Monday, July 9, 2012

Public sector austerity is killing economic recovery

Heidi Shierholz and Josh Bivens at Economic Policy Institute explain that cutbacks in the public sector are the key to understanding the current stagnant "recovery" that has turned deep recession into lingering depression.  The private sector - while still not robust enough, given the deep trough created by the 2008 financial meltdown - is recovering at a pace consistent with previous recessions.  But prior recessions weren't accompanied by cutbacks in state and local employment that we are currently seeing.  As Bivens and Sheirholz demonstrate, this strangling of the public sector is the single biggest difference from previous recessions that weighs upon current potential recovery:
(T)he most glaring weakness in the current recovery relative to previous ones is the unprecedented public-sector job loss seen over the last three years. The figure belowshows that private sector job growth in the current recovery is close to that of the recovery following the early 1990s recession and is substantially stronger than the recovery following the early 2000s recession.

Yet, as the figure below shows, the public sector has seen massive job loss in the current recovery—largely due to budget cuts at the state and local level — which represents a serious drag that was not weighing on earlier recoveries.

How many more jobs would we have if the public sector hadn’t been shedding jobs for the last three years?  The simplest answer is that the public sector has shed 627,000 jobs since June 2009.  However, this raw job-loss figure understates the drag of public-sector employment relative to how the economy functions normally.

Over this same period the overall population grew by 6.9 million. In June 2009 there were 7.3 public-sector workers for every 100 people in the US; to keep that ratio constant given population growth, the public sector should have added roughly 505,000 jobs in the last three years.  This means that, relative to a much more economically relevant trend, the public sector is now down more than 1.1 million jobs. And even against this more-realistic trend, these public-sector losses are dominated by austerity at the state and local level, with federal employment contributing only around 6% of this entire gap.

It should be noted that this counter-factual of 1.1 million additional public sector jobs is a perfectly reasonable benchmark.  Before the Great Recession, the number of public-sector workers per 100 people had averaged right around 7.3 since the late 1980s.  In other words, having 1.1 million more public-sector workers, which would put us back at 7.3 public-sector workers per 100 people, would simply restore our economy to a normal level of government employment.  Further, if the public sector had simply grown in this recovery at the average rate of the last two recoveries, the labor market would currently have 1.2 million more public-sector jobs, so public-sector job growth of this pace is clearly in line with past history.

However, even that 1.1 million public-sector jobs gap leaves out an important component:  public-sector job cuts also cause job loss in the private sector, for a couple of reasons. First, public-sector workers need to use inputs into their work that are sourced by the private sector. Firefighters need trucks and hoses, police officers need cars and radios, and teachers need books and desks. When public-sector jobs are lost, it stands to reason that the inputs into these jobs will fall as well, and indeed research shows that for every public-sector job lost, roughly 0.43 supplier jobs are lost.[3]
Second, the economic “multiplier” of state and local spending (not including transfer payments) is large – around 1.24.[4] This means that for every dollar cut in salary and supplies of public-sector workers, another $0.24 is lost in purchasing power throughout the rest of the economy. Teachers and firefighters stop going to restaurants and buying cars if they’re laid off, which reduces demand for waitstaff and autoworkers and so on. Add these two influences together (supplier jobs and jobs supported by this multiplier impact) and roughly 0.67 private sector jobs are lost for every public sector job cut.   This means that the public sector being down 1.1 million jobs has likely cost the private sector 1.1 million*0.67 = 751,000 jobs.

Further, it should be noted that this 0.67 figure only accounts for private-sector job loss that is due to direct public-sector job loss. But state and local austerity has components besides cutting direct jobs; when these governments cut back, they often don’t just cut jobs, they also cut transfer payments (generally safety-net programs like Medicaid and unemployment insurance which are not associated with much direct public-sector employment, but instead transfer money straight to distressed households).

A rough estimate of this additional impact of jobs lost due to cutbacks in transfer spending can be constructed using the fact that that transfer payments constitute roughly a quarter of state and local spending, and tend to have slightly higher economic “multipliers” than the direct state and local spending. If we assume that the labor intensity of jobs supported by these transfer payments are the same as that spending undertaken directly by states, this implies that the 1.1 million in state and local job losses is likely matched by 275,000 jobs lost due to reduced transfers as well. Applying a standard multiplier to this number (the 1.52 multiplier for unemployment insurance benefits, for example), yields another 412,500 jobs likely lost as states cut back on transfer payments as well as direct jobs.

This estimate of reduced transfers actually is conservative – the gap between transfer spending at this point following a recession’s trough in 2012 is actually at least as large compared to the 1990s and early 2000s recoveries as the gap between direct government consumption spending in those periods.
Putting our four components together – the jobs lost in the public sector, the jobs the public sector should have gained just to keep up with population growth, the jobs lost in the private sector due to direct public-sector job declines, and the jobs likely lost when state spending cutbacks on transfer programs were made– we find that if it weren’t for state and local austerity, the labor market would have 2.3 million more jobs today – and half of these jobs would be in the private sector.

This is more than a fifth of our 9.8 million “jobs gap”, the number of jobs needed to bring the economy back to full employment. If all of these 2.3 million jobs had been filled, it is likely that the unemployment rate would now be between 6.7% and 7.5% instead of 8.2%, and the labor force participation rate (which has dropped dramatically in recent years due to weak job opportunities) would be up to three-tenths of a percentage point higher than it is.

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