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May 22, 1981

JobCreation: A Post-Mortem?
The Reagan Administration has proposed
cuts in many programs, but few are to be cut
as deeply as the Labor Department's "job
creation" effort-programs designed to encourage employment through the subsidization of employee wages. For fiscal 1982, the
White House plans to cut $3.6 billion out of
these programs, or almost one-tenth of its
total proposed reductions;
With the nation's unemployment rate stuck
near 7112
percent for most of the past year,
critics argue that dismantl ing these programs
could seriously jeopardize the uneasy peace
with the unemployed in central cities. The
Administration, on the other hand, argues
that the programs are growing out of control, as well as posing serious management
problems. Behind the political controversy,
however, is an important economic debate
concerning the usefulness of job-creation
programs as a remedy for employment
problems.

The programs
The notion that governments can and should
directly stimulate employment is not new.
Indeed, today's Federal job-creation programs can be traced to the work-rei ief and
public-works programs of the Great Depression, which at their peak in 1938 employed
nearly four million workers. The urban riots
of the 1960's and the high unemployment
rates of the 1970's later stimulated renewed interest in programs to counter
the chronic unemployment problems of
unskilled workers.
By the early 1970's, nearly 20 Federal jobs
programs were in operation, involving both
training projects and direct job creation. In
1973 these efforts were consolidated by the
Comprehensive Employment and Training
Act (CETA). In contrast to the programs it
replaced, CETA provided for decentralized
administration. Federal funds were channeled to prime sponsors-largely county and

city governments-who then became responsible for providing training and creating
job opportunities.
The programs and aims ofCETA shifted significantly overtime. Initially, ittried primarily to
solve long-run or "structural" unemployment problems, by preparing individuals for
the workforce through training and workexperience programs. Direct job creationthe focus of our discussion -represented less
than a third of total spending in the early
1970's. However, as unemployment rates
rose during the 1974-75 recession, the emphasis shifted to countercyclical job creation.
. As a result, this type of spending increased
from $440 million in 1974 to $6.3 billion in
1979, or 60 percent of the CETA budget. At
the peak of the public service employment
effort, almost 700,000 jobs had been created
by CETA subsidies.

Theory of job creation
Or had they? Does a government have the
ability-even theoretically-to
"create"
jobs through subsidization of an employee's
wages? The answer depends upon the structure and functioning of the labor market.
Proponents of job programs argue that the
labor market is segmented, with different supply and demand processes for the ski lied and
unskilled segments. For skilled workers,
movements in wage rates clear the market for
their skills, so that few of them become involuntarily unemployed except during severe
recessions. For unskilled workers, on the
other hand, market imperfections (especially,
some argue, the minimum wage) keep wages
artificially high. This prevents the market
for their services from clearing at prevailing
wages, leading to high and relatively permanent levels of involuntary unemployment.
A public-service employment program, accordingtothis view, could reduce unemployment of unskilled workers without creating

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Opinions
in
newsletter do not
necessarilv reflect the Vie"INSof the rnanagement
of the Federal Reserve Ban k of San hancisco,
or of the Board of Covemors of the Federal
Reserve System.
The architects of CETA tried to solve the targeting problem by defining a set of eligibility
criteria to identify truly disadvantaged workers. There is evidence to suggest, however,
that despite these criteria, low-ski II workers
were not well represented among those in
CETA job slots. Indeed, a 1 977 study found
that those receiving CETA
employment tended to be better educated than
the experienced labor force as a whole; 76
percent of those in CETA job slots had 12 or
more years of education, versus 71 percent
for the experienced labor force. (Minorities
did, however, tend to be better represented in
CETA jobs.)

general inflationary pressures on wages; this
would be achieved by identifying and hiring
those workers who were unable to get a job at
the prevailing wage. (The same effect could
be achieved by subsidizing a private employer to hire these individuals.) In this view, jobs
can be "created": by circumventing the market imperfection, the program increases
employment of unskilled workers without affecting the employment of others, for a net
increase in employment and output.
Rejecting this "segmented markets" view,
opponents of job creation argue that market
imperfections are a relatively unimportant
influence on unemployment. Rather, high
unemployment rates among unskilled workers are seen to be the result of the high iobturnover rates inherent to these markets.
Therefore, the wages of unskilled workers
clear the market for thei r services, and any
increase in demand resulting from jobcreation programs only increases the wages
paid these workers (relative to the wages of
skilled workers). This in turn tends to reduce
the private sector's demand for unskilled
labor. In the extreme, therefore, a jobs program might simply convert private-sector
employment into public-sector employment
one-for-one, with no net job creation -but
with an adverse effect on wage inflation.

A related problem is the tendency by employers to use the funds to hire people that they
would have hired anyway. The effect ofthis
"fiscal substitution effect" is to convert the
jobs program into a general-purpose subsidy
to the employer.
This problem is difficult to handle through
eligibility criteria or other administrative
means, because an employer usually is better
qualified than a jobs-program administrator
to judge the potential value of an individual
in a particular job-and hence what should
be paid. Even without a subsidy, an employer
might be quite willing to hire an individual
who superficially appears to be in need
of assistance.

Targeting problems
Such theoretical considerations have undoubtedly contributedto the lack of enthusiasm for job creation among Administration
pol icymakers. But the efficacy of job creation
programs can be questioned on operational
grounds as well. For example, there is the
difficulty of "targeting" job-creation expenditures on the individuals suffering employment problems. Market forces tend to cause
inaccurate targeting of program expenditures. If the subsidized jobs pay the prevailing
wage (or greater), they will attract individuals
who have no employment problems, and the
impact on the target group will be lost. This
tendency would be weakened if subsidized
jobs paid significantly less than the prevailing unskilled wage, but this is typically not
the case.
.

Under CETA, employers apparently have
found it easy to convert conventional employment to subsidized employment. In one
study, economists George Johnson and James
Tomola found almost perfect fiscal substitu. tion among state-and-Iocal government employers-after
only six quarters, virtually all
of the public-service slots had replaced conventional positions, leaving total employment unaffected. In effect, CETA unintentionally became a revenue-sharing program
for public employers.

Youth problem
In view of these considerations, many economists see job-creation efforts as an unpromising method of dealing with the overall
unemployment problem. Towards the end of
2

studied the effects of family-income guarantees that were 25 to 30 percent more generous than conventional welfare programs.
Economist Richard West of SRI International
found that these experimental programs reduced the work effort of youth by 33 to 43
percent. These results suggest that it may
be difficult for job-creation programs
to significantly affect the youth unemployment problem.

the Carter Administration, in fact, Congress
itself had begun shifting the emphasis of CETA
away from public-service employment.
Some enthusiasm remains, however, for the
use of this approach in dealingwith the youth
unemployment problem -partly because of
its severity (with 40-percent unemployment
rates among minority youth) and partly because of the belief that market imperfections
may be more important in youth labor markets. For this reason, the Carter Administration in 1 980 sought to channel more CETA
funds toward youthful workers.

Future of job creation
Overall, the theoretical uncertainties and
practical difficulties involved with job creation have raised questions about the efficacy
of such programs as a general remedy for
hardcore unemployment. At the very least,
the Carter Administration's ambitious plan to
create one million jobs through such programs would not have the support today
among labor economists and policymakers
that it had in 1977. And in the short term, the
Reagan Administration has made it clear that
it is switching the emphasis of unemployment
policy-from job creation to job training and
fiscal reform, and from the public sector to
private business and unions.

Some economists are skeptical, however,
that the "segmented markets" notion is operative even for youth. High unemployment
among teenagers may reflect not only the
wage rigidities created by the minimum
wage and other market imperfections,
but also young workers' (voluntarily) high
job-tu rnover rates and lengthy job-search
patterns. Such behavior may in turn be stimulated by improved nonwork income opportunities, particularly family-assistance
(welfare) programs.
Both points of view may have some relevance. Many studies have found an association between the minimum wage and youth
employment, suggesting the existence of a
certain amount of "market segmentation."
The association is far from perfect, however,
and other forces appear to be at work. In
addition, some direct support for the "voluntary turnover" view comes from recently
completed welfare experiments (the Seattle
and Denver Income Maintenance Experiments). These Federally-funded experiments

Nevertheless, job creation is a durable concept, made durable perhaps by the memory
of the extensive Great Depression programs
which did appear to "work" -albeit under
radically different labor-market conditions. If
unemployment does not yield to the new
Administration's initiatives, job creation may
return to the top of the labor-policy agenda
once again.

Randall Pozdenaand Karen Vangsgard

Thousands

700

Public Service Jobs

600
500
400
300
200
100

o

1975

1976

1977

1978

3

1979

1980

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BANKI NG DATA-TWELFTH FEDERAL
RESERVE STRI
DI
CT
(Dollar amounts in millions)

SelectedAssetsand Liabilities
large Commercial Banks
Loans (gross,adjusted) and investments*
Loans (gross,adjusted) - total#
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.s. Treasurysecurities*
Other securities*
Demand deposits - total#
Demand deposits - adjusted
Savingsdeposits - total
Time deposits - total#
Individuals, part. & corp.
(Large negotiable CD's)

Weekly Averages
of Daily Figures
Member Bank ReservePosition
ExcessReserves(+ )/Deficiency (- )
Borrowings
Net free reserves( + )/Net borrowed( - )

Amount
Outstanding
5/6/81

148,982
126,879
37,809
51,998
22,855
1,662
6,465
15,638
41,312
28,852
30,503
78,225
69,117
31,059

882
1,026
545
76
50
163
81
63
771
62
240
1,093
956
797

Change from
year ago
Dollar
Percent

Change
from
4/29/81

Weekended
4/6/81
n.a.
62.3
n.a.

10,475
10,074
3,456
5,461
- 1,426
787
84
321
- 1,889
- 1,859
4,269
12,915
12,870
7,682

Weekended
4/29/81
n.a.
400.8
n.a.

7.6
8.6
10.1
11.7
- 5.9
89.9
1.3
2.1
- 4.4
6.1
16.3
19.8
22.9
32.9

Comparable
year-ago periOd

78
34
44

* Excludes trading account securities.
# Includes items not shown separately.
Editorial comments may be addressed the editor (William Burke)or tothe author . .. . Freecopiesof this
to
and other FederalReserve
publications can be obtained by calling or writing the Public Information Section,
Federal ReserveBank of SanFrancisco,P.O. Box 7702, SanFrancisco94120. Phone(415) 544-2184.