The Employment Puzzle: Should Dodd and Frank Be Blamed?
It has now been five years since the end of the Great Recession. Unfortunately, the US labor market is far from recovery. Despite encouraging news, over 9.5 million people are still jobless and there are about 4 million long-term unemployed. There are likely millions more long-term jobless that are not being counted.
Policymakers are currently invoking two very different explanations for why firms don’t want to hire the long-term unemployed. The more convincing reasoning is that the demand for goods and services is depressed because of the long-lasting effects of the financial crisis that has led to both a deleveraging of households and a cratering of the construction sector.
There is a competing story which claims that hiring has been held back by uncertainty over financial regulations that have been put in action since the end of the Great Recession. The logic behind this “uncertainty” argument is that employment growth has been sluggish because firms have been turning down profitable opportunities because they fear existing and new regulations will not allow these sales opportunities to be as profitable in the future and they fear making the longer-term commitment of hiring permanent workers. The source of this threat, according to some people, is the Dodd-Frank Act –the 2010 measure designed to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices.
The act aimed to keep institutions from becoming "too big to fail." But the question of how big is too big remains unresolved, and whether Dodd-Frank's heightened regulatory scrutiny will safeguard the financial system can only be conjectured. The nation's biggest banks have grown only bigger since the 2008 crisis — by as much as a third, according to some estimates. But their business has also become less complex, which may be more important. Bank of America, Citigroup, JPMorgan Chase and Goldman Sachs, among other big firms, have all cut back their trading or shed "noncore" assets in recognition that in the post-Dodd-Frank world, simpler is better.
The bottom line is an old story: that regulation will raise costs and make future business opportunities to sell goods and services insufficiently profitable. The new twist is that these fears are suppressing current investments and hiring, and are thus a major cause of our unemployment problem.
How credible is the “uncertainty” story?
The graph below decomposes the ratio of layoffs to total private employment by reason for mass layoff using data that goes back to 1995, when the data series starts. The top line ("Total Initial Claimants") shows the BLS measure for the total number of workers laid off each quarter in what the BLS calls "mass layoff events," expressed as a share of total private-sector employment. For most of the period since 1995, mass layoffs were never more than 0.4 percent of total private-sector workers. At the peak of the recession in 2009, mass layoffs spiked at over 0.7 percent of private-sector workers per quarter, before falling back down closer to historical levels. What is most interesting about the graph is that the middle line -- which tracks layoffs due to declines in business demand --is driving almost all of the overall level of mass layoffs. The thick, almost flat line at the bottom tracks the portion of mass layoffs caused by government regulation. Government regulation has essentially no impact on layoffs and can't explain any of the increase in layoffs in the last several years.
In 2010, 0.3 percent of the people who lost their jobs in layoffs were let go because of “government regulations/intervention.” By comparison, 25 percent were laid off because of a drop in business demand.
There is another set of data which also calls into question the “regulatory uncertainty” argument. If firms were nervous about hiring new employees but had immediate profitable sales opportunities (say, before new regulations are established), then they could readily increase the weekly work hours of current employees to produce more goods and services.
The graph below shows that weekly work hours for private-sector workers averaged 34.6 in 2007 but had fallen to 33.7 by June 2009 (the start of the recovery). Since then, weekly hours have recovered about half that loss and were at 34.2 in August. It is hard to believe that regulatory uncertainty is what is preventing employers from adding work hours to current employees to fulfill current profitable opportunities to sell goods or services. Something else must be going on: Customers and sales opportunities are simply not there.
If regulatory uncertainty was a major impediment to hiring right now, we would expect to see indications of this in corporate profits. However, corporate profits as a share of gross domestic income have recovered their pre-recession peak, and earnings per share in industries most affected by recent regulatory changes, such as energy and health care, have among the highest earnings per share of those in the S&P 500. This growth is inconsistent with a corporate sector held back by regulation.
There is no hard evidence that has been offered for claims that ergulations if the principal factor holding back employment. Instead of uncertainty about regulations, there is strong evidence that the absence of job creation reflects the continued unwinding of the financial collapse and the corresponding lack of demand. The graph below shows that the first quarter of this year was only the second with negative growth in the 15 quarters since Dodd-Frank was signed into law, four years ago.
Firm investments and hiring are lower because they have ample capacity to produce the goods and services they are selling to a shrunken market, while firms are deleveraging at the same time. The optimal response to sluggish increase in demand when interest rates are as low as they can go and households and firms are still not spending is for government to step in to augment demand. The Federal Reserve’s power to make up the shortfall seems to have reached its limit –politically. One neglected avenue remains, however: keeping the long-term unemployed attached to the labor force in a time when we’ve deprived them from their unemployment benefits.