Monday, January 24, 2011

More on the labor market in the Great Recession

There is an interesting debate in the blogosphere exploring the reasons for the persistent high unemployment rates in the US and elsewhere. Conservatives lay the blame on the structural skills mismatch and argue that this cannot be resolved through any stimulus spending measures. Liberals claim that the massive slump in aggregate demand from the boom, means that there are massive idling resources which can be brought to work with an appropriately structured stimulus program.

Okun's law (for every percentage increase in the unemployment rate, GDP will fall by an additional roughly two percentage points) also means that productivity falls during recessions. Labor economists attribute this to labor hoarding - firms except recovery any time and therefore keep workers on their rolls despite not needing since it might be both difficult and costly to find workers when needed. Therefore conventional wisdom would have it that firms hoard labor during recessions in expectation of a quick recovery.

In an excellent post, Nick Rowe compares the peculiar dynamics of unemployment and GDP growth rates of the major economies and finds that the US economy violated Okun's law during the Great Recession. Further, instead of declining during a downturn, labor productivity in the US actually rose during the Great Recession. In contrast, the labor productivity in Europe has been pro-cyclical, as conventional wisdom would have expected. The GDP fell a little over 4%, peak to trough, and employment fell nearly 6%, so the GDP/employment ratio increased by over 1%.

To explain this deviant behaviour, Rowe makes the distinction between general and firm-specific human capital (which is useful at one firm), and argues that firms prefer to lay-off the former and retain the latter (since both finding and training them when recovery returns will be costly). He attributes the observed deviation from Okun's law to the specific nature of the booms in countries like US, Spain, and Ireland, driven as they were by real-estate and construction bubbles. When the bubble burst, a disproportionate share of the job losses were concentrated in the construction sector.

He writes, "the construction trades require a lot of general human capital and very little firm-specific human capital. Two building sites can swap bricklayers easily, with minimal re-training." Further, given the magnitude of the bubble, firms also realize that normalcy is not going to return anytime soon, thereby reducing the need to keep workers on rolls.

The diminished incentive for labor hoarding has initiated an argument that the US labor market suffers from a problem with the productivity of the unemployed instead of any fundamental issues with the economy itself. Since less number of workers in the US are producing the same output, Tyler Cowen has raised the issue of zero marginal product (ZMP) workers. He suggests that unemployment rate has not returned to earlier levels despite the output being restored because those workers did not add any value. Paul Krugman answers him here by examining evidence from the recovery in early eighties. See also Scott Sumner here explaining much of the higher unemployment as result of trend-productivity growth over the past two-and-half years.

Alex Tabarrok cites many reasons for firms being labor disgorging in recent recessions, thereby causing labor productivity to be mildly pro-cyclical than counter-cyclical. They include the structural nature of the recession, due to which many firms may not need the same workers anytime; expectations are for a long, flat U shaped recession, thereby eliminating any incentive to hoard; competitive labor markets; and severe competitive pressures on firms. He also clarifies on the issue of sticky wages,

"The problem of sticky wages is often misunderstood. The big problem is not that the wages of unemployed workers are sticky, the big problem is that the wages of employed workers are sticky. This is why stories of the unemployed being reemployed at far lower wages are entirely compatible with the macroeconomics of sticky wages."

Also coming against the ZMP hypothesis are findings that unemployment rate pretty much doubled across all groups of labor. Charlie Eisenhood has found a rough doubling across groups with different ages and education levels. Mike Konczal and Arjun Jayadev have found that under-employment (people working involuntary part-time jobs) too doubled in every occupation and in every career. All these lend ample weight to the demand-side explanations of persistent unemployment rates.

Moreover, unlike others, though the US GDP recovered back quickly the unemployment rate has remained high. In fact, the US unemployment rate is amongst the highest in the world. Paul Krugman, Christina Romer and David Leonhardt explore the possible reasons for the persistence of the high unemployment rates in the US. See also this earlier post on the labor market during the Great Recession.

Paul Krugman points to three possible reasons for the persistence of unemployment in the US. One, unlike the earlier recessions, recent ones have been caused by private-sector over-reach (through rising debt and/or asset values) and not by monetary policy actions of Fed to tame the cycle. Recoveries from these tend to be "long flat U's rather than the V-shaped recoveries of yore". And to the extent that firms know this, they have less reason to hoard labor; they’re not going to need those laid-off workers for a long time.

Second, the weakness of private-sector labor unions (unlike Europe) has eliminated a powerful obstacle to mass lay-offs. Finally, competition at the top means that businesses cannot afford to retain slack, for however small a period, and survive, especially in such uncertain times. Put together, all the three have reduced the incentive to hoard labor during uncertain times.

In any case, the final word should go to Economix,

"Solving the structural issues — such as slow-growing educational attainment — will take years. In the meantime, we could make a whole lot of progress by focusing on the cyclical problems."

Update 1 (8/3/2011)

David Leonhardt points out that while those at the higher end of the income ladder and those with four year college degrees have performed well during the Great Recession, those at the middle levels have done better than those at the bottom.

This runs contrary to the hypothesis, pioneered by David Autor, that the middle of the US job market is hollowing out. He has characterised the US job market as one "with expanding job opportunities in both high-skill, high-wage occupations and low-skill, low-wage occupations, coupled with contracting opportunities in middle-wage, middle-skill white-collar and blue-collar jobs".

Update 2 (28/7/2011)

Economix points to a new report that concludes that the great bulk of new jobs created since the economic recovery began are in lower-wage occupations, paying $13.52 or less an hour. It finds that while 60% of the jobs lost during the downturn were in midwage occupations, 73% of the jobs added since the recession ended had been in lower-wage occupations, like cashier, stocking clerk or food preparation worker.

It points to "The Good Jobs Deficit", wherein the number of jobs in midwage and high-wage occupations remains significantly below the prerecession peak, while the number of jobs in lower-wage occupations has climbed back close to its former peak. The report divides the nation’s occupations into equal thirds: lower-wage, midwage and higher-wage. It found that during the downturn, the nation lost 3.9 million jobs in midwage occupations, while losing 1.4 million in lower-wage occupations and 1.2 million in higher-wage ones.

The report said that of the net employment losses during the recession, 60 percent were in midwage occupations, while 21.3 percent were in lower-wage occupations and 18.7 percent in higher-wage ones. Since the recession ended, there had been a 1.7 million increase in the number of jobs in low-wage and midwage occupations, with low-wage jobs accounting for nearly three-quarters of that. But the number of jobs in high-wage occupations has declined by 461,994 since the recession ended (from first quarter 2010 to first quarter 2011).

Update 3 (4/6/2012)

Mike Konczal and Arjun Jayadev has this nice paper on the US labour market in the Great Recession. See also Mike's blog posts here and here.


1 comment:

KP said...

Dear Gulzar,

An extremely interesting post.

I feel that the training into higher value jobs scenario - is only a convenient explanation rather than an apt one that explains the dynamic.

A sobering implications is - a steep decline in earning as the workforce crosses the median age - 4o's as the ability to absorb new skills diminish.

We are yet to see the chinese unleash branding as a weapon in the mass market - and how a chinese take on, for instance, the ipod (with chinese characteristics!) can completely disrupt industries in the mass market .

India even with its overt western focus has pulled off some strong branding wins.

I think another interesting country to observe in terms of factor productivity - Land-Labour-Capital- is Singapore. With deep pockets singapore can buy into investment opportunities to continue its growth at the country level.

Similarly, with its carefully calibrated workforce management it keeps wages sufficiently high and in check - at the upper and lower bands.

But, to continue to maintain the same blistering pace of growth - innovation as the solution seems more like a bandwagon response.

Are a new wave of economists faced with the problem of creating a more equitable system of distribution - if for nothing else to keep economies chugging by continually keeping the demand engine primed?