Solved !!: The Dropout Puzzle Jude Wanniski July 19, 2005

Memo To: Paul Krugman, NYTimes columnist
From: Jude Wanniski
Re: A Shrinking Work Force?

It has been several months since I have been moved to comment on one of your columns, Professor, although I do take the trouble to read, or at least begin, all of them. You've been much better in criticizing the Republicans on Iraq than you have in zapping them on economics, and I assume that is because you are not trained in foreign policy and have a Ph.D. in economics from one of the Ivy League schools. Today, though, I want to help you out on the column you wrote yesterday, "The Dropout Puzzle," about how the unemployment rate could be falling at the same time fewer people are looking for work. The column cites a new paper that purports to have figured out this latest "conundrum." You say maybe the lower unemployment numbers are throwing off false signals and maybe things are worse than they seem to be:

Economists who argue that there's something wrong with the unemployment numbers are buzzing about a new study by Katharine Bradbury, an economist at the Federal Reserve Bank of Boston, which suggests that millions of Americans who should be in the labor force aren't. "The addition of these hypothetical participants," she writes, "would raise the unemployment rate by one to three-plus percentage points."

To tell you the truth, I had not heard any buzzing about the Boston Fed report, but I do know your column got the immediate attention of Wall Street economists who are also scratching their heads about the puzzle. Citigroup's chief economist, a fellow named DiClementi, cited your column in a Bloomberg radio interview yesterday and figured your assessment (Ms. Bradbury's) may be correct, i.e., "that there are at least 1.6 million and possibly as many as 5.1 million people who aren't counted as unemployed but would take jobs if they were available."

In other words, you and she believe the labor force is shrinking because people are giving up on finding jobs that are not there or they lack the skills to be hired for the jobs being offered. And unless people are actively seeking work, they are not counted among the unemployed.

The good news, Professor, is that I not only figured out what was happening two years ago, but also predicted it would continue and be A GOOD THING for the national economy. Where you think the Republican tax cuts of 2003 were giveaways to the rich, I argued that providing lower tax rates on capital returns, the capital/labor ratio would increase and make households that had to send two breadwinners to work would find they could make ends meet with one breadwinner.

This is actually the reverse of what happened when the stock market went into decline in 2000, hitting lows after 9-11. When that sharp decline occurred, households that had earlier reached retirement age and found they could live nicely on the equity gains in their 401(k) plans or other investments found that either or both husband and wife had to return to the job market to supplement the cash flow from their public and private pensions. At the same time, workers who were approaching retirement age thinking they could do so because of their increased household wealth were forced to reconsider, staying in the work force in order to maintain their standard of living.

It didn't stop there, because the relative stagnation in productivity that we've seen since President Nixon took us off the gold standard was the chief reason why lower- or medium-income families could no longer make ends meet with only one breadwinner. Women entered the work force in droves, not because they felt liberated from household chores and excited with the prospect of working for WalMart, but because they needed the income to pay the bills. In a great many case, Grandma was called upon to tend to the children while Mom worked in a shop or as a file clerk in an office.

What's been happening since the stock market hit its recent bottom in 2001 is the reverse of that process. In my client letters at the time I predicted a lower labor-participation rate -- which would indicate that people who didn't want to work could once again stay home to watch the kids or enjoy retirement because their net worth had climbed. I not only mentioned the rising stock market, but also the boom in housing that followed the 1997 tax provision that exempted the first $500,000 on a primary home from capital gains taxation. This was at least a $4 trillion increase in household wealth, especially for the middle-incomes that benefit most from that kind of dollar cap. With interest rates now at lows because the Fed deflated away the last remnants of the old Nixon inflation that began in 1971, average household wealth has been climbing these last four years and previously unhappy workers are happily leaving the work force.

Remember, Professor, even though you have a Ph.D. in economics and I never took a course in the subject, I do know that the term "economics" means "to economize." The object of good economic policy should always be to produce more of the things the people in the economy desire with less effort. This tells me that if we continue to stay on this track, lowering tax rates on capital investment and increasing rewards to successful capital investment (instead of doing the opposite, as you believe), then we should be able to get back to those halcyon days of the 1950s and early 1960s when an ordinary worker could earn enough after-tax income to support a family of four or five without his wife having to work at a shop or a firm to make ends meet. The objective, in other words, should be to produce more than we are today with a smaller work force. It may sound like a puzzle to you, but that's economics, Prof.