The American labour market has had a bad recession.
A smaller fall in output has resulted in a larger fall in employment and a bigger rise in unemployment than in Europe. The rate of unemployment in the United States has risen close to that in Europe. The big question is whether this is just a cyclical phenomenon and will ease once the economy returns to its trend rate of growth or whether a deep economic shock has exposed structural rigidities within the American labour market?
A greater share of the Employment Cost Index is now accounted for by costs that are harder for employers to avoid or adjust to in changing labour market circumstances. The principal cost employer’s face is higher health care insurance. If anything this is likely to become more expensive as a result of the Affordable Health Care Act 2010. These and other regulatory costs deter employers from hiring workers when the relative cost of employing Americans is rising compared to using technology and capital and as a result of foreign competition. The supply of labour, both in terms of whether in certain circumstances it is worth taking a job and in terms of the intensity of labour effort and hours worked is also likely to be reduced by the complex interaction of Federal Government, state government and local authority income taxes and benefit transfer payments. The operation of income taxes at federal and state level when combined with the rules governing the Earned Income Tax Credit, other Federal Government transfer payments relating to things such as college fees and the means testing applied to Medicare have a complex and malign effect on work incentives. These kind of entrenched structural labour market issues that arise out of the operation of taxes and benefits are well recognised in the United Kingdom and in the European Union. The United States plainly exhibits them as well. The Affordable Care Act will aggravate these structural labour market problems by imposing an obligation on most employers to provide health care insurance as well as tightening the rules about what is scored as adequate employer provided health care. By extending the coverage of Medicaid and providing a means tested subsidy to help uninsured people pay for the health insurance they will be compelled to purchase, more people will be brought into the range of poverty and unemployment traps distorting the American labour market.
Like most other advanced OECD economies America has a large and expensive public sector that will become increasingly costly to manage at a time when it faces increased competition. If anything long-term public sector liabilities are greater in the United States than in other OECD countries largely as a result of its market in health care. The combination of a large public sector and defective private markets in health and higher education along with the costly and erratic impact of an unusually expensive common law tort regime combine to offer an exceptional economic challenge to America's policy makers.
Warwick Lightfoot is the author of the forthcoming America's Exceptional Economic Problem.