The relationship between economic growth and employment

Each time the economy tries to recover from a recession, there is much discussion regarding the relationship between job creation and economic growth. This time again, the sustainability of the recovery is being questioned, because recent economic growth has not translated into job growth. The unemployment rate is considered by many to be a lagging indicator, because when it starts to react to an economic recovery, the recovery is already well under way. For example, in the early 1990s, the unemployment rate rose for about a year following the end of the previous recession. Companies wait until they are convinced about the sustainability of an economic recovery before they start hiring again, and many unemployed persons who had given up looking for work – and who were therefore excluded from the unemployment statistics – return to the labour market, which raises the unemployment rate.  In 2001, at the end of the recession, not only did the unemployment rate increase but the number of new jobs created in the economy actually declined during the first year of the recovery. Two factors explain this phenomenon: first, in the initial phase of a recovery, companies tend to increase their employees’ work hours; second, many upgraded their equipment and boosted their productivity, thereby reducing their need for workers.

Is there really a lag between economic growth and employment growth and, if so, how long is the lag? In a 2004 study published in the Southwestern Economic Review, William Seyfried of Winthrop University examined what he calls “employment intensity throughout an economic cycle.” He observed high employment intensity when growth in output leads to considerable job creation, and low employment intensity when there is little correlation between economic growth and employment. In times of technological innovation leading to strong productivity growth, there is generally a weak correlation between output growth and employment. This observation explains the situation we have seen for the past decade: to have an impact on employment, the economy must grow at close to its full potential. Curiously, the first conclusion that William Seyfried reached is that employment reacts quickly to changes in output, because the job market reacts to an increase in output in the same quarter.

The findings seem to support the hypothesis that economic growth provides an impetus to employment, but employment may take on a momentum of its own, either positive or negative. In other words, weak employment generates weak employment, and vice versa. For example, at the beginning of an economic recovery, output starts to grow, providing an impetus to employment. However, employment growth may lag, especially at the end of a recession, because weak employment leads to more of the same. This concept is difficult to explain, but it’s a little like a highly trained elite athlete who injures himself: when the injury heals, he remains weak and is slow to regain top form because of the injury he suffered and the physical toll it took. Similarly, economic growth must be sustainable to have an impact on employment: once employment starts to react to economic growth, it is carried by its own momentum.

What can we learn from all of this? That economic growth has a definite impact on employment, but that it can take time for the impact to be felt. How much time? It depends on how deep and long the recession was. The current situation confirms the findings of William Seyfried’s study: the recovery is not robust and employment is slow to react.

The author

Marc Desnoyers

Marc Desnoyers

B.Sc., M.B.A., C.F.A