Fault Lines: How Hidden Fractures Still Threaten the World Economy (16 page)

The weak safety net and the emergence of jobless recoveries imply that the American electorate has far less tolerance for downturns than voters in other industrial countries. The reason that stimulus was applied so long during the recovery from the 2001 recession was that even though output recovered in just one quarter in 2001, it took 38 months after the trough of the 2001 recession for all the lost jobs to be restored. Indeed, job losses continued well into the recovery. In an attempt to induce recalcitrant firms into creating jobs, both the government and the Federal Reserve, especially the latter, ended up aiding and abetting a house-price bubble and the financial crisis.

As the United States struggles with near-double-digit unemployment at the time of writing, there is panic in the corridors of power in Washington. Meanwhile, the capitals of continental Europe, where unemployment safety nets are stronger, seem to be taking similar levels of unemployment in their stride. Once again, there is extraordinary political pressure on Congress and the Federal Reserve to somehow produce jobs. Although there are some virtues to retaining the flexibility to tailor policy to the situation, policy made under the political gun and with political rather than economic objectives typically does not produce effective policy. It has two important effects: first, as I argue in this chapter, it tends to make the United States the reliable stimulator of first resort for the world, taking the burden off other countries and giving them less incentive to alter their growth strategies. Second, as I argue in the next chapter, the excessive political incentive to stimulate produces monetary policy that warps incentives in the financial sector and contributes to the kind of financial disaster we have just experienced.

An important historical difference between the United States and most continental European countries has been the level of unemployment benefits. For example, a comprehensive study over the period 1989–94 shows that U.S. unemployment benefits were not only somewhat lower than in most continental European countries—the United States, on average, replaced 50 percent of lost wages, while France replaced 57 percent and Germany 63 percent—but these benefits ran out much more quickly. In the United States, on average, benefits ran out in six months, whereas in France benefits lasted for up to three years, and in Germany they lasted indefinitely. Since that study, German reforms have brought down the duration of benefits to one and a half years, but the maximum wage-replacement rates in both France and Germany have been increased somewhat, with little change in the United States.

There are holes even in the relatively scant unemployment benefits on offer in the United States. Although more than 90 percent of workers are covered by unemployment insurance, only about 40 percent of them receive benefits when they become unemployed. Some don’t qualify for benefits because they have not worked long enough, others because they left voluntarily, yet others because they are involved in labor disputes, and still others because they do not make themselves available for work while unemployed.
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The worry for someone who loses a job in the United States is compounded by the absence of universal health care or affordable private medical insurance. Because America’s tax code subsidizes health insurance provided through employers, the unemployed have to pay several times more to get the same benefits they obtained previously through their jobs. Moreover, even when individuals can afford it, private insurers can refuse them coverage if they have even a mild preexisting medical condition, as Badri did. Given that even the apparently healthy could have a preexisting condition they are unaware of, most Americans are understandably anxious about potential unemployment, and the desire of the unemployed to rejoin the ranks of the employed is immense. And when Americans are anxious, they are not shy about letting their representatives know. As unemployment mounts, so too does the pressure on politicians to do something.

As we have seen, job growth in the United States from the trough of postwar recessions has typically been rapid. Thus even though the unemployment benefits are of short duration, in previous downturns they were enough to support most of the unemployed until they found a job. In contrast to the situation in continental European countries, long-term unemployment has been rare, perhaps because the short duration of benefits forced the unemployed to search harder and settle for less.

Economists are still arguing over why the 1990–91 and 2001 recessions in the United States were different. One theory is that unlike in past recessions, in which factories laid off workers temporarily when demand was low and rehired them when demand recovered, the economy at these times was undergoing deep structural change.
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Resources were moving from mature old industries to new young ones—from steel to software, so to speak. As a result, laid-off workers had to search much harder and also retrain themselves for the available jobs—hence the jobless recovery. Although this argument is plausible, the evidence that there was much more mobility of workers between industries during these recessions is weak.

Another explanation has to do with the “cleansing” role of recessions. In the same way as regular small fires rid forests of undergrowth that could contribute to a greater and more devastating conflagration, recessions force firms to think hard about their resources and compel them to reallocate resources ruthlessly in a way that would not occur in more normal times. In the process they help the economy avoid deeper long-term damage. For example, supervisors accumulate all sorts of unproductive employees and positions over the course of expansions. Not only is it personally painful for a supervisor to fire an incompetent employee, it also damages morale among the rest of the staff, so the natural tendency is to avoid harsh actions. A recession offers supervisors an excuse to cut the dead wood: “We have to cut jobs in order to remain competitive.” Furthermore, the anxiety of surviving employees is limited to the duration of the recession. Firms therefore use recessions to clean house effectively.
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What was different about the 1990–91 and 2001 recessions is that each came after nearly a decade of growth. According to this view, firms had acquired far more “undergrowth” during the long expansion: thus more cleansing was necessary and its effects more prolonged. Put differently, the longer the years of plenty, the longer the famine. But because we have not had many postwar recessions following long expansions, the evidence for this explanation is not overwhelming either.

Yet another hypothesis has to do with improvements in the hiring process. In earlier recoveries, firms would put out advertisements for positions, people would reply by mail, be screened, and then be called for interviews, all of which took time. Long lead times in hiring meant that firms had to worry that they might not have enough employees to meet the growing demand and could lose sales if they did not start hiring early enough. With the advent of the Internet, it is easier for firms with positions and candidates with the right qualifications to find a match. The Internet also makes it easier for firms to wait and watch their order books, hiring just in time to meet demand.
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Of course, when every firm does this, it diminishes the incentive to hire: not only does unemployment persist, depressing demand, but the pool of available candidates is also likely to remain large, so there is no urgency to move quickly to hire the best candidates.

One piece of evidence in support of the “just-in-time” hiring theory is the greater dependence of firms on temporary workers in the two most recent recoveries, which suggests a reluctance on the part of firms to create permanent jobs. As temporary jobs grow in the current recovery also, William Dennis of the National Federation of Independent Business reaffirmed this view, saying: “When a job comes open now, our members fill it with a temp, or they extend a part-timer’s hours, or they bring in a freelancer—and then they wait to see what will happen next.”
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Regardless of which of the theories is right, if most or all future recoveries are likely to be jobless, the United States, with its weak safety net, is singularly unprepared for them.

Why are unemployment benefits so much more limited in the United States? Americans are not necessarily less caring or generous than the citizens of other rich countries. In fact, Americans typically give more to charity than people in many other industrial countries. According to one study in 2000, the average American gave $691 to charity, while the average for the United Kingdom was $141 and for Europe as a whole $57.
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If the explanation is not stinginess, what is it? There is no single answer to this question, but understanding the genesis of this policy is critical to figuring out why the United States has not been able to reform its system easily, and why so much of a burden has fallen on policy stimulus in recent times.

Caricatures are useful because they can draw out the essential nature of the object being caricatured. If I had to caricature U.S. firms (or more broadly, Anglo-American firms, encompassing firms from Australia, Canada, New Zealand, the United Kingdom, and the United States), I would describe them broadly as
operating at arm’s length
with their suppliers, lenders, customers, and employees,
innovative and radical
in thought and action, and
ruthless
in assigning both blame and rewards. Contrast these attributes with firms in continental Europe or Japan, which are better described as relying on
long-term relationships
with suppliers, banks, customers, and employees,
incremental
in thought and action, and more willing to share pain and gain among their associates. The spirit of the long-term relationship rather than the letter of the legal contract drives interactions.

These characteristics are neither static nor all-encompassing. Firms across the world are changing rapidly. In Japan, a country once famed for long-term employment, a career spent working for one company is no longer the norm, and a large number of young workers occupy temporary positions. Nor would it be difficult to find caring, sharing firms that have strong relationships with suppliers in the United States or ruthless ones in Europe. But I did say these were caricatures, correct in the broad sweep rather than in fine detail.

The point of drawing out these characteristics is to argue that they may belong together and may generate different forms of safety net. Specifically, mature firms in the arm’s-length Anglo-American economies face a market-oriented financial system that depends on transparency and disclosure. Hard information like quarterly sales, earnings, and cash flow can be easily transmitted to investors in the market. But the more up-to-date information that management gets, such as incoming sales numbers or inventory buildup, as well as market rumors, is not easy to transmit widely to investors because it could be inaccurate as well as less concrete. Moreover, soft information such as management character, capabilities, and strength of purpose—which can often be gauged over time through personal meetings—simply cannot be transmitted to the market other than through assessments by investment analysts, whose own views may color their judgment. How, for instance, can investors gauge whether the CEO is in touch with everything that is going on in the firm or simply the talking head delivering the PowerPoint presentation at investor meetings—especially when he is politically astute at choosing which questions to answer?

By contrast, in the continental European and Japanese system, firms have stronger, longer-term, more relationship-based interactions with investors, who are typically institutions like banks and insurance companies. Firms can share tremendous amounts of inside as well as soft information with a banker whom they have interacted with for years. This relationship improves the banker’s ability to make sound lending decisions and shape management actions, and the relationship gives her a greater incentive to help a troubled client firm because she knows the client will not abandon her lightly when good times come around.
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The arm’s-length system applies pressure for hard measurable and communicable results, because this is how the market gauges top management. The pressure travels through the system, and managers who do not make their numbers are put on notice. In a downturn, the pressure is especially high because earnings become a key indicator of whether a firm is profitable and whether it should be cut off from funding. Firms have little incentive to nurse excess labor through a downturn, preferring instead to lay off redundant workers and hire them back, or hire new ones once the recovery sets in. Similarly, the market ruthlessly cuts off underperforming firms from finance, ensuring that they have to be restructured or liquidated—much as it forced Badri’s employer to close its U.S. operations.

The relationship system allows top management a little more leeway. Because lenders know the management and can look beyond the numbers in a downturn, they can live with lower profitability for a while. The pressure to fire redundant workers is lower, especially if they are considered important and hard to replace in the longer term. Conversely, workers are more loyal and have the incentive to develop skills that make them especially valuable to the firm, even if those skills are not easily marketable elsewhere. Finally, governments tend to be willing to go the extra mile to preserve existing jobs.

A recent example of the differences may be useful.
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In early 2009, as a result of the financial panic and the associated difficulty in securing financing, car demand plummeted around the world. In both North America and Europe, politicians approved billions of dollars of aid to car manufacturers because they felt the millions of jobs tied to the industry made it too big to fail. In the United States, General Motors and Chrysler secured government funding on condition that they take drastic action to restructure their firms, close unviable plants, and sell unprofitable brands. After an initial restructuring plan was rejected by government overseers as too timid, the firms did indeed take drastic action, emerging from bankruptcy significantly shrunken. By contrast, in France, Peugeot and Renault received substantial amounts of government funds on condition that they close no plants and fire no workers over the term of the government loan!