Wednesday, June 22, 2011

Here is an Economics version of "That 70's Show"--This episode is about the divergence of the actual rate of unemployment from the Natural Rate of Umemployment. See Donna's analysis here!

Well, not Donna, but...Jared Bernstein, former Economic Advisor to President Obama, has a nice analysis on why middle class wages have stagnated over time.  It is useful to the study of AP Macroeconomics in that it uses the concepts of Productivity, Unemployment and the NAIRU ("Non-Accelerating Inflation Rate of Unemployment"). In class, I use a simplified version of this---just the NRU ("Natural Rate of Unemployment").

The NRU or NAIRU is, given current conditions, the lowest unemployment rate an economy can reach WITHOUT triggering inflation. If the actual unemployment rate observed in the economy equals the NRU, then the economy is said to be at full-employment.  You can see from the first graph below (the BLUE line) that the NRU has hovered consistently between 5% and 6% since 1949. The RED line represents the actual unemployment rate at a given time. 

When the actual unemployment rate goes below the NRU, this means there is a relative scarcity of labor (skilled and unskilled, but skilled is probably more relevant) in the marketplace. Wages tend to increase during this period of time. When the actual unemployment rate goes above the NRU wages tend to stagnate because there is a relative surplus of labor available in the marketplace.  What do you notice about the trend between the NRU and the actual unemployment rate over time? 

This was pretty amazing to me.  In the above graph, examine the two lines before 1979 and after. Look at the chart below. Prior to 1979 the economy spent more time at or below the NRU and after 1979 more time at or ABOVE the NRU.    
Source: Jared Bernstein
Wage and employment gains primarily come through gains in productivity. Productivity is defined as the amount of output a worker produces in an hour of work.  If a worker produces more output in a labor hour it is generally due to  (1) enhanced skills (education and/or training), (2) production efficiencies through improved processes, or (3) using new/improved tools/capital equipment. 

Two things SHOULD happen as a result--1. Workers produce more, the business makes more money, the workers get paid more (2) Workers produce more, the business makes more money and they hire more workers.

As you look at the graph below, remember--productivity gains should translate into income gains for workers....

Source: Jared Bernstein
Pretty shocking, isn't it? Prior to 1979 wage growth keep up with worker productivity.  After 1979 wage growth was stagnant relative to gains in productivity.   

What went on in the mid-1970's to change this?  If my friend over at The New Arthurian Economics is reading this, I THINK he has the answer.. Try HERE and HERE to get started...
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