US labor market: little sign of structural damage so far

Transcription

1 Deutsche Bank Group DB Advisors A Closer Look US labor market: little sign of structural damage so far November 2012 Joshua N. Feinman Chief Global Economist DB Advisors Tel: josh.feinman@db.com

2 A Closer Look US labor market: little sign of structural damage so far Overview After being pummeled by the Great Recession, the US labor market has had only a patchy and incomplete recovery. True, the unemployment rate has been trending down for nearly three years, but it is still well above pre-recession readings, while the share of the working-age population employed and the share participating in the labor force (i.e., employed or actively seeking employment) have both barely even begun to recover (charts 1 and 2). What s behind this enduring weakness? Some contend it s the result of structural damage to the supply of labor that will be hard to repair, even by a vigorous recovery in aggregate demand and additional monetary and fiscal stimulus. On this reckoning, changes Chart 1: Unemployment Rate wrought by the Great Recession have reduced the ability and willingness of potential workers to be matched to available jobs at economically viable wages because some have been left without the requisite skills, or ability to relocate, or incentives to find employment. As a result, the natural rate of unemployment has risen, and the fraction of the population able and willing to participate in the labor force has declined, implying there is less slack in the labor market than would be suggested by pre-recession relationships. According to this view, it will take improvements in education, the honing of appropriate skills, and changes in micro labor policies (like scaling back the expanded unemployment insurance program, and increasing job training and mobility assistance), rather than a Chart 2: Shares of the Working-age Population 11 In the Labor Force Employed Percent Percent Source: BLS Source: BLS 1

3 pickup in aggregate demand and more macro stimulus, to solve the underemployment problem. Others push back against these arguments, countering that most of the damage to the labor market is cyclical, owing to a sharp fall-off in the demand for labor that can be turned around by a stronger economic recovery and macro-policy easing. On this logic, there remain vast pools of labor willing and able to be re-employed at profitable, non-inflationary wages. Of course, these different views are not mutually exclusive. It s really a question of degree: how much of the problem is cyclical, demand-driven, and hence potentially correctable by a conventional demandside recovery, and how much is structural, supplydriven, and thus more apt to endure absent changes to labor supply. This note briefly surveys the arguments and evidence in this debate. On balance, the cyclical case seems stronger. That is, the damage appears to be more the result of the terrible shock to aggregate demand initiated by the bursting of the housing and credit bubble, and at least in principle it ought to be reversible by a more vibrant recovery in labor demand that taps into the substantial pool of idle employable capacity. This is not to deny the structural argument entirely. There is some evidence to suggest that the effective supply of labor may have been damaged, partly by an increase in skills mismatch and partly by things like the extension of unemployment benefits (though the former seems to have already reversed, and the latter will likely dissipate as the extension program is eventually phased out). As for the argument that the supply of labor would improve if people sharpened their education and skills, that s undoubtedly true, but it was true before the Great Recession too. The question is whether the labor supply problem has gotten worse since the crisis. And the answer seems to be only a little. There are some caveats, though. First, even if most of the damage has in fact been caused by a temporary, cyclical shortfall in demand, the longer it takes to correct, the greater the chances it could morph into something more permanent. One reason is that the longer people remain unemployed or detached from the labor force, the higher the risk they will eventually lose their skills and/or attachment to work in ways that are not easily reversible. In other words, if a transitory demand shock lasts long enough, it could become a more permanent supply shock (this actually strengthens the case, though, for a more aggressive macropolicy response to try to boost demand now before it s too late). The other caution is that even if demand shocks have been the prime culprit, and someday they fully heal so that whatever cyclical forces that have pushed up unemployment and lowered labor force participation completely lift the shares of the population that will be employed and/or seeking employment will not come all the way back to pre-recession readings. That s not because of some lingering structural damage caused by the crisis. It s because of longer-term labor market trends, especially demographics, which have little to do with the Great Recession. The aging of the baby boomers, for example, has already started to shift the population toward age groups that normally have lower participation and employment rates. So even if the Great Recession had never happened, and the unemployment rate were still 5% or less, the rates of employment and labor force participation would be below 2007 rates simply because the population is older. And it is slated to get older still, making it unlikely that even a fully recovered labor market, with no lingering scars from the Great Recession, will ever again see as large a share of the population employed and in the labor force as in the pre-2008 world. The structural case There are several strands to the structural, supplyside argument. One focuses on increased mismatch between the types of labor supplied by workers (or potential workers) and the types of skills demanded by employers. This mismatch 2

4 could be geographic: people may be having a tougher time moving to places where jobs are available than they did in the past because the collapse of house prices has left them unable or unwilling to sell their homes. This is often referred to as house lock, and could be one cause of greater frictions in the labor market. Another is that the demand for labor may have shifted toward occupations or industries requiring skills that a lot of unemployed people just don t have. It will take time, for example, for unemployed construction workers or idled financial-sector employees to acquire the skills needed to fill openings in, say, technology, or health care management. Another arrow in the quiver of those who push the structural case is that incentives have become less favorable to employment. In particular, some argue that work has become less valuable because the subsidies available to remaining without work have increased relative to labor compensation. The main culprit often cited here is the extension of unemployment insurance benefits, but other potential factors include increased food stamps and income supports, including health and mortgage assistance that require low income. 1 Indeed, some estimate that the extension of Chart 3: Lots of Long-term Unemployed unemployment insurance benefits alone has raised the unemployment rate ½% to 1%, and a few suggest the impact has been even greater. 2 There s no doubt that long-term unemployment remains elevated, near all-time highs (chart 3), and some contend this is at least partly due to the extension of unemployment insurance benefits and other government-induced distortions that have reduced the rewards to work. Similarly, the Social Security disability rolls have swelled (chart 4), and some argue this is because it s easier to qualify and more remunerative to be on disability than it was in the past, which has encouraged more people to drop out of the labor force entirely. 3 The bottom line, according to these lines of reasoning, is that much of the rise in unemployment and decline in labor force participation is structural, due to a decline in labor supply (or inappropriate supply for the skills that are in demand in the locations in which they are demanded). Simply put, some people have become less able and others less willing to be matched to available employment. Buttressing this argument is the apparent shift in the Beveridge curve, which relates job openings to the unemployment rate (chart 5). In general, unemployment and job vacancies tend to be inversely related: when the labor market is Chart 4: Disability Recipients Unemployed Six Months or Longer (lhs) 5.4 % of Unemployed Median Duration of Unemployment (rhs) Weeks % of Population Aged 25 to Source: BLS Source: SSA, BLS 3 1 See Mulligan, Casey (2011), The Expanding Social Safety Net, NBER Working Paper no See, for example, Aaronson, Daniel, and B. Mazumder, and S. Schechter (2010). What is Behind the Rise in Long-Term Unemployment? Federal Reserve Bank of Chicago Economic Perspectives. Farber, Henry S. and R. Valletta (2011), Extended Unemployment Insurance and Unemployment Duration in the Great Recession: The US Experience, Federal Reserve Bank of San Francisco. Rothstein, Jesse (2012), Unemployment Insurance and Job Search in the Great Recession, Brookings Papers on Economic Activity, Fall. Grubb, David (2011), Assessing the Impact of Recent Unemployment Insurance Extensions in the US, OECD Working Paper (June). 3 See Autor, David H. and Mark G. Duggan (2006), The Growth in Social Security Disability Rolls: A Fiscal Crisis Unfolding, Journal of Economic Perspectives, Volume 20, Number 3, Summer.

5 strong, there are usually a lot of openings and not much unemployment; when it s weak, there are many people searching for work and not many open positions. This negative correlation held pretty tightly between late 2000, when the current series on job openings from the Job Openings and Labor Turnover (JOLTS) survey began, and early Since the Great Recession, however, the relationship appears to have shifted; unemployment has been higher for any given rate of job openings than it was in the previous cycle. For example, the rate of job openings so far this year is similar to readings seen in early 2004, yet the unemployment rate then was only about 5 1 2%, not 8%. To some, this is indicative of an increase in structural unemployment due to deterioration in the matching efficiency of the labor market. Whatever the cause greater skills mismatch, less geographic mobility, reduced incentives to work, or all of the above the implications of the structural case are clear: since the problems are on the supply side, they cannot be remedied by stronger demand and macro policy easing. What s needed is structural reform: phasing out extended unemployment benefits, tightening the rules for the disability program, providing mobility assistance, and improving education and skills. Problems with the structural case Closer inspection reveals several weaknesses in the structural case. For starters, it just doesn t pass the smell test, at least not as the prime Chart 5: Beveridge Curve Quarterly Data Job Vacancy Rate (%) Unemployment Rate (%) Source: BLS cause of the labor market s collapse during the Great Recession. That collapse was just too stunning and abrupt; in less than two years, the unemployment rate soared more than five percentage points, and nearly nine million nonfarm payroll jobs were lost. Most structural changes in the types and locations of employment opportunities, or matching efficiency, or how people respond to changing work incentives are unlikely to occur so rapidly. Still, even if structural problems were not initially to blame, they may have grown gradually more important over time, and could explain at least some of the labor market s stunted recovery over the past few years. But if increasing skills mismatch or the changing composition of labor demand across industries, occupations, or regions were the prime culprits, we d expect to see asymmetrical signs of labor market weakness disproportionate hits in specific sectors, and among certain kinds of workers. Yet that is not what we ve seen, at least not persistently, or in ways that differ sharply from past cycles. While it s true that certain sectors were especially hard hit during the Great Recession construction, for example, accounted for nearly 20% of the rise in the unemployment rate, despite employing only about 8% of the workforce, even at the peak these are the kinds of sectors that are often the most cyclical, and they ve come back symmetrically since the recovery began, with unemployment among construction workers accounting for about 20% of the drop in the aggregate unemployment rate since late To be sure, many of those formerly-unemployed construction workers have found jobs in other industries (they must have, because construction employment continued to fall for awhile even as unemployment among former construction workers was receding). But that just further undercuts the structural argument because it suggests that there has been some inter-industry job mobility. A more systematic way to look for signs of increasing mismatch is to compare job vacancy 4 See Edward P. Lazear, and J. Spletzer (2012), The United States Labor Market: Status Quo or a New Normal? 4

6 rates with unemployment rates across many industries, occupations, and regions. An index of mismatch can be constructed that varies from zero to one: it s zero if there is no mismatch, meaning that all industries (or occupations, or regions) are in perfect alignment, with each having a vacancy/unemployment ratio equal to the aggregate ratio; it s one if there is complete mismatch, meaning that half the industries (or occupations, or regions) have no vacancies and positive unemployment, while the other half have all the vacancies and no unemployment; and it s somewhere between zero and one if there is some mismatch. 5 The index measures the share of workers that would have to be moved across industries (or occupations, or regions) to remove the mismatch and restore perfect alignment. Using data on job vacancies and unemployment across 12 major industries to construct such an index reveals that mismatch did increase sharply during the Great Recession, but has since receded back to pre-crisis levels (chart 6). Other studies have found a similar story with mismatch across occupations. 6 What about regional mismatch, due perhaps to house lock? Here, the case against is even Chart 6: Index of Job Mismatch by Industry Dec 01 Jun 02 Dec 02 Jun 03 Dec 03 Jun 04 Dec 04 Based on 12-month mov average of NSA data on job openings and unemployment across 12 major industries Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Source: BLS, DeAM estimates stronger, as mismatch between job openings and the unemployed in different parts of the country seems not to have increased at all, even in , and has come down a bit since then. 7 While people do appear to be moving less than they used to, this trend predates the Great Recession, and the continued decline in geographic mobility that has occurred in recent years has actually been greater for renters than for home owners the opposite of what we d expect if the house lock story were correct. 8 All told, there seems little evidence to suggest any permanent, structural increase in mismatch between available jobs and the unemployed across industries, occupations, or regions. As for the apparent shift in the Beveridge curve, this may not necessarily be the telltale sign of structural damage to the labor market and a higher natural rate of unemployment that some contend. Evidence from past business cycles not using JOLTS data, which were not available then, but using the help wanted index from the Conference Board as a proxy for job openings suggests that the recent counter-clockwise shift in the Beveridge curve is not unusual in recessions and early-stage recoveries, perhaps because job openings never fall below a certain threshold level, even when unemployment is high, and usually begin to pick up before firms start to hire more intensely. 9 In the past, the Beveridge curve has tended to shift back toward its original position once the recovery got stronger and unemployment retreated toward pre-recession levels. So we probably won t know for sure whether the curve has really shifted for good this time until the unemployment rate moves closer to pre-crisis levels and we see how the job vacancy rate behaves as that happens. For now, it s premature 5 5 Lazear and Spletzer, ibid. 6 Lazear and Spletzer, ibid. 7 Dickens, William T. (2011), Has the Recession Increased the NAIRU? Brookings Papers on Economic Activity (June). 8 See Farber, Henry (2012), Unemployment in the Great Recession: Did the Housing Market Crisis Prevent the Unemployed From Moving to Take Jobs? American Economic Review, 102(3), and Valetta, Robert G. (2012), House Lock and Structural Unemployment, Federal Reserve Bank of San Francisco Staff paper, for more house lock evidence, and Kaplan, Greg and S. Schulhofer- Wohl (2011) Interstate Migration Has Fallen Less than You Think, Federal Reserve Bank of Minneapolis Staff report, for more on long-term trends in geographic mobility. 9 Daly, Mary C., and B. Hobijn, A. Sahin, R. Valletta (2012). A Search and Matching Approach to Labor Markets: Is the Natural Rate of Unemployment Rising? Forthcoming, Journal of Economic Perspectives.

7 to conclude that the curve has shifted permanently, not only because apparent shifts in the past often proved temporary, but also because recently firms seem to be recruiting less intensively to fill job openings, offering lower initial wages, and requiring more qualifications so a job opening today may not be quite as solid as a job opening before the Great Recession. 10 Moreover, movements in the vacancy/unemployment ratio that have occurred in recent years have been pretty widespread across industries (chart 7); there are no industries with unusually high or low vacancy/unemployment ratios, reinforcing our earlier conclusion that structural mismatch across industries has not become a persistently greater problem than it was in the past. Even so, the labor market s ongoing struggles could still be due to supply issues, just not idiosyncratic, job-matching ones, but broad-based deteriorations in work incentives. In principle, if enhanced non-work benefits from the government have made some people less willing to accept available jobs at prevailing wages, this could shift out the Beveridge curve, drive up the natural rate of unemployment, and depress labor force participation. As already noted, the most often-cited potential problem here is the extension of unemployment benefits, and there are a wide range of estimates of the impact of this extension on the Chart 7: Vacancy/Unemployment by Industry 12-month mov Average Education and Health Services Government Transportation and Utilities Other Services Dec 01 Jun 02 Dec 02 Jun 03 Dec 03 Jun 04 Dec 04 Jun 05 Professional and Business Services Information Leisure and Hospitality Wholesale and Retail Trade Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Finance Manufacturing Construction Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Source: BLS unemployment rate. Some of the upper-end estimates, though, are based on extrapolations of past episodes in which unemployment was not as high and the labor market not as weak, so they may overstate the impact that today s extension of benefits may be having in boosting unemployment. Also, the duration of unemployment has increased even for those who are not eligible for benefits at all those who quit their jobs and those who are new to the labor force suggesting that the extension of benefits is far from the whole story. 11 Still, almost all studies find at least some modest impact a boost of 1 4% to perhaps as much as 3 4% to the unemployment rate due to the extended benefits program (though this program may also have slightly mitigated some of the downward pressure on labor force participation because to qualify for benefits one must be in the labor force). 12 But whatever the impact, it will likely be temporary, as the extended benefits program has already begun to be scaled back in some states, and will likely be phased out entirely before too long, as it always has been in past cycles. The unprecedented rise in the number of longterm unemployed is a worry not because it s a definitive sign of structural problems cyclical weakness in labor demand would also tend to create more long-term unemployed but because it could become more of a permanent condition if it takes too long to reverse. That s because the likelihood of returning to work declines as the duration of unemployment increases, perhaps because longer bouts of idleness erode skills and employment contacts, 13 so having so many people unemployed for so long raises the risk that even a vigorous rebound in labor demand might not be able to bring back all of them not to mention those who ve already become disillusioned and left the labor force entirely. Again, this is not necessarily a problem now, but it could become one in the future. How big of a problem? A recent 10 Davis, Stephen J., and R. Faberman, and J. Haltiwanger (2012). Recruiting Intensity During and After the Great Recession: National and Industry Evidence. American Economic Review Papers and Proceedings, 102 (3). 11 Kuang K. and Valletta R. (2010). Extended Unemployment and UI Benefits. Economic Letters. 12 Dickens (2011), ibid. 13 See, for example, Shimer, Robert (2008), The Probability of Finding a Job, American Economic Review, 98 (2),

8 simulation found that if the labor market strengthens enough so that those who ve been unemployed for less than six months are able to find jobs again as quickly as they did before the Great Recession, but the long-term unemployed see no improvement in their job-finding rates, the aggregate unemployment rate would fall to 6% or a bit less. 14 That s not all the way back to the sub-5% rate prevailing before 2008, but the difference is probably an upper bound on any long-term increase in structural unemployment because it assumes no improvement at all in the rate at which the long-term unemployed find jobs even if the labor market gets much stronger. This seems an overly pessimistic assumption. Still, it is a caution about the kind of structural damage that could ensue down the road if the labor market continues to struggle, and is another reason to try to kick it into higher gear soon before permanent sclerosis sets in. As for the decline in labor force participation, that s not necessarily a sign of structural, supplyside problems either; it too could be a normal, cyclical response to weaker labor demand. Yes, the disability program may have enticed some people to drop out of the labor force, but this trend began long before the Great Recession (chart 4). And some of the decline in the labor force participation rate (LFPR) reflects the Chart 8: Labor Force Participation Rate continuation of other longer-term labor market trends, especially demographics, which would have happened anyway. The aggregate LFPR declined from a peak of 66.3% in 2007 to 63.6% in Q3 2012, but about half of this decline would have occurred even if within-age-group LFPRs had remained steady simply because the population was shifting into older age groups, who normally have lower participation rates (chart 8). A similar result would have obtained if the pre-recession trends in within-age-group LFPRs (particularly, the declines among the young, due to increased schooling, roughly offset by increases among the old) had continued. The bottom line is that you can t just look at the decline in the aggregate LFPR and say it is all due to the Great Recession. Some of it would likely have occurred anyway. It s a similar story for the employmentpopulation ratio, or E/Pop (chart 9). And the demographic trends depressing these ratios are slated to continue. Indeed, the changing age distribution of the population will shave another one-half percentage point or so off the aggregate LFPR by So even if the labor market fully heals, and the unemployment rate falls back to pre-recession readings, the LFPR and E/Pop will not come all the way back not because of lingering structural damage from the Great Recession, but largely because of demographics. Chart 9: Employment/Population Ratio Actual Due to Demographics (holding within-age-group LFPRs constant) Due to Demographics and Pre-Recession Trends in Within-Age-Group LFPRs Actual Due to Demographics (holding within-age-group LFPRs constant) Due to Demographics and Pre-Recession Trends in Within-Age-Group LFPRs Percent Source: BLS, UN, DeAM estimates Source: BLS, UN, DeAM estimates 7 14 Elsby, Michael, and B. Hobijn, and A. Sahin, and R. Valletta (2011). The Labor Market in the Great Recession: An Update. Federal Reserve Bank of San Francisco Working Paper Series (October).

9 So far, the evidence we ve reviewed suggests that cyclical, demand factors have been the predominant cause of the labor market s enduring weakness persistently higher unemployment than before the Great Recession and lower participation and employment rates than can be attributed soley to demographics and pre-recession trends. But what really seals the case for the cyclical, demand-side arguments is the behavior of labor compensation. If damage to labor supply were the main problem, and labor demand were more or less intact, we d expect to see wage pressures as firms competed to attract suitable, interested workers. But we re not seeing that at all not in aggregate, not adjusted for compositional changes in the workforce, not among new hires, not even in certain regions or industries, with very few modest exceptions. 15 On the contrary, most metrics suggest real labor costs have decelerated. And anecdotes of labor shortages remain limited, scattered, and confined to a few very specific skills. Of course, this doesn t mean there s been no damage at all to labor supply, only that the hit to labor demand has been much greater. Again, we won t know for sure whether there are any permanent supply effects until after labor demand has recovered more fully. Then, we can look at wages, the unemployment rate, the vacancy rate, and LFPR and E/Pop (adjusted for demographics and pre-recession trends) to see if there is lingering, structural damage to labor supply. But so far, cyclical demand factors seem to have been dominant. Conclusion Most of the damage to the labor market has been due to the awful demand shocks precipitated by the economic and financial crisis. There is not much sign of permanent structural damage, at least not yet, though there is some risk it could emerge if demand doesn t come back soon. And we won t know for sure until it does. 15 Rothstein (2012), ibid. 8

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