Are We Even Close To Full Employment?

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The unemployment rate is currently about 3.6%, which is the lowest it has been in five decades. Time to break open the Champagne and blow into kazoos! So we invited an economist to the party, and, naturally, he ruined it.

David Blanchflower, an economist at Dartmouth College, believes the unemployment rate can go much lower. That's one of the central arguments of his new book, Not Working: Where Have All the Good Jobs Gone?. Central bankers, he says, have been making a huge mistake by not putting their foot on the gas and helping to drive us to an even better job market. The reason for this is that they've clung to an old view of what the unemployment rate actually means. What's changed? And, more importantly, how low can we go?

A Central Mistake

Blanchflower is British, but he lives in the United States. He has spent his whole career analyzing the relationship between wages and unemployment, including a stint as a central banker at the Bank of England. That's Britain's equivalent of the Federal Reserve. Central banks try to use their power over interest rates and the printing of money to maximize employment while controlling inflation.

Economic theory says there's a short-term trade-off between inflation and employment. When unemployment gets low enough — when we reach "full employment" — we'll hit a line, and if we cross it, we start to see lots of inflation. To see the connection, imagine if employees are marked as "available" or "not available." When they're all marked "not available," getting one to work for you is going to cost more. They already have a job. At a certain point, it becomes like an arms race. This causes wages to increase, which is great, but it could also result in more expensive goods and services (inflation), which is not great.

For years now, central banks have looked at the unemployment rate and have guessed wrong that inflation was just around the corner. It's like they've been playing this high-stakes game of limbo: How low can we go before we mess things up? Blanchflower says first they thought it would happen below 6% unemployment. Then 5%. We're now under 4%, and it still isn't happening, something the Federal Reserve seemed to acknowledge recently.

"Their estimate of where full employment is has come down and come down," Blanchflower says. He believes full employment will be when the unemployment rate drops much further, like "probably down there in the twos — and it could even be in the ones."

The Unemployment Rate Ain't What It Used To Be

"It used to be the unemployment rate told you about what the labor market was doing," Blanchflower says. "Since 2008, that's no longer true." The year 2008, Blanchflower says, was "a huge structural break."

The labor market was already being upended by global trade and technology, which killed manufacturing and other middle-class jobs. Wage growth was pathetic. Corporate power was rising, and union power was declining. Then along came the financial crisis, which made everything worse. The result, Blanchflower argues, is a situation where workers have crummier jobs and less bargaining power.

This has given rise to "underemployment." People have jobs, but they're not good jobs — and they don't offer enough hours to pay the bills. So when we look and see 3.6% unemployment, that doesn't mean the same thing as 3.6% unemployment back in 1965. The unemployment rate doesn't mean what it used to mean.

If our economy were truly at full employment, Blanchflower says, workers would have tons of options and employers would be forced to entice them with fat paychecks to recruit them. This would show up in the data as a sustained and energetic blast of wages into the stratosphere. We have, in fact, seen flashes of good news about wages in recent months, but Blanchflower believes the news would be much better if we drove unemployment — and underemployment — lower.

We just don't know the magic number that will maximize employment without sparking runaway inflation. Hawks urge caution, because if inflation gets out of hand, that's bad news for the economy. Sure, they say, wages will rise, but so will the prices of goods and services. And if those rise too much, workers will be worse off. They want the Federal Reserve to remain a credible opponent of inflation. Blanchflower is very much on the dovish side of the debate, arguing that we should keep interest rates low for the foreseeable future. "That would be a really good source of wage increases for workers," he says, adding that central banks can always raise rates if inflation does finally take off.

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