What's the Solution to Unemployment?:
The solution for unemployment is, obviously, to create new jobs. Usually, a healthy economic growth rate of 2-3% is enough to create the 150,000 new jobs needed to keep unemployment from rising. When unemployment creeps above 6-7% and stays there, it means the economy isn't strong enough to create sufficient new jobs without help. That's when the government is expected to step in and provide solutions. See what the government has tried in the past with Unemployment Rate by Year.
The solution used first to address sustained high unemployment is monetary stimulus from the Federal Reserve. Expansive monetary policy is powerful, quick and usually effective. Lower interest rates allow families to borrow more cheaply to buy what they need, like cars, homes and consumer electronics. This stimulates enough demand to put the economy back on track. Low interest rates also allow businesses to borrow for less, giving them the capital to hire new workers to meet rising demand.
However, when monetary policy doesn't work, then fiscal policy is usually demanded. This means the government must either cut taxes or increase spending to stimulate the economy. Fiscal policy is usually slower to get started, since Congress and the President must agree on what should be done. However, it can be more effective once executed. It also provides much-needed confidence that the government will stimulate the economy and things will get better. Confidence is a crucial ingredient in convincing people to spend now for a better future.
Cutting taxes has a similar, but even more direct, effect as lower interest rates. It gives consumers more money to spend, increasing demand. It also cuts costs for businesses, which can use the cash to invest in their business and hire more workers. Government spending usually takes the form of jobs programs, where the government hires workers and businesses directly to build things or provide services. This acts like a tax cut, by providing consumers the cash they need to buy more products.
What's the Most Cost Effective Unemployment Solution?:
However, not all fiscal policy solutions are created equal. Dollar for dollar, what's the best investment that creates the most jobs? Several research studies show that the most cost effective solution is providing construction jobs for, of all things, mass transit. The next most cost effective is unemployment benefits, and the third best jobs provider is funding education. Tax cuts, whether payroll or across-the-board income tax, are less effective. What's the least effective jobs producer? Defense spending. Here's why.
According to a U Mass/Amherst study, the most popular fiscal stimulus, across the board income tax cuts, is not the most cost effective. One billion dollars in cuts created 10,779 jobs, because only half the money ($505 million) workers received was spent. The rest was saved or used to pay down debts. (Source: UMass/Amherst, Robert Pollin and Heidi Garrett-Peltier, Department of Economics and Political Economy Research Institute, The Employment Effects of Military and Domestic Spending Priorities, October 2007)
It's more cost effective to provide businesses payroll tax cuts. A study by the Congressional Budget Office (CBO) found that every $1 billion in payroll tax relief created 13,000 new jobs. The best place to give business tax relief is with small businesses, which are the key driver for 65% of all new jobs. (Source: CBO, "The Economic Outlook and Fiscal Policy Choices," September 28, 2010)
The U Mass/Amherst researchers found that funding mass transit gives the most bang for the buck. One billion dollars spent creates 19,795 construction jobs. Another cost effective solution is spending on education. One billion spent hiring teachers creates 17,687 jobs. It has the additional benefit of adding an additional $1.3 billion into the economy, as more highly educated people get better jobs on their own, and are able to buy more things with the higher wages they earn.
The least cost effective in jobs creation is military spending, which only creates 8,555 for the same investment. That's because it's more capital intensive, as modern defense relies more on drones, F-16s, and aircraft carriers than infantry.
Next to public works projects, the second most cost effective use of government funds is providing benefits to the unemployed. The CBO study found 19,000 jobs are created for every $1 billion in benefits. That's because the unemployed are most likely to spend every dime they get on the basics, like groceries, clothing and housing. This drives retailers and manufacturers to hire more people to meet the additional demand. The other advantage of unemployment benefits is it is fast. The government just writes a check,which immediately goes into the economy. Public works projects can take a while to get implemented. For more, see Why Extended Unemployment Benefits Are the Best Way to Boost the Economy.
Fiscal Policy Risks:
The downside of fiscal policy is it can add to the budget deficit, creating more government debt. As debt approaches 100% of the economy's total output, it can actually slow economic growth. That's because investors lose demand for that government's debt, which makes interest rates rise, increasing the cost of borrowing.
However, advocates of supply-side economics say that, over time, the economy will be boosted so much that it will make up the lost tax revenue. All solutions to reduce unemployment must create demand to stimulate the economy. For more, see Job Creation: Ideas, Statistics and Creation by President. Article updated August 30, 2012