The rise of finance undermines employment growth
The stagnation in labour demand in the US is linked to the rise of finance. Strategies to encourage long-term employment growth must be found in that direction too.
Economic recovery since the Great Recession in the United States has been overshadowed by high unemployment. Five years after the end of the economic contraction, the official unemployment rate still had not returned to its pre-recession level. The employment-population ratio suggests an even more pessimistic outlook, with the number dropping from 63 to below 59 percent during the recession and has shown no clear sign of recovery. As such, economists such as Lawrence Summers and Paul Krugman suspect that high unemployment might become a permanent feature of the US economy: the absence of substantial job growth reflects not only variations in cyclical demand, but also long-term, structural shifts.
While it is yet to be determined whether the latest financial crisis acted as a catalyst or a cause of persisting high unemployment in the United States, there is some evidence indicating non-cyclical, qualitative changes in labour demand that predate the recent financial crisis. First, a similar divorce between GDP and employment growth was observed in the recoveries following the 1990-1991 and 2001 recessions. Second, most job losses during these recent economic downturns are permanent; newly added jobs during the recoveries have been new positions in different firms, not rehires. Lastly, scholars have identified a long-run retreat of large corporations from the US labour market, marked by mass layoffs and a decreasing concentration of employment.
My ongoing study of the largest US corporations indicates that the stagnation in labour demand is linked to the rise of finance through three pathways. First, since the late 1970s, increasing numbers of non-financial companies started to extend their financial arm into trading, leasing, small business lending, mortgage, and other consumer finance services for greater profit. When comparing non-financial companies that engage in financial activities with those who focus on their core business, I find that the former tend to have much weaker employment growth than the latter.
Second, as discussed in Eileen Appelbaum’s opinion article in the Employment debate, my study shows that system-wide excessive leveraging is detrimental to long-term job growth. Compared to companies primarily funded by equity, debt-loaded companies are under constant pressure to meet fixed obligations. As a result, these companies face greater layoffs during recessions and are more conservative in expanding their workforce even during economic booms. Indeed, a high corporate debt level was the main reason that the US economy was highly fragile to credit contraction, as demonstrated in the recent financial crisis.
Lastly, there is a robust trade-off between employment and the rewards to the shareholders. The emergence of large institutional investors and the performance-based compensation packages both encourage top executives to boost stock prices through high dividend payment and aggressive share buyback with resources available for employment. My analysis shows that companies that are more generous in terms of dividend payment and stock repurchase tend to have weaker job growth. More importantly, the tradeoff relation has been increasing over time, suggesting that executives today are less reluctant to reward shareholders at the expense of employment.
I suggest three directions to encourage long-term employment growth and stability:
- Interest, capital gain, and dividend income for non-financial companies should be taxed at higher rates than income generated from the core business. If a firm claims financial investment as part of its core business, it should be subject to the same regulation and scrutiny that apply to other financial institutions.
- Interest payment is currently tax-deductible as business expense. To echo Appelbaum’s suggestion, the deductibility should be eliminated or reduced.
- The tax rate for dividends and capital gains should be further increased from 20% from high income families.