- The Washington Times - Wednesday, May 11, 2005

Financial markets are inherent worriers. No sooner was the 274,000 April surge in jobs reported than worries of an economic slow-up gave way to inflation worries.

Financial markets are also myopic. The least bump in the economic road too often becomes a prognosticator of horrific things to come. A week before the April jobs number brightened the economic picture, first-quarter economic growth was reported to have slowed to 3.1 percent, instantly creating pessimists whispering about stagnation. It’s as if the pages in economics textbooks about self-sustaining momentum, underlying growth, and the unevenness of expansions were torn out and discarded and memories wiped clean.

Prior to the April employment report, expectations called for about a 175,000 increase in jobs and a 5.2 percent unemployment rate. Happily, jobs came in 100,000 higher than anticipated, though unemployment came in on target. However, if expectations had been for a stronger 275,000 or so job growth, most forecasters would probably have predicted a drop in unemployment. As it happened, the above-expected employment growth failed to lower the jobless rate. Why?

The reason was a rise in the labor force participation rate. (The labor force is employment plus the unemployed actively looking for work. The participation rate is the percentage of the working-age population in the labor force). Many of the jobless outside the officially measured labor force entered the market and got the lion’s share of new jobs. With an unusually large backlog of hopefuls waiting on the sidelines for the job market to improve, the stickiness in April unemployment is not too surprising.

The accumulation of jobless outside the measured labor force is mainly the result of the 2001 recession followed by one-and-a-half years of job stagnation — the so-called jobless recovery. Therefore, even with continued solid employment growth, it will take time to absorb the jobless in and outside the labor force.

The April jump in jobs took the labor market a giant step closer to full employment. How much longer is it likely to take to get there? Before answering that question, we first must decide what constitutes full employment.

Economists differ in their definition of noninflationary full employment. Full employment also varies over time as institutions and the economy change. Today’s full employment estimates in the 4-5 percent unemployment range.

In the three years prior to the March 2001 business cycle peak, inflation was well contained and unemployment averaged 4.2 percent, a reasonable estimate of full employment. Since then, the full-employment unemployment rate may have crept up a little. Although recent compositional changes in the labor force have not been dramatic, the structural component of the jobless rate may have increased because of a growing gap between available workers skills and skills demanded by employers. The extended job market weakness during and after the last recession also may have caused some erosion of skills. Therefore, a 4.5 percent unemployment rate is probably not an unreasonable estimate of full employment today.

Just as the unemployment rate has a lower limit below which wage-price pressures exert themselves, the labor force participation rate has a cyclical upper limit above which inflation pressures take hold. There are some jobless both in and outside the work force who will only accept work at relatively high wages. Therefore, the participation rate also needs to be factored into the definition of full employment.

The participation rate rose to 67.2 percent at the cyclical peak in March 2001. However, in recent years the trend appears to be leveling or slightly declining, though it’s difficult to separate out the cyclical component from the longer-term trend. Nevertheless, shaving a few tenths of a point off the previous peak seems reasonable for an estimate of

the full-employment participation rate.

Taking population increase into account and assuming robust future total employment growth, averaging 250,000 a month (roughly the average growth so far this year), it would take about two years for the labor market to reach full employment. With employment growth of 200,000 a month, it would take more than three years to reach full employment.

Though it will take a while for the economy to achieve full employment, even in a strong labor market, recent history suggests we have the time to get there. The previous economic expansion that started in 1990 lasted 10 years, and the 1980s expansion lasted nearly eight years. By comparison, the current expansion so far is only a 31/2-year-old youngster. If time stays on our side, and there are good reasons to believe it will, full employment looks quite achievable.

Alfred Tella is former Georgetown University research professor of economics.



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