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The Unemployment Rate and State and Local Economic Policy

June 1, 2009

By Bill Conerly, Businomics, Conerly Consulting,

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.

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Discuss this article

John June 1, 2009

I thought I understood it the first time, now I’m not so sure.

snow June 1, 2009

As costs to business rise we pass on what we can to the customer, or close our doors. This high minimum wage in most service industries is a job killer. The new business tax that is being proposed is also a job killer. I have spoken to several small business owners and even though it is a low percentage, it will put them out of business. You know the old saying, ‘you can’t get blood out of a turnip’ Most small business are turnips. Now they’re after the turnip juice. This just cannot go on. If that tax passes and if the state doesn’t start allowing us to do our business without interference or greed on the part of politicians who want all they can get, unemployment is going to go higher.

Higher minimum wage doesn’t help either. As prices increase so the employer is able to pay that wage, it stifles real growth of the business and it also stifles employment. Instead of demonizing business, they should recognize business is the goose that lays the golden egg. Remember what happened when they killed the goose.

Trevor June 1, 2009

Turnup juice…that is one to remember.

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