-posted at the NDN Blog.