What it really takes to get unemployment down

November 16, 2010, 6:54 PM UTC

The harsh reality is that it will take tremendous growth in the GDP even to make a small dent in the unemployment rate.

Despite some mildly good economic news this week including an uptick in retail sales for October, the US economy is likely still years away from seeing unemployment fall in any meaningful way.

In fact, the American economy appears to barely be able to keep joblessness from rising further. US unemployment has held steady at 9.6% since August. For the three months ending in September, GDP grew at annual rate of 2% — still a bit short from the 3% minimum needed to solidly keep the jobless rate from trending up.

But the economy needs to grow at more than double that rate — 5% — in order to shrink the unemployment rate by just one percentage point. Even if that happens, which almost no economist is predicting for the next couple of years, most in the job market would feel little difference. An 8.6% unemployment rate is still much higher than the approximately 6% jobless rate before the Great Recession.

The 5% benchmark most economists go by dates back to the 1981-82 recession when unemployment peaked at 10.8%. During the first years of the recovery, annual GDP growth increased an average of 6.7%, which helped unemployment fall to 7.2% in just two years.

But the current economic recovery isn’t experiencing anything close to that growth, which is why it feels like a so-called jobless recovery. Many economists, including former OMB director Peter Orszag, expect GDP growth to slow for the next 12 to 24 months — Orszag says growth of 0%-2% is actually a best-case scenario.

The long slog

It gets worse. Besides GDP growing 5% a year, the economy would need to consistently add 100,000 to 120,000 jobs a month just to keep up with population growth – a demand that hasn’t been easy to meet, especially since the US has been losing jobs for the most part during the past several quarters.

“The growth rate we’ve seen hasn’t been enough to do anything substantial with the unemployment rate,” says Josh Bivens, economist with Economic Policy Institute, a Washington DC-based think tank.

Even if the economy could actually grow 5% annually right now and thereby reduce unemployment only modestly, there’s the threat that it could encourage a steady rise in prices. Laura Gonzalez, finance and business economics professor at Fordham University, estimates that US GDP must only grow between 2.5% to 3.5% to avoid inflation.

So even while retail figures for October show signs of improvement in consumer spending, the news is not all that positive given how much it will take to improve the job market. Retail sales grew sharply by 1.2% from September, marking the fourth consecutive monthly rise in sales and the biggest gain since March, the Commerce Department reported Monday.

Certainly this is significant as consumer spending overwhelmingly makes up the biggest part of America’s economy. But the figures were driven by a rise in auto sales — excluding cars and auto parts, retail sales grew by 0.4% during the month.

Indeed, in the grand scheme of things, the consumer is far from recovering from too much spending in the years leading up to the latest recession that started in December 2007 and ended June 2009. And for many consumers, the job market still looks far from the good old days.

Also from Fortune.com:

Orszag: Why the 2011 outlook is dismal

10 signs the consumer is not dead

How El Paso, Texas dodged the recession