Employment’s effect on Entitlements

One of the big data-points focused on these days is the unemployment rate. Although there are numerous unemployment rates measured by the Bureau of Labor Statistics, it is a bad idea to focus exclusively on one (or a few) of these, since they measure very specific things and are relatively easy to game for political purposes.

(Further Reading: How the government measures unemployment.)

Like GDP, each rate has its own specific and appropriate usage, but many people rely on one or another either erroneously or for the purposes of political demagoguery. EMRatio (which I’ll get to in a second) doesn’t include everybody, but it’s the best approximate measure for what it is.

Unemployment isn’t the exclusive measure of health for the economy, or the health of a company — but unemployment is a pretty important measure when it comes to the health of government entitlement programs.

Greg Mankiw, author of my college macro text, and former chairman of the Council of Economic Advisers (CEA) for President Bush recently shared the chart below from the St. Louis Fed’s “FRED.” It’s a must for technocrats and data nerds.

When Mankiw shared this chart, which depicts the Civilian Employment-Population Ratio (EMRatio), he just shared it with the title “Monitoring the So-Called Recovery” and left it at that. The guy teaches at Harvard and has a ton of other things to do. Thus, his blog posts are brief — maybe that’s the professor in him, expecting readers (read: students) to learn from it.

So, I’ll share what little I know about EMRatio and a theory about why a jobless recovery is really bad for entitlements.

The EMRatio is not something routinely brought up in the news because it seems harder to grasp than the unemployment rates (U1-6) that BLS tallies. (I don’t buy that argument — all of these measurements are technical.)

If media folks and talking heads really wanted to delve into the varying measures of unemployment, I’d expect that they might find it much more difficult than they originally expected. Some rates capture certain unemployed individuals, while others do not, and vice versa. Page one of this (outdated) BLS release shows, via a chart, how the six different unemployment rates appear differently on paper.

The EMRatio isn’t too terribly different in this regard, in that it is technical, but it is rarely used in public discourse about economics.

So, what is the EMRatio? What does it represent? Some economists argue, and I agree, that EMRatio is the probably the broadest statistical measure of unemployment. But while broad, and it’s precisely that, if I went on CNN tomorrow and told people that 41.4% of the U.S. population was unemployed, I’d be laughed off of the set. But I’d be right.

The EMRatio is, simply, the ratio of employed citizens to that of the population. It’s important to note that unemployed folks in EMRatio include retirees who aren’t working, which is the central thrust of why this is bad news. (Note: Like debt/gdp, EMRatio changes with the population.)

Between 1948 and 1978, this figure hovered between 55 and 58% (it’s 58.6 percent today). The highest it has ever been was about 64.6%, and that was in the year 2000. During the low of President Bush’s tenure, it hit 62% — but that was before the recession. On President Bush’s last day in office (President Obama’s first day) it was about 60.3%.

To put it in perspective, at the height of the economic boom during Bush’s presidency (late 2006), the EMRatio was at 63.45%. And right now, it’s at 58.6%. That’s a negative change of about 5%.

The EMRatio has never been this low since 1983, the year I was born.

You might have heard the term “jobless recovery.” This, arguably, is what we are experiencing right now. Basically, the shaded portions on the chart below are official “recessions.” We are no longer in one (but we tend to find out retroactively, because of the way NBER defines things) and are in danger of a double dip recession.

NBER, the National Bureau of Economic Research, defines recessions this way:

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

In perspective to the EMRatio, you might wonder: “Gee, a lot of people relative to the population aren’t working. Doesn’t that mean we are still in a recession?”

Not necessarily. There’s a difference between the “market” and the “economy.” Just as there is a different between how certain major indices are doing relative to how many people work. One must be careful not to confuse correlation and causation between different measures of economic health.

This is why President Obama might claim one thing, and Republicans will claim another. Despite my admitted bias as a former economic policy staffer for Congressional Republicans, there is no doubt that the unemployment figures are really quite bad.

While President Obama can rightly claim that some companies are doing well (and surprise, he wants to tax them more!), they’re doing well because they are rational economic actors — who change their employment levels to appropriately suit their needs. Others, of course, are doing well because of crony capitalism and government largesse.

Stagnant unemployment is detrimental to a full recovery, nobody denies that, and looking at EMRatio will tell you we have a while to go. It shows the “new normal” in our current labor force, which, on balance, is stagnant.

However, failure to bring the EMRatio back towards the “old normal” presents serious problems for our entitlement programs: social security and medicare.

The fact that there are fewer and fewer workers per retiree should give one pause. A declining ratio of working age people to retirees is one thing, but it’s another when far fewer of those working age people are, well, working. If they’re not, they’re not paying the FICA taxes that they normally would, and this is bad.

Add to that the current structural deficit in these programs, the first in decades, and the clock is ticking.

Another figure is the “labor force participation rate (LFPR)” — which is about 63.6%, this is the percentage of the working age folks who are actually in the labor force. It’s a completely different ballgame, but worth researching. Over the past two decades, it’s normally been between 66 and 67%.

As the chart below depicts (since the data was first measured) no president has experienced such a slow recovery to higher levels in EMRatio after steep decline as President Obama during his time in office. (Though, the mid 1960s are pretty darn close, but most economists chalk that up to hippies, like I do.)

One difficulty in explaining why this failure to recover quickly is a serious problem is because the demographic problem compounds matters and makes them worse. In short: we have a growing number of seniors, and social security and medicare are losing trust fund money every year.

Let me put it this way: politicians have made promises to our parents (and grandparents) regarding entitlements like social security and medicare. A significant decline in the EMRatio means that there are more and more mouths to feed and fewer workers contributing FICA taxes to feed them.

Just because the stock market is doing alright doesn’t mean that these entitlement trust funds are solvent. There’s no direct correlation between corporate well-being and the health of entitlements. And we all know that many peoples’ savings have diminished a good deal. This is why entitlement reform is so important. However, not every retiree is a “mouth to feed” per-se, but with baby boomers retiring, generally it’s true that there will be a lot more of them. With diminished savings. And less workers per retiree.

On a related note, my recent post about the poor health of these programs might interest you.

So, yes. The decline of EMRatio is bad, and its stagnancy is worse because of entitlements and their structural problems.

With fewer workers per retiree (historically a lot less, actually) the EMRatio problem is far bigger than most expect, and in my opinion, raising FICA taxes won’t begin to cover the problem. Since that will impede growth, it is counter productive.

This is why growth — a rising tide — seems to me to be a key component to staving off disaster. Of course, everyone wants robust growth, but it seems to be eluding us during the Obama administration.

What are some things that, absent a very positive change in EMRatio, we could do to make our entitlement situation better?

Restructuring social security and medicare will definitely help, and raising the retirement age to account for enhanced life expectancy will help too. Of course, this won’t be popular with seniors, who vote in much greater numbers than youth do. Politicians aren’t likely to do this.

So, too, will changing how negative growth in the CPI-U effects social security payments. In short, when the CPI-U (the measure for SS increases) retards, seniors got as much as they did the year before, despite the fact that their money can buy a bigger basket of goods. Cost of Living Adjustments, or COLAs, have artificially inflated what seniors really should be getting on social security.

Nobody likes “taking food from grandpa” — but since all of my grandparents are dead, I can tell you this dirty secret without fear of alienation: Just like some states actually reduce their minimum wage when there’s deflation — which is good policy — changing how COLAs are calculated won’t be a panacea, but it will help. And it will be unpopular.

My conclusion is this: Despite being a libertarian leaning Republican with obvious biases, we have a serious structural problem facing us. More taxation won’t solve this problem, but if we focus on competitiveness, serious entitlement reform, and reducing spending to prudent levels (which will help cover trust fund deficits), it won’t be as bad as it probably would absent serious action.

If we do nothing, these trust funds will run dry, and the law states that benefits will automatically reduced. Or, Congress can “plus up” the difference out of general revenues. Both scenarios suck, but that’s where we’re headed.

UPDATE: Russ Roberts, always insightful, weights in on the importance of EMRatio.

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