The $787 billion economic stimulus package that President Barack
Obama championed has not stemmed the unemployment rate, which has
risen sharply since the recession began. Sharply reduced creation
of new jobs has driven this rise in unemployment. Businesses and
entrepreneurs have cut back on investment, so they create fewer
jobs. Had job creation remained at the same level throughout the
recession as during the last quarter of 2007 the private sector
would have created three million net jobs despite increased
layoffs. A third stimulus bill with yet more government spending,
as some in Congress propose, will do just as little to reduce
unemployment because, once again, it will not encourage the
entrepreneurship and risk-taking that create jobs.
Unemployment has risen sharply since the economy entered a
recession in early 2008, rising from its low during the previous
expansion of 4.4 percent in March 2007 to 9.4 percent in July
This rising unemployment has attracted significant political
attention. It was the justification for both the $152 billion
stimulus the Congress passed in February 2008 and the $787 billion
stimulus package Congress passed in February 2009.
President Obama promised that the stimulus package he signed
would "create or save" 3.5 million jobs. His economic advisers
predicted that unemployment would rise to 9 percent by 2010 if
Congress did not pass the stimulus bill, and that with the stimulus
unemployment would stay below 8 percent.
That has not happened. Chart 1 shows the unemployment rate that
the President's economic advisers predicted in January as well as
actual unemployment since then. By the President's own measures,
the stimulus has failed.
Layoffs Not Driving Unemployment
Most media coverage of the rising unemployment has focused on
losses of existing jobs. Behind this coverage is the strong
implication that the unemployment rate rises during economic
downturns because firms become more likely to lay off employees,
swelling the ranks of the unemployed.
This view is understandable--it was conventional economic wisdom
for many years. It also contains a large element of truth. Layoffs
have increased noticeably over the past year and a half. The Bureau
of Labor Statistics' Job Openings and Labor Turnover Survey (JOLTS)
tracks new hires and job separations on a monthly basis. In the
last quarter of 2007 private-sector employers laid off or
discharged 1.5 percent of their workers. That rate had risen to 1.8
percent by June 2009. Layoff rates are now one-fifth higher than
at the start of the recession. (See Chart 2.)
These job losses are real and painful for the workers involved.
But they alone do not explain why the unemployment rate has more
than doubled since mid-2007. Recent research shows that an
increased likelihood of layoffs is not the main reason that
unemployment rises during economic slumps. In the relatively mild
1990-1991 and 2001 recessions, greater job losses caused very
little of the total increase in unemployment. In more severe
recessions, such as that in 1981-1982, a rise in job losses
explained only one-third of the total increase in unemployment.
The main reason unemployment rises during economic downturns is
that job creation falls while the labor force continues to
grow, making available jobs scarcer. As a result, many without
work stay unemployed longer, driving up the unemployment rate. This
may seem counterintuitive, and it is not the impression the media
creates. It is also cold comfort to any breadwinner who has just
received a pink slip. But the fact remains nonetheless that it is a
drop in job creation, not a rise in job losses, that accounts for
the majority of unemployment increases during recessions. This fact
implies distinct policy strategies for reducing unemployment.
Dynamic Labor Markets
How does reduced job creation send unemployment skyward? The
American economy is highly dynamic. Industries continually expand
and contract while entrepreneurs create new companies and
uncompetitive firms go out of business. Workers move between jobs
frequently as this occurs. In good times and bad, the number of
jobs created or lost each month is the difference between the
number of workers starting new jobs and the number of workers
leaving old ones.
Changes in either job-loss or job-creation rates affect
unemployment. Unemployment obviously rises when employees leave
their jobs--either voluntarily or involuntarily--directly
increasing the number of job seekers. But unemployment also rises
when job creation falls. In that case, even if workers are no more
likely to lose their jobs, the workers who do leave their jobs, or
who enter or re-enter the labor force have a harder time finding
work--because fewer jobs are available. Consequently, these
job-seekers remain unemployed longer and the unemployment rate
During the average month in 2008, 4.7 million workers started
new jobs despite the recession. Another 4.9 million workers left
their jobs each month, either voluntarily or involuntarily. These
vast movements in and out of jobs dwarf the net 200,000 jobs that
were lost each month in 2008 and that the media typically
reports. Even small shifts in job creation and job
loss rates have large effects on net job losses.
Decline in Job Creation at Fault
This is exactly what has happened since the recession began.
JOLTS survey data reveal this clearly. Chart 3 displays the job
hire and separation rates since January 2007. The figure also
breaks down job separations into involuntary layoffs, voluntary
departures, and other separations, such as retirement.
Overall job-separation rates have not increased. In fact, they
have fallen. In the fourth quarter of 2007, 4.1 percent of workers
left their jobs compared to 3.7 percent in June 2009. Overall job
separations fell by 0.4 percentage point, despite increased
layoffs, because workers became much less likely to quit their
jobs; 2.3 percent of workers quit their jobs in the fourth quarter
of 2007. By June 2009--in the midst of the uncertainty of the
recession--only 1.6 percent of private-sector workers voluntarily
quit their jobs. Overall, private-sector workers are leaving their
jobs in smaller numbers than before the recession began.
How can unemployment rise so sharply when fewer workers are
leaving their jobs each month? Hiring has fallen sharply since the
recession began. In the last quarter before the recession, 4.2
percent of private-sector workers started work with a new employer;
today that number is only 3.4 percent. So while monthly layoff
rates have increased by 0.3 percentage point--roughly 300,000 jobs
a month--private-sector job creation has fallen even further, by
0.8 percentage point. That represents more than 900,000 fewer
private-sector jobs created each month. Thus far into the current
downturn, unemployment has primarily risen because private-sector
job creation has dropped sharply. Research into past downturns
suggests that this will continue to be the case throughout this
More Job Creation Needed to
Over the past 12 months, an average of 424,000 more workers in
the private sector have left their jobs than have started new
ones. Had job creation rates remained at their
Q4 2007 level, the economy would have instead averaged 223,000 net
new jobs a month despite the increase in layoff rates.
Had job creation remained stable private-sector employers would
have created 3 million net new jobs during the recession, even with
the increased firings and plant closings. Instead, because
businesses and entrepreneurs are creating fewer new jobs,
private-sector employment has fallen by 6 million net jobs.
Private-sector job creation must rise for the unemployment rate to
Less Investment and Entrepreneurship. Why has
private-sector job creation fallen so sharply? The obvious and
broad answer is the recession. A more precise answer is that
businesses are retrenching wherever they can. While taking measures
to survive the immediate downturn, such as laying off workers, and
conserving cash, businesses have also grown wary about the future
of the economy, especially in light of the many new threats
emanating from the White House and the Congress. In addition to the
various tax hikes President Obama has proposed to fund his
climate-change legislation, he has also proposed tax hikes
specifically targeted at small businesses. Now, the House of
Representatives is considering raising tax rates on small
businesses to pay for the move to government-run health care.
In addition, enormous increases in federal spending on
traditional liberal priorities, such as for government-run health
care, raise the prospects of vastly higher taxes or rapidly rising
inflation. The federal deficit is expected to approach $2 trillion
this year, and to remain well above $1 trillion for many years to
come, doubling the national debt in just five years. This situation
is not sustainable, but businesses can only guess how the federal
government will restore order to its fiscal house, knowing full
well that successful businesses make an attractive tax target.
In the face of such a threatening environment, it is not
surprising that companies are likely to make only the most critical
investments. In addition, the credit crunch has made credit less
available to entrepreneurs who want to start new businesses,
thereby adding to the shortfall in business investment and business
Gross private investment in equipment and software--a good
measure of business investment spending-- has fallen by a full 20
percent since the recession began. As long as business investment
remains low and entrepreneurs hold back from starting new
enterprises, job creation will remain low--and unemployment,
Less Investment Means Fewer Jobs. The data show this
clearly. Chart 4 shows the percent year-to-year change in new hires
and business investment. The two are strongly correlated. Business
hiring has fallen as investment has dried up.
What creates jobs? Employers with profitable businesses,
innovating and creating wealth. As long as entrepreneurs and
investors have reduced opportunities to create wealth, unemployment
will remain high.
The Congressional Response
To reduce unemployment, Congress needs to encourage firms to
innovate, invest, and take risks--and Congress must remove policies
that discourage them from doing so. One policy proposed by
President Obama would encourage innovation and job creation. During
the election campaign, Candidate Obama had proposed eliminating the
capital gains tax on startup companies. Repealing the capital gains
tax on startups would encourage more venture capital investment in
new businesses. Most new businesses fail. Venture capital funds
invest in many new companies and make up the losses of the many
failures with large profits on the handful of startups that do
If Congress repealed the capital gains tax on startup
businesses, investors would earn greater after-tax profits on the
few successful startups. The higher returns would encourage venture
capital funds to invest in more new companies, including some
riskier ventures they will not now invest in. The greater profits
from successful companies would compensate for the risk of failure
from others. The net result would be more investment, more startup
businesses, and more jobs. This would increase job creation and
A broader, more powerful policy would be for the President and
the Congress to commit to restraining spending to alleviate this
threat of higher interest rates and higher inflation. They should
also commit to raise no taxes and impose no new burdens on
businesses at least until the economy is approaching full
employment. This means no rate hikes for health care reform, no
rate hikes to pay for the massive hike in federal spending, and no
new assessments associated with global warming legislation.
American businesses and the American economy need time to
recover and heal from this deep recession before facing new threats
from massive government intervention in the economy. Presented with
a more certain path forward, businesses will regain their optimism
for the future, and will resume making the investments they need in
order to expand and to compete in the global marketplace.
The unemployment rate has doubled since the recession began in
2008. Many Americans fear that their jobs are at risk, and Congress
passed two stimulus bills to reduce unemployment. Congress and the
American public should understand that increased layoffs are
not the main reason unemployment has risen. While layoffs
have increased, the larger factor increasing unemployment has been
businesses cutting back on investment and entrepreneurs starting
fewer new companies. Consequently they have created fewer jobs.
Hundreds of billions in federal spending will not spur
private-sector investment and risk-taking. A third stimulus bill
will not promote job creation or reduce the unemployment rate any
more than the first two. Congress should reject any calls for a
third stimulus package.
Sherk is Bradley Fellow in Labor Policy in the Center
for Data Analysis at The Heritage Foundation.
for example, Louis Uchitelle, "Jobless Rate Climbs to 5.7% as
51,000 Jobs Are Lost in July," The New York Times, August 2,
(August 12, 2009). See also Neil Irwin and Michael S. Rosenwald,
"Job Losses Accelerate, Signaling Deeper Distress," The
Washington Post, October 23, 2008, p. A01, at http://www.washingtonpost.com/wp-dyn/content/article/2008/10/22/
AR2008102203709.html?hpid=topnews (August 12, 2009).
Department of Labor, Bureau of Labor
Statistics, Job Opportunities and Labor Turnover Survey, Total
Private Layoffs and Discharges, Seasonally Adjusted.
Robert Hall, "Job Loss, Job Finding, and
Unemployment in the U.S. Economy over the Past Fifty Years,"
National Bureau of Economic Research Macroeconomics Annual
2005 (Cambridge, Mass.: MIT Press, 2005), at /static/reportimages/4C9477E9D38337634352D847E4CDD6DA.pdf
(August 12, 2009); Robert Shimer, "Reassessing the Ins and Outs of
Unemployment," NBER Working Paper No. W13421, September
2007; Michael Elsby, Ryan Michaels, and Gary Solon, "The Ins and
Outs of Cyclical Unemployment," January 2007, NBER Working
Paper No. W12853, at http://ssrn.com/abstract=959129 (August 12,
Elsby, Michaels, and Solon, "The Ins and Outs
of Cyclical Unemployment," p. 11.
job-finding rate is the key variable in understanding the large
fluctuations in unemployment over the past 50 years. The separation
rate, the other determinant of unemployment, has been stable, by
all the available evidence." Hall, "Job Loss, Job Finding, and
Unemployment," p. 135.
Heritage Foundation calculations based on data
from the Department of Labor, Bureau of Labor Statistics, "Job
Openings and Labor Turnover Survey," 2008 / Haver Analytics. More
precisely, in the average month in 2008, 4,950,000 workers
separated from the job they held in the previous month, and
4,707,000 workers started a new job, for net monthly job losses of
Figures do not add perfectly due to
Hall, "Job Loss, Job Finding, and Unemployment
in the U.S"; Shimer, "Reassessing the Ins and Outs of
Unemployment"; Elsby, Michaels, and Solon, "The Ins and Outs of
Heritage Foundation calculations using data
from the Department of Labor, Bureau of Labor Statistics, Job
Openings and Labor Turnover Survey from 2008-2009.
Business investment here is gross private
investment in equipment and software.