It was John Maynard Keynes who first argued that economies can get stuck operating below full employment, in an “underemployment equilibrium.” While the idea was revived in support of fiscal stimulus when the 2008 global financial crisis began, policymakers were careless in analyzing such an equilibrium’s attributes, and failed to distinguish adequately between underemployment and unemployment.
Given that underemployment is not simply about how many people have jobs, an underemployment equilibrium can exist even when unemployment is relatively low. As Keynes pointed out, involuntary unemployment does not mean that workers are idle. Workers may, as a last resort, fill positions in which they earn a lower real wage than they potentially could. And someone “who is not ‘out of work’ may prefer to be occupied for a longer working week,” even if it lowers their real hourly wage.
There are at least four categories of underemployment:
• People looking for work, but unable to find a job (unemployed);
• People working part-time, because they cannot find full-time work (hours-constrained);
• People who have left the labor market, because they cannot find work; and,
• People working in jobs below their skill level.
Consider the United Kingdom. At the end of last year, the unemployment rate was 7.7%. But, as the sociologist David NF Bell and the economist David Blanchflower have argued, a more comprehensive measure of inactivity should include both the unemployed and those who are hours-constrained. Using labor-force survey data, Bell and Blanchflower estimate that the UK had an underemployment rate of 10.5% in 2012. That amounts to more than a half-million additional jobs.
While the hours-constrained approach is a much more accurate way to measure desired employment than the headline claimant count, it still covers only two of the four categories of underemployment. A proxy for the third category – those who are compelled to leave the labor market, because they cannot find jobs – could be the labor-force participation rate, which can be expected to fall as the amount of work to be done declines.
But this indicator, too, has its distortions. The UK’s labor-force participation rate has actually increased slightly since its pre-recession peak, and now stands at 77.7%. While it has fallen among young people, it has risen among older people, especially those close to retirement age. It has also been driven up by tighter claimant testing for long-term illness benefits.
The Institute for Fiscal Studies suggests that the increase in labor-force participation can be attributed to losses of wealth and income during the financial crisis – average household income has declined by 7.5%, or about £2,500 ($4,000) since 2008 – along with changes to benefits and pensions. Indeed, contrary to expectations, the recession has forced more people into the labor market, in order to offset declining household wealth.
Finally, there is the challenge of incorporating the mismatch between jobs and skills into employment data. Anecdotal evidence suggests that there has been a notable shift in the UK toward the sector that Keynes called pis aller – that is, minimum-wage jobs – with university graduates working as taxi drivers, waiters, gardeners, and so on.
An economy in which a sizeable proportion of the labor force is working below skill level cannot be described as an economy operating at full employment. But such a mismatch is difficult to measure, owing to a fundamental ambiguity: Is the accountant who lost his job and became a taxi driver an unemployed accountant or an employed taxi driver?
Keynes believed that an economy afflicted with underemployment could fall into an equilibrium or persistent state. While such an economy could recover from troughs, insufficient effective demand would cause the recovery to peter out before full employment was achieved.
Modern research supports Keynes’s view, and suggests that the longer a recession lasts, the worse the underemployment situation becomes, with workers losing both their skills and their motivation. As policymakers pursue economic renewal, they would be advised to consider underemployment more carefully.