The unemployment rate dropped in November to 8.6 percent from 9.0 percent in October and from 9.8 percent a year ago. This is clearly welcome news. However, the underlying dynamics of the drop-off in unemployment this last month and over the last year are disappointing and have clear implications for policy and for politicians.

The issue is a decline in labor force participation, a topic that both Jared Bernstein and Ezra Klein have picked up on. To be blunt, among groups with high voter turnout rates, the fall in unemployment has been driven by people leaving the labor force and not because of job gains: this applies to those 25 and older who have a high school credential, some college, or a college degree or further education. In contrast, job gains were responsible for falling unemployment among lighter voting groups: young people (ages 16-24) and the 8.0 percent of the labor force that lacks a high school credential. The only exception to this breakdown is that job gains lowered the unemployment rate of those 55 and older (but only 40 percent of this group is in the labor force). Among women, unemployment has fallen very little (0.3 percent) while employment has fallen as well, indicating that job growth has not driven their modest unemployment gains. Men, in contrast, have seen a large drop in unemployment (1.2 percent) but modest growth in employment, indicating a shrinking labor force as the major explanation.

Overall, the dynamics in the labor market do not point to people generally feeling happier or more prosperous because a great deal of the falloff in unemployment is not because people are earning money in newly found employment, but because people are no longer in the labor market. There are some analysts who point to demographic changes (e.g., the population aging) as a reason to expect labor force participation to not return to prior levels: however, such longer-term trends are not salient in explaining the trend over the last year because such demographic shifts occur gradually.

This morning’s news prompted me to do a bit of analysis on how much of the drop in unemployment over the last year is due to greater employment and how much is due to the shrinkage of the labor force. It is not easy to produce a clean decomposition, but simply displaying the trends in the unemployment rate, the employment rate (the share of the population employed), and the labor force participation rate (the share of the population in the labor force, meaning they are either employed or unemployed) certainly helps. The table below presents the data for key demographic groups along with the shares of the labor force of each group. The data are for the most recent three months compared to the comparable months a year ago (avoiding the volatility of one month’s data).

The top line tells a clear story that unemployment fell by 0.8 percentage points but the share of the population employed rose by just 0.1 percentage point. The share of the population in the labor force fell by 0.4 percentage points. This tells you that in the aggregate it was not greater employment driving the drop in unemployment.Read more

Here’s a quiz any undergrad business major should be able to ace: Assume you invest $10,000 in an asset with an expected return of 10 percent, and another $10,000 in an asset with an expected return of 4 percent. What’s the expected annual return on your portfolio over a 30-year period?

Answer: 8.1 percent (because $10,000 x 1.04³⁰ + $10,000 x 1.10³⁰ = $206,928, and $20,000 x 1.081³⁰ = $206,928)

But in a new working paper, Rochester University finance professor Robert Novy-Marx asserts that a pension fund manager following accepted accounting rules for public pension funds would assume an expected portfolio return of 7 percent in this situation (which he gets by averaging 10 percent and 4 percent). From this false premise, Novy-Marx draws outlandish conclusions about pension fund accounting, such as the claim that a pension fund with just $10,000 invested in the higher-yielding asset would appear to be better funded, all else equal, than one with $20,000 split equally between the higher- and  lower-yielding asset (because $10,000 x 1.10³⁰ > $20,000 x 1.07³⁰). Novy-Marx concludes that these rules give public pension fund managers a perverse incentive to “burn” the low-yielding bonds in order to inflate their plan’s funding status.

If this sounds absurd, it’s because it is. To begin with, you can’t just average the two rates of return as Novy-Marx does, because over time the portfolio becomes more weighted toward the higher-yielding asset. In practice, pension funds periodically re-balance in order to prevent a portfolio from becoming too heavily weighted toward risky assets, but they would have to re-balance continuously in order to reduce returns to 7 percent, which is unrealistic. In any case, Novy-Marx doesn’t even mention re-balancing, nor any other realistic pension fund practices in his paper. If he did, he’d also have to acknowledge that public pension funds assume stable, long-run returns that vary little across plans, clustering around 8 percent—less than the roughly 9 percent these funds have averaged over the past quarter century. Thus, they wouldn’t be affected by the kind of gaming Novy-Marx conjures up in this paper.

Novy-Marx’s claims are exasperating because the accounting method he prefers would actually create perverse incentives. Novy-Marx et al. believe that since pension liabilities are guaranteed (only partially, but that’s another matter), pension funds should be required to assume a nearly “risk-free” rate of return no matter the fund’s actual asset allocation. Thus, in Novy-Marx’s example, the assumed rate of return would be the 4 percent yield on nearly risk-free Treasury bonds even if the entire portfolio were invested in stocks with an expected 10 percent return (Novy-Marx doesn’t deny the existence of an equity premium).

It’s important to note that this wouldn’t encourage prudent investment practices any more than the doctrine of predestination eliminated sin. If anything, it might have the opposite effect—incite a desperate hunt for yield—as all pension funds would immediately appear drastically underfunded. It would not guarantee that the fund would earn a 4 percent return or better, since it wouldn’t require funds to invest in Treasuries or other low-risk assets. All it would do is make pension funds look bad and cause required contributions to spike, inciting a taxpayer revolt. It would also cause funded ratios and required contributions to vary for no logical reason, since Treasury yields fluctuate with monetary policy and market conditions that may have little or no bearing on pension fund adequacy.

Elsewhere, Novy-Marx has actually suggested that state and local governments with shaky finances should be allowed to contribute less to their pension funds because their higher borrowing costs—and the greater likelihood that they renege on pension promises—should translate to a higher discount rate on future pension liabilities. Though this illustrates where his logic takes you, Novy-Marx isn’t trying to promote fiscal irresponsibility.

(However, allies like Andrew Biggs of the American Enterprise Institute want to be able to assume high expected returns on assets in 401(k)-style plans while requiring public pension funds to assume low returns on the same assets.)

Novy-Marx’s latest sally is more an effort to provoke than to persuade. But he and his allies have already had a significant impact in the policy arena. The Government Accounting Standards Board has proposed valuing some pension liabilities using low municipal bond yields, a change that will likely result in significantly lower funded ratios and higher required contributions.

More generally, Novy-Marx and a small group of other economists have succeeded in attacking public funds for supposedly engaging in aggressive accounting and ignoring risk, deflecting attention from the real problem (in states where there is one) of elected officials neglecting to make required pension contributions. Astonishingly, they have done so without presenting any actual evidence that public pensions take on too much risk or inflate expected returns, but have rather harped on arcane accounting issues until enough people have concluded that where there’s smoke there must be fire.

President Obama and many Democrats are making the case for an expansion of the payroll tax holiday primarily on the grounds of protecting middle-class families from a tax hike. This is intrinsically problematic even if it seems politically expedient.

The one-year Social Security payroll tax holiday set to expire at the end of December reduced employees’ payroll taxes by 2.0 percentage points, increasing disposable income by $112 billion in 2011 and generating upwards of a million jobs. The Senate is expected to take up an expansion of the tax cut that would provide a 3.1 percentage-point reduction for employees and partially reduce employers’ payroll taxes. The largest component of Obama’s proposed American Jobs Act, the measure would do more for employment in 2012. But framing the argument instead as taxpayer protection digs proponents of progressive job-creation efforts into a deep hole in two ways.

First, if the measure is presented as anti-tax, we could never end the payroll tax reduction since any advocate would then be accused of favoring taxing the middle class! And if we do not end this measure, it eventually will lead to scaling back Social Security, which would deliver a long-sought conservative goal and further exacerbate our already growing retirement insecurity.

Second, presenting the measure as taxpayer protection advances a false narrative. For one thing, it further reinforces the misguided notion that economic policy is about whose tax cuts are better. This is a debate we don’t want to prolong, as its pursuit over the last several decades has been the recipe leading to a shrunken public sector. It also fails to articulate the real imperative behind it: to maintain consumer spending which supports jobs throughout the economy. We are neglecting the crucial narrative that Obama’s policies are pro jobs whereas his opponents’ are not.

Finally, we are failing to distinguish between the two types of tax cuts being offered. Conservatives claim that protecting lower tax rates for the wealthy creates jobs because those folks will work harder and invest with their extra cash. This policy is really not about generating jobs in the near term—trying to lower unemployment substantially in the next year—but, at best (if it is at all true, which I doubt), about more investment and jobs in the long term. In contrast, the payroll tax holiday is about temporarily infusing some spending into the economy which, in turn, keeps people working or adds jobs as families shop and spend, raising demand for goods and services.

Of course, the payroll tax holiday is a second-best approach: job-creation through spending is far more effective. Direct spending on infrastructure or even on government hiring people to perform useful public jobs (as was done by the Works Progress Administration and Civilian Conservation Corps) is more effective in raising demand and generating jobs. Seeing temporary tax cuts put in the category of competing tax cuts rather than that of job-generating efforts makes me want to recant my support for this measure. I understand the urge to find an allegedly effective argument and call out the hypocrisy of promoting tax cuts for the wealthy but not for low-earners and the broad middle class. But right now, this argument we are waging for the payroll tax cut is just digging us into a deeper hole, which is the way Democrats and liberals seem to fight every fight. Please stop digging!

The Congressional Budget Office recently released a comprehensive report on income distribution and inequality trends of the last three decades. The report was widely viewed as an affirmation that the Occupy Wall Street movement’s concern with the distribution of economic rewards is well-founded.

Strikingly, House Budget Committee Chairman Paul Ryan (R-Wisc.) interpreted the report as an affirmation that his budget policy wish list is a panacea for the societal challenges of income inequality and economic mobility. The House Budget Committee Majority Staff’s 17-page rebuttal dodges the broad takeaway of CBO’s report by distinguishing between economic mobility and absolute well-being versus relative inequality, but Ryan’s own budget proposals belie this distinction.

As Ezra Klein points out, Ryan’s report presents a false dichotomy between closing the income gap (i.e., redistribution through a progressive tax) and growing the economic pie (i.e., regressive tax cuts for upper-income households). Implied is that redistributive policies increasing taxes on upper-income households would sharply reduce economic activity, making all households absolutely worse off. But this premise is contradicted by recent experience: President Bush cut taxes for upper-income households and we got the worst economic expansion since World War II, in which the ‘economic pie’ grew a meager 2.6 percent annually (and 65 percent of national income gains went to the highest-income 1 percent of households). The failure of the supply side experiment is unsurprising given ample evidence in the economics literature that the elasticity of taxable income is relatively low, changes in the top marginal tax rate have little impact on productive investment, and marginal tax rates are well below optimal rates.

Yet there is a more fundamental problem with Ryan’s analysis. Ryan is for redistribution, but the kind of redistribution that shifts the burden of taxation from upper-income households to the middle class. Just look at the Ryan Roadmap, his 2010 budget that served as a blueprint for the House Republican 2012 budget. The figure below depicts how the Roadmap would change shares of federal taxes paid and average federal tax rates paid by cash income levels, relative to current policy (from this Tax Policy Center table). Households with income above $1 million would see their average tax rate plummet from 29 percent to 13 percent, lowering their share of federal taxes paid by 10 percentage points. On average, households earning between $20,000 and $200,000 would see their taxes rise, subsidizing the upper-income tax cut. More than two-thirds of households would see a tax increase.

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This redistribution will not close the income gap or foster economic mobility; this will merely confer a tax cut of $500,000 to households earning over $1 million annually. And for the reasons noted above, these tax changes are unlikely to spur long-term growth (any more than the public investments that Ryan’s budget would instead cut).

Finally, Ryan’s rhetorical support for economic mobility is contradicted by his oppositions to the very policies that promote mobility. Education and training provide a means by which low-income Americans can climb the socioeconomic ladder, and the social safety net helps that climb by lowering its risk. Yet Ryan supports massive cuts to these government functions and programs, such as Pell Grants helping low-income students pay for college.

Ryan’s acknowledgment that income inequality is a problem is certainly appreciated, but one wonders if the staffers who wrote this rebuttal are actually familiar with his policy positions.

The crisis in the eurozone, and the bizarre failure of the European Central Bank (ECB) to even try to manage it, has united strange bedfellows in arguing that the United States Federal Reserve should begin acting as in loco Responsible Central Bankis for the eurozone.

Brad DeLong argued a week ago for the Fed to begin buying up Italian and Greek debt to avoid a financial crisis potentially as big or bigger than the fallout from Lehman’s collapse in 2008. Dean Baker and Mark Weisbrot, often skeptical of finance-centric explanations of (and solutions to) the ongoing jobs crisis over the years since the Great Recession began … agree wholeheartedly.

Yes, as a general rule, economists agreeing with each other is usually a recipe for other people to begin reaching for their own wallets, but this group is both smart and (much) more importantly right on this specific issue. If the ECB won’t act like a central bank, and if the absence of a central bank in the eurozone threatens American economic growth (and it does – the eurozone is a crucial export market for the U.S. and fallout from U.S. banks holding eurozone could indeed be ugly), then it makes sense for the Fed to step in.

It would be really helpful, by the way, to have the two current vacancies on the Fed’s Board of Governors filled by people who were consistently arguing for aggressive actions to stem the economic crisis.

This week, the House of Representatives is expected to vote on two regulatory reform bills: H.R. 3010, the Regulatory Accountability Act (RAA), and H.R. 527, the Regulatory Flexibility Improvements Act. These bills would alter the regulatory process significantly, likely severely restricting the adoption of new regulations. In advancing these bills, proponents argue that regulations have become exorbitantly costly and are a large threat to jobs. These claims do not hold up to scrutiny, and are frequently made in a greatly exaggerated or substantially misleading manner.

EPI has issued a series of reports this year that assess these claims.  The evidence we have compiled, which I summarized in two recent EPI publications, might be of particular interest this week.

“A quick guide to EPI’s research on the costs and benefits of regulations” describes three main findings:

• Government data show that over several decades, and during the Obama administration as well, the benefits of regulations have significantly and consistently exceeded their costs.
• The much-scrutinized EPA regulations fare especially well according to cost-benefit criteria. The compliance costs of Obama EPA regulations are tiny relative to the size of the economy, are neutralized by their economic benefits, and are dwarfed by their health benefits.
• Regulatory opponents often cite large cost estimates that are entirely unsupportable. This conclusion particularly applies to their repeated use of the Crain and Crain $1.75 trillion estimate of the costs of regulation, which our own research, the Congressional Research Service, the Administration’s Council of Economic Advisers, and the Center for Progressive Reform have found is unreliable and grossly overstated.

“A quick guide to the evidence on regulations and jobs,” also has three main findings:

• A huge shortfall in demand, not regulatory uncertainty, is what ails the economy.
• New EPA regulations, in particular, can be expected to have a negligible effect on the overall economy. The largest EPA regulation proposed so far (the “air toxics” rule) would, in fact, likely create a modest number of jobs.
• Academic studies of and data on the relationship between employment and regulations generally find they have a modestly positive or neutral effect on employment.

Throughout the past year, the case against regulations has been driven by inaccurate overestimates of the economic damage they cause. As Congressional debate over sweeping regulatory reform bills proceeds this week, these erroneous claims are likely to be repeated, potentially contributing to the adoption of legislation damaging to the rules necessary to promote public health and safety, as well as economic stability.  It is an important time to compare these claims to the facts documented by EPI research this year.

Before Thanksgiving dinner each year, my stepfather likes to say a prayer imploring all of us to “try to keep things in perspective.” Despite it being more than a bit stale at this point (sorry, dad), I can already hear him delivering this refrain yet again this year. So in that spirit, I think it is worthwhile—especially at a time of frustrating congressional inaction and worrisome missed opportunities—to take stock of what some government programs do achieve, while being mindful of all that still needs to be done.

As I have written previously, the Census Bureau’s new Supplemental Poverty Measure (SPM) is an attempt to better identify America’s poor, by accounting for many of the additional expenses that families face and the resources that government programs provide. As the figure below illustrates, the effect of many of these programs is significant.  While the percentage of people below the SPM poverty line is already a woeful 16 percent, it would increase to 18 percent without the Earned Income Tax Credit (EITC). That would be an additional 6 million people living in poverty. If you consider the EITC’s effect on those under 18, the benefit is even more striking: from 18.2 percent in poverty with the EITC to 22.4 percent without it. That’s roughly 3.1 million children kept above the poverty line.

The Supplemental Nutritional Assistance Program (SNAP, formerly the Food Stamp Program) shows a similar impact. The overall poverty rate would be 17.7 percent versus 16 percent without accounting for SNAP, a difference of about 5.2 million people. For children, the poverty rate goes from 21.2 percent without SNAP down to 18.2 percent – roughly 2.2 million children.

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These are nontrivial differences, to be sure.  Yet even with these programs, the picture of America described by the SPM is one of substantial unmet need: 49 million people living in poverty, including almost 14 million children. We are the richest nation in the world, yet one-sixth of our nation is considered poor, and almost half (47.9 percent) are within 200 percent of the poverty line – what some might call “near poor.” That strikes me as a potentially “perspective altering” statistic. Maybe my stepfather is on to something.

Jason Richwine of the Heritage Foundation and Andrew Biggs of the American Enterprise Institute are at it again (following up on an earlier study for the Business Roundtable), claiming that government workers—in this case teachers—are grossly overpaid. EPI  and others have expended much ink on this topic, and forthcoming EPI research will address some of the latest claims in greater detail (though maybe Jon Stewart said it all in his message to teachers about “the greed that led you into the teaching profession”).

But one of the key arguments Richwine and Biggs make is so sloppy, it should only take a blog post to rebut: the claim that “teachers exhibit low cognitive abilities compared to other college graduates” and that once you take this into account teachers suffer no wage penalty. Since all employers would love to be able to accurately assess the skills of prospective employees, it’s amazing that such a tool, if it exists, isn’t in widespread use. The miracle tool turns out to be the Armed Forces Qualification Test, which Richwine and Biggs refer to as an IQ test. Here’s what the AFQT actually tests:

• general science
• arithmetic reasoning
• word knowledge
• paragraph comprehension
• numerical operations
• coding speed
• auto and shop information
• mathematics knowledge
• mechanical comprehension
• electronics information

Is it really surprising that a future kindergarten or high school history teacher would score lower on this test than a future engineer or army officer?  There are many other issues one can raise about the AFQT score, but that will have to wait for a later time.

But even if the AFQT score contained important information about teaching ability, Richwine and Biggs aren’t content to add this measure to their statistical model to explain wages as economists normally do.

That’s because adding this variable doesn’t change the basic story, which is that teachers’ earnings are significantly lower than those of similar college grads, even those with the same AFQT scores.

See the results in their table. In regressions with the traditional specification (i.e., the variables included as controls) they find teachers earn 12.6 percent less than comparable workers (see row 1). In their next specification, they add the AFQT score, thus controlling for comparable education and AFQT score (which they mistakenly refer to as IQ). Their results show that teachers earn 10.7 percent less than other workers with comparable education and AFQT scores. That means that including the AFQT score seems to reduce the teacher penalty (actually, they do not provide the statistical information to judge whether there is a statistically significant difference between these two estimates) but in no way eliminates it. So, how do Richwine and Biggs reach the conclusion that there is no teacher wage penalty? They say:

“The wage gap between teachers and non-teachers disappears when both groups are matched on an objective measure of cognitive ability rather than on years of education.”

Check out EPI research on the teacher pay penalty and the updated analysis and watch this space for an upcoming blog on teacher benefits, which Richwine and Biggs claim are worth as much as teacher salaries. In the meantime, you may want to read this DailyKos blog from a teacher inviting Richwine and Biggs to join him in the public schools. We can give Richwine and Biggs a pass on the value of their research if they want to enjoy these lavish perks themselves.

Yesterday, the congressional supercommittee announced that it failed to come to an agreement to reduce the deficit by at least $1.2 trillion over 10 years. The committee’s failure automatically triggers $1.2 trillion in cuts to domestic and defense spending starting in 2013, along with the expiration of the Bush tax cuts. The failure of the committee is no surprise to observers, given the failure of past commissions, negotiations, and various other initiatives. This is especially true since congressional Republicans continue to rule out reversing Bush-era tax cuts for high-income individuals, effectively insisting that the burden of deficit reduction be borne primarily by low- and moderate-income Americans.

The commission has not only failed to address medium-term deficits, but it has passed up an opportunity to address the immediate crisis: jobs. With unemployment and underemployment remaining high and job creation remaining weak, we cannot continue to let the wounds to the labor markets fester.

Looking forward, Congress needs to immediately turn to jobs. This means continuing emergency measures to boost consumer demand by extending support for unemployed workers and preserving tax cuts targeted to low-income taxpayers (by extending the payroll tax holiday or enacting a more targeted credit). It also means providing federal assistance to prevent further pullbacks by state and local governments. Finally, this means investing in America’s future by boosting infrastructure spending, supporting our children’s education, and creating work opportunities for all.

Congress can still address the jobs crisis, and should do so immediately.

From left, supercommittee members Sen. Max Baucus (D-Mont.), Rep. Rob Portman (R-Ohio), and Sen. John Kerry (D-Mass.). (Image from Flickr Creative Commons by sunlightfoundation)