Is the Fall of Unemployment Good?

Is it good news or bad news that the rate of unemployment in the United States has gone back to a 50-year low of 3.5%? It depends on what caused it. Discussing this question will lead us to look at numbers that some may find surprising.

Figure 1 and Figure 2 show the evolution of the unemployment rate and of total (non-farm) employment under the previous and current administration. There appears to be little difference. If we calculate the average (compounded) quarterly growth of employment between, on the one hand, the first quarter of 2009 and the first quarter of 2017 (the Obama administration) and, on the other hand, the first quarter of 2017 and the third quarter of 2019 (the Trump administration thus far), we get a quite small difference with respectively 0.3% and 0.4%.

Figure 1: Unemployment Rate

Figure 2: Employment Level

A few caveats: Small compounded differences will matter as time passes, if they persist. We are comparing only nine quarters of Trump administration against eight years of Obama, and broad macroeconomic series are not necessarily significant in the short run. Moreover, note that a decrease in the unemployment rate from, say, 4.5% to 3.5% should be more difficult to obtain than a reduction from 5.5% to 4.5%. This is not only because the percentage of the decrease is higher in the first case, but also because increasing employment becomes more difficult as full-employment is approached.

The first hypothesis for the apparently (slightly) better performance under Trump is that it has been caused by the removal of obstacles to employment, such as previously higher taxes and regulation growth. Such a result would of course be good: everybody wants to work at the prevailing wage rate can find a job and increase his consumption.

If however—this is the alternative hypothesis—the reduction of unemployment has been driven by an increase in the number of individuals who are necessary to produce the same or lower GDP per capita, then the news would be bad. For example, if all mechanization were forbidden in agriculture, at least 15 million new jobs would be created—about three times more than the current number of unemployed. More radically, if computers were forbidden, imagine the increase in employment! North Korea must always be at full employment, but with a low GDP per capita, which is bad.

As a matter of fact, under both Trump and Obama, real GDP per capita increased, and the rate of growth under Trump (a compounded quarterly average growth rate of 0.5%) has been higher than under Obama (0.4%). The difference is small and is not obvious on Figure 3, which shows quarter-by-quarter increases in real GDP per capita.

Figure 3: Quarterly Growth of Real GDP per Capita

Now suppose that imports are banned or restricted by government-imposed handicaps such as higher tariffs. Then, more employment will be needed to produce the same volume of, say, furniture and sporting goods that were previously imported from China—and were effectively purchased with exports of agricultural products and jetliners employing fewer workers. Comparative advantage implies that fewer workers (or fewer hours per worker) were needed than with less free trade. Theoretically, in other words, less free trade implies more employment but less consumption. This suggests that, instead of GDP per capita, we look at consumption expenditures per capita.

Figure 4 and 5 show real personal consumption expenditures per capita in both levels and quarter-to-quarter percentage change. Here again, there is no obvious difference in the pattern of change between the previous and current administrations, except perhaps for the return of high volatility under Trump. We can however calculate that real consumption expenditures per capita grew at a (compounded) quarterly rate slightly higher under the Trump administration (0.6%) than under the Obama administration (0.4%).

Figure 4: Real Personal Consumption per Capita

Figure 5: Quarterly Growth of Real Consumption Expenditures per Capita

These data suggest that the net effect of Trump’s policies has been to extend the previous trends in employment and economic growth. And they do not show that the increases in employment have been obtained at the cost of lower GDP or consumption per capita.

Why didn’t Trump’s trade wars have more of a negative effect? First, it is nearly certain that economic growth would have been higher without them; the fact that it did not decrease does not mean that it has not been affected. Second, despite the drop in imports and exports caused by Trump’s trade wars, trade-and especially trade with China-remain a small part of the American economy, of which two-thirds is made of (mostly) non-traded goods and services such as housing, health care, and education. Data analysis from Galina Hale and Bart Hobijn of the San Francisco Fed shows that total imports from China correspond to about 1.9% of American personal consumption expenditures.

The answer to our starting question, then, is that the recent increase in employment and lower unemployment are quite certainly good news. Certain Trump policies such as the reduction of tax rates and lower growth of regulation have more than compensated for his disastrous trade policies (and increased public debt). How long will the good policies make up for the bad ones is a question that time will answer.

P.S. (12/14/2019): See Jon Murphy 's valid critique and my rejoinder in the comments below.

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