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Unemployment: 2008 vs. 1981

Courtesy of Bob Hall at Stanford (Bob is on NBER recession dating committee):

The news on employment was worse than expected. The recession appears to be headed in the direction of the worst of the past 60 years. The graph shows the decline in employment from its peak in December 2007, with the previously worst recession superimposed on it, scaled up to make it comparable. This recession began in July 1981. Until recently, the decline of employment in this recession was rather less than in the 1981 experience, but the last two months actually declined faster than the decline in 1981. If the current decline bottoms out at the same point as the earlier one, it means that the remaining decline in jobs is about as large as the one that has already occurred–we are halfway to the worst point of the recession.

Gaming ‘Hot Money’

I think China’s recent policy to remove the almost certainty of its currency appreciation was really a smart move. Chinese policy makers may have simply based their policy move on the concern over the grim export outlook, but the unintended consequence or byproduct of this policy is that it will actively discourage the flow of ‘hot money’ into the country.

Here below I borrow the framework of game theory to illustrate the gaming of the ‘hot money’. Hot money here refers to the short-term international capital investment, and it’s different from long-term international investment such as FDI.


The graph illustrates how a sequential game works. Chinese government chooses their first move based on their policy objectives, i.e. to discourage hot money inflow; then foreign investors respond with their best move. In this game, we implicitly assume hot money inflow is bad.

The numbers in the parenthesis show the payoff structure of the game. Chinese government first decides whether to make the prospect of currency appreciation certain, and foreign investors then choose to invest or not.

The equilibrium of the game is at the left upper corner, where Chinese government makes the appreciation uncertain and foreign investors choose not to invest as the payoff is greater for not investing (0>-1).

In hindsight, Chinese policy makers should have made the move earlier. But it’s O.K.

Now read the related article on WSJ that touches the same issue:

China’s policy makers have done a great job of creating confusion in foreign exchange markets. That might’ve been their intention all along.

Beijing has much to gain by inserting doubt into the minds of the “yuan will always rise” crowd; namely, putting an end to so-called hot money inflows that are predicated on this assumption.

[Yuan deposits held in Hong Kong bank accounts]

These potentially volatile capital flows can cause inflation on the way in. Their sudden exodus, meanwhile, leaves a significant financial hole in bank balance sheets or asset prices — something China’s neighbors learned all too well during the 1997 Asian financial crisis.

Analysts think more than $150 billion of these funds made their way into China in the first half of 2008 alone, and Beijing’s made no secret of its efforts to put an end to the trend.

This is where the recent debate over the yuan’s direction could help. It started last week with a not-too-subtle move by Chinese policy makers to set the daily dollar-yuan “fixing” 0.2% higher than the day before. That was taken by some as a hint of bigger things to come, sparking trading in derivatives that profit only if the yuan is devalued in the year ahead.

The yuan itself, which trades within a band around that that daily fixing, also fell quickly. Against the dollar, the currency is down around 0.7% in the last week.

This will be unsettling for those who’ve seen the yuan’s inexorable rise as a sure-thing. Residents of Hong Kong, for example, have been converting massive amounts of their savings into yuan deposits. Over the last three years, these yuan deposits in Hong Kong banks have tripled in value to about $10 billion.

Those Hong Kongers may think twice now. They and the rest of the hot money crowd have been warned that they shouldn’t make any assumptions about Beijing’s intentions, even if a large-scale devaluation remains unlikely.

Decipher China’s Unemployment Rate

Digest of China's true unemployment rate. Could global recession cause social unrest in China? (source: Economist Magazine)

The great wall of unemployed

Joblessness in China is rising, prompting fears of social unrest. But how high is the true unemployment rate?

THE employment outlook is “grim” according to Yin Weimin, China’s minister of human resources and social security. So grim, in fact, that on November 26th the People’s Bank of China slashed rates by more than a percentage point—the most in 11 years—to boost growth. The slowing economy has led factories to cut jobs, and there are mounting fears that the swelling ranks of the unemployed might one day take to the streets and disrupt China’s economic miracle. To assess such risks one must consider how high unemployment might rise.

The snag is that both the level and trend of China’s official jobless figures are meaningless. Until the 1990s, the government more or less guaranteed full employment by providing every worker with an “iron rice bowl”—a job for life. But when soaring losses at state-owned firms forced the government to lay off about one-third of all state employees between 1996 and 2002, the official unemployment rate rose only slightly. Today it is 4% in urban areas, up from 3% in the mid-1990s.

But the official rate excludes workers laid off by state-owned firms. Thus at the start of this decade, when lay-offs peaked, it hugely understated true unemployment. Over time, as laid-off workers have found jobs or left the labour force, the distortion will have shrunk. Another flaw is that the official unemployment statistics cover only people who are registered as urban dwellers. An estimated 130m migrant workers have moved from the country to the cities, but there is no formal record that they live there, so they are ignored by the statisticians. After adjusting the official figures for these two factors, several studies earlier this decade concluded that the true unemployment rate was above 10%—and might be even as high as 20%.

If unemployment is already so high, it would not take much of an economic slowdown to push it to crisis levels. However, a more recent study suggests that the jobless rate has fallen a lot since the start of this decade. Albert Park, of the University of Oxford, and Cai Fang and Du Yang, of the Chinese Academy of Social Sciences, have analysed China’s 2000 census and 2005 mini-census (covering 1% of the population), which include migrant workers. The raw census data suggest that the total urban jobless rate fell from 8.1% in 2000 to 5.2% in 2005. But when the jobless figures are adjusted to an internationally comparable definition, the rate in 2005 was less than 4%.


As a crosscheck, the economists also used the 2005 Urban Labour Survey of five big cities. This confirmed that the urban unemployment rate, including migrant workers, had indeed fallen—from 7.3% in 2002 to 4.4% in 2005 (see chart). But the rate for migrant workers is lower than for permanent residents because they return home if they cannot find work. As the chart also shows, excluding migrants, the urban unemployment rate fell from 11.1% to 6.7%. And since 2005, unemployment has undoubtedly fallen further. Earlier this year, factory bosses complained that they could not find enough workers; and faster real-wage growth also suggested that demand for labour was outpacing supply. Thus before China’s economy started to sputter this summer, its jobless rate was probably only 3-4%. One important qualification to these numbers is that China’s labour-force participation rate—ie, those in work or seeking it—fell to 65% in 2005 from 69% in 2000. If discouraged workers have left the labour force because they could not find a job, then the unemployment rate may understate the hardship they face.

But the finding that unemployment has fallen sharply in China over the past five years makes sense. The right-hand chart, from the World Bank’s latest China Quarterly Update, shows GDP growth relative to its estimated potential growth rate if the economy operated at full capacity. From 2003 to 2007, actual growth ran ahead of potential, so unemployment should indeed have dropped. However, the bank expects China’s growth to fall below trend in 2008 and 2009, implying that unemployment will climb. The bank forecasts growth of only 7.5% next year, its slowest for almost 20 years and well below its estimated potential growth rate of around 9.5%. Jobs are already disappearing—especially in southern China, where thousands of small exporting firms have closed this year.

Chinese commentators are currently fixated upon whether the economy can continue to grow by at least 8% a year. That was the old rule of thumb for the growth needed to absorb new entrants into the labour market. But that 8% figure has little scientific basis. Over the past decade, the trend growth rate has increased as a result of heavy investment and faster improvements in productivity. Maybe that is why the World Bank reckons that China’s potential growth rate (ie, the rate needed to keep unemployment steady) is now about 9.5%.

For employment, the type of growth matters as much as its pace. China is creating fewer new jobs than it used to. In the 1980s, each 1% increase in GDP led to a 0.3% rise in employment. Over the past decade, 1% GDP growth has yielded, on average, only a 0.1% gain in jobs. Growth has become less job-intensive, so the economy needs to grow faster to hold down unemployment.

One reason for this is that the government has favoured capital-intensive industries, such as steel and machinery, rather than services which create more jobs. Louis Kuijs, the main author of the World Bank’s report, argues that China needs to shift the mix of its growth from industry, investment and exports to services and consumption. To adjust the structure of production requires a further strengthening of the yuan, raising the price of energy, scrapping distortions in the tax system which favour manufacturing, and removing various shackles on the services sector.

More labour-intensive growth would also boost incomes and consumption and so help to reduce China’s embarrassingly large trade surplus. But most important, by allowing more workers to enjoy the rewards of rapid growth, it could help to prevent future social unrest.

Becker: Economists are unprepared

Gary Becker says economists are unprepared and government actions are not enough to contain the damage.

Clearly, however, central bankers and we economists were unprepared for the magnitude of the present financial crisis, and even less for its large effects on the real economy through the drying up of credit for mortgages and business investments. This recession is still ongoing, but it appears as if it will be the most severe recession since 1982, when American unemployment peaked in some months at about 10.5 percent. One year into the recession according to the NBER dating, unemployment has reached 6.7 percent, and it is still rising at a fast pace.

Central banks, especially the Fed, did respond rather rapidly to the unfolding of the financial crisis, even before it had a large impact on the economy. The Fed employed all the weapons in its traditional arsenal, such as lowering interest rates and easing access to the discount window. It also innovated beyond traditional approaches by allowing investment banks access to its credit, and by helping to arrange for the takeover or elimination of weak investment banks, such as Bears Stern and Lehman brothers.

In contrast to the Fed, the US Treasury took a series of actions with dubious merit, including bailouts and a fiscal stimulus, that had few consistent principles. The latest as reported in the NY Times and Wall Street Journal is to use Fannie Mae and Freddie Mac to encourage banks to drop mortgages to 4.5 percent in order to raise housing prices and encourage home building. Yet Freddie and Fannie and their government guarantees contributed to the housing mess by encouraging excessive building of residential dwellings. Any effect of this proposed price ceiling on housing prices on mortgage rates would be small, but the damage to adjustments in the housing market would be major. The goal of policy should be to reduce, not increase, the power and distortions caused by these two institutions.

In any case, the Fed and Treasury's actions combined obviously were not sufficient to greatly contain the damage to the real sector. The retreat from risk has been so large that treasury bills and bonds are selling at very low interest rates, other measures of risk are way up, and lenders are reluctant to lend, even when expected rates of return on their investments are high. Not surprisingly, the confidence of central bankers and economists that we have learned how to moderate greatly the real business cycle has been shattered. It is revealing how many leading macroeconomists have been silent during the unfolding of this crisis. Perhaps the prudent approach is to go back to the drawing board before offering an interpretation of what happened, and how to combat it.

full text here