In today's Financial Post, MLI's Philip Cross makes the case that Canada's economy is facing the new challenge of too low unemployment.  Using the same metrics as the US, Canada's unemployment is closer to 6% and maybe even lower; instead of maintaining ultra-low interest rates and continued deficits, government should look for specific solutions to key demographics and broader participation in the workforce.

Unemployment Dangerously Low

Philip Cross, Special to Financial Post, Tuesday, Apr. 23, 2013

Unemployment may be lower than the headlines suggest. This leaves employers facing widespread labour shortages and the economy vulnerable to upward pressure on wages and prices.

No government stimulus needed

For most people, an unemployment rate of about 7%, while well below its recession peak of 8.7%, still reflects an unacceptable degree of slack in the labour market. This leads some to advocate further government action to stimulate the economy and create jobs, and others to more extreme calls to limit immigration.

A closer look shows that the unemployment rate already is unusually low, especially after a sub-par recovery from recession. Moreover, unemployment may be lower than the headlines suggest. This leaves employers facing widespread labour shortages and the economy vulnerable to upward pressure on wages and prices.

Start with the unemployment rate in Canada. For all of 2012, it averaged 7.2% using the conventional rate calculated by Statistics Canada. So far in 2013, it has been 7.1%. These are historically low levels by any standard. Quarterly unemployment never fell below 7% in the 1980s and 1990s, and only dipped below it during the resource boom before the 2008 recession. At a similar point in the recovery from the recessions in the early 1980s and 1990s, the unemployment rate was still near 10%. Considering the sub-par growth rate in the current recovery, this shows that unemployment already is at an exceptionally low level.

Now, instead of the conventional measure of unemployment, calculate Canada's unemployment rate by applying U.S. concepts (basically, they are a little more hard-nosed about what constitutes job search and exclude 15-year-olds). By this measure, Canada's unemployment rate last year would have been 6.3%, nearly a full percentage point lower than the headline rate.

Remember, the U.S. Federal Reserve Board has said it will start tightening monetary policy when unemployment reaches 6.5%. So Canada's unemployment rate, using the same yardstick as the U.S., already is below the level that would induce the Fed to tighten.
Moreover, from a macroeconomic standpoint, the underlying rate of unemployment may be closer to 5% than 6%. Joblessness is concentrated in two groups with double-digit unemployment rates, teenagers and recent immigrants. Last year, youths aged 15 to 19 had an unemployment rate of 20.1%, while for recent immigrants (in the country for five years or less) it was 13.5%. I am not sure how much of a social problem unemployed teens represent, but clearly it is not something which needs the heavy artillery of ultra low interest rates. For recent immigrants, we will see if recent government reforms improve the integration of immigrants into our labour market, but the problem should be addressed with specific policies aimed at this group, not the economy-wide tools of monetary or fiscal policy.

Macroeconomy is closer to full capacity than many think

Together, teens and recent immigrants account for a full percentage point of total unemployment. Using the U.S. concept of unemployment, and then subtracting the impact of teenagers and recent immigrants from unemployment, and suddenly you are looking at an unemployment rate of 5.2%, at which point alarm bells have to start sounding (there is a small amount of overlap in excluding 15-year-olds from both the U.S. definition and from teens, but this is inconsequential to the argument).

This has major implications for policy formulation. Instead of maintaining budget deficits and low interest rates to dampen unemployment, it would be better if specific policies targeted the problems of teens and immigrants, or even other groups with above-average unemployment rates like Aboriginals or the disabled.

That the macroeconomy is a lot closer to full capacity than many think is supported by the widespread complaints from the business community that labour is in short supply. Early this year, the Chamber of Commerce characterized worsening shortages as "desperate" and a threat to future growth. We are already seeing a sustained upward trend in real wages, with average hourly earnings up 3.0% in the past year, close to its peak rate of 3.2% at the height of the boom early in 2008. This is another reason why the Bank of Canada should be unwinding its ultra easy monetary policy and starting to raise interest rates, never mind the damage these policies are doing to the economy's allocation of capital.

How can unemployment be dangerously low when we just saw another quarter of sluggish growth in GDP? Partly, the slack in GDP represents transitory factors. But mostly, this is the new normal in labour markets, as the population ages and people leave the labour force. The labour force participation rate has fallen steadily since 2008, its longest and most pronounced slide on record. The impact of aging is easily seen. While the participation rates of both primed aged adults and people over 55 years are rising, the overall participation rate is falling because people are moving rapidly into the latter group, who have a much lower rate of being active in the labour force.

A declining participation rate also has been the major factor lowering unemployment in the U.S. from 10% to below 8%, despite an even weaker recovery than in Canada. If, heaven forbid, growth ever began to pick-up, the pressure on labour markets could quickly lead to a jump in wages.

Instead of striving to buttress aggregate demand, which only aggravates labour shortages, more attention should be placed on boosting labour supply. This includes a better job of integrating people who are often marginalized in the labour force, like the very young and the very old, as well as immigrants and Aboriginals. Soon, Canada will need the contributions of all its peoples to sustain non-inflationary growth.

Philip Cross is the Research Coordinator for the Macdonald-Laurier Institute and the former Chief Economic Analyst at Statistics Canada

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