Keith Rankin: Jobless Recovery

With the release of the October-December unemployment figures on 2 February, there is renewed talk of a "jobless recovery", as a kind of paradox.

References to 'jobless recovery' include: "Latest unemployment stats show risk of a jobless recovery" (Scoop), "Rise in jobless rate stokes recession fear" (Dominion Post), "GDP growth without jobs is no recovery at all" (Werewolf), and "Fantasy economy exposed" (Business Day).

The language of business cycles is very imprecise, which makes life hard for journalists and readers. The phase of the cycle that is generally called a recovery is in fact precisely when we expect unemployment to peak. When unemployment consistently falls from its peak, the recovery is over, giving way to an "expansion" phase.

The best way to think about the business cycle is the simplest. There are really just two phases: expansion and contraction. An expansion is a period of falling unemployment or full employment; a contraction a period of rising unemployment. For New Zealand, we can regard an expansion as a period of 2+ percent economic growth. Thus two percent growth can be considered "normal" for New Zealand whereas maybe nine percent growth is normal for China at its current stage of development (Strictly, New Zealand's normal growth rate since the mid-1970s would be two-and-a-half percent; I will use two percent here, for simplicity.)

What makes 2% normal for New Zealand? In short, under normal circumstances the population increases by 1% each year, and productivity increases (thanks to learning, and improved technology) increases by 1% per year. Thus, if the economy is growing at 2% each year, the rate of unemployment should be unchanging. If the economy is growing at less than 2% each year, the rate of unemployment should be rising.

A contraction can thus be understood as any period in which growth is less than normal. An appropriate government policy or monetary policy response during a contraction is an expansionary policy. Thus a contraction means a period when the 'economic cake' becomes smaller relative to the size it would be with normal growth.

An appropriate government of monetary policy response during an expansion is a neutral policy (if unemployment is reducing) or a contractionary policy (if spending becomes unsustainable once full employment is reached). Thus an ideal policy is countercyclical.

A contraction has three components: a downturn (when growth falls below 2% in New Zealand), a trough (which may or may not be a recession), and a recovery (when the growth rate is rising but remains below 2%). [A recession is when economic growth is negative; a period of absolute as well as relative contraction.] A recovery is, generally, the last part of a contraction. The exception is a double-dip recession, when a recovery from one recession gives way to another.

When an economy is in a contractionary phase - and New Zealand's has been so now since January 2008 (three years) - governments should never implement contractionary policies. A contractionary policy is any policy that is intended to reduce the rate of spending, whether by raising interest rates, reducing the government's budget deficit, or compelling (or incentivising) us to save more. A contractionary policy always makes a contraction worse.

New Zealand experienced below-normal economic growth for eight years from the beginning of 1985 until the end of 1992. Unemployment stubbornly refused to fall below 4% in the years 1985-87, then increased steadily, peaking in 1992 at an official rate of 11%, and an unofficial rate almost certainly over 20%.

A recovery is a period in the business cycle when unemployment rises more slowly than in a recession, and then peaks as the contraction comes to an end. A contractionary policy applied during a recovery sends an economy back into recession, setting off a new wave of unemployment. If, as a result of such a policy, economic growth sits at about 0%, unemployment in New Zealand will steadily rise to 10% and beyond. Further, poverty will rise and income tax receipts will stagnate. That means personal and government debt would increase.

Economics is an imprecise and paradoxical science. We should never be surprised at the oxymorons it delivers upon its unsuspecting consumers. We should always question what we hear. Rarely, in economic wonderland, is anything exactly what it seems.

Keith Rankin teaches economics at Unitec.