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August 22, 2011

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The US Jobless Recovery: Assertive Management Meets the Double Hangover

Posted: 22 Aug 2011 12:42 AM PDT

Robert Gordon says the changing balance of power between labor and management helps to explain the jobless recovery:

The case of the US jobless recovery: Assertive management meets the double hangover, by Robert J. Gordon, Vox EU: High and persistent unemployment in the US has emerged as one of the most important macroeconomic legacies of the 2007–09 world economic crisis. While the decline of business activity in the US was no larger than in Europe, the US is an outlier in its outsized response of the unemployment rate to its decline in output (IMF 2011).

Here we quantify the shortfall of US employment—some 10.4 million missing jobs—and ask: Why did the number of jobs decline so much and why has it recovered so little? Two sets of causes stand out.

  • First, there has been a changing balance of economic power in the US between management and labour in the past two decades that has led to more aggressive firing of workers when business profits head south.
  • Second, the large negative output gap (actual real GDP below trend or potential) is not shrinking, due to the "double hangover" persisting in the aftermath of the housing bubble.

By explaining why the recovery of aggregate demand has been so weak, we provide an understanding of the refusal of the large negative output gap to shrink—a refusal shared by its twin, the employment gap.

Dimensions of the job shortfall: 10.4 million missing jobs in the recovery

Part of the job shortfall is reflected in the rise of measured unemployment. The rest comes from a decline in labour-force participation. The employment-population ratio (E/P in the figures) measure combines the two.1 As shown in Figure 1, the ratio (as shown by the green line) was 64.3% at the NBER business cycle peak in 2001:Q1. By the next peak (2007:Q4) it had fallen to 62.8% (blue line).

  • This descent from 64.3% to 62.8% led numerous commentators to lament that the 2001-07 US economic recovery was not a complete recovery. Indeed, the seemingly 'minor' 1.5% drop in the ratio represents more than 3.6 million "missing" jobs—even before the recent recession.
  • In mid-2011, the ratio (wavering red line) is only 58.1%—far below 2001 and 2007 levels.

How many jobs are lacking? Figure 2 shows that the shortfall amounts to 10.4 million missing jobs compared to the 2007 version of normality and a much higher 14.1 million missing jobs compared to the 2001 definition. In the rest of this analysis, we take the less ambitious 2007 value for the ratio of 62.8% as the relevant benchmark.

Figure 1. Actual vs. two criteria of normal employment per capita (2000 Q1—2011 Q2)

Figure 2. Actual vs hypothetical employment, 2000 Q1—2011 Q2

What caused the destruction of 10.4 million jobs?

The first explanation is the change in managerial power. For decades I have been tracking the responsiveness of labour market variables to the output gap (see most recently Gordon 2003 and 2010).

  • Before the mid-80s a 1% change in the output gap would generate roughly a response of 0.45% in the similarly-defined gap of the Employment-Population ratio.
  • The rest of the 1% shortfall of real GDP would show up in declining productivity and in hours per employee.

The observed ratios in the data for 1954–86 are roughly consistent with the predictions made by Arthur Okun (1962) in what soon became christened as 'Okun's Law'.

After the mid-1980s, however, these responses changed in a process I have described as the "Demise of Okun's Law". The response of the ratio jumped from 0.45 in the 1954–86 interval to 0.78 in an otherwise identical regression equation applied to 1986–2011. This means that when output slumps, employment drops much more than it would have done previously.

The disposable worker hypothesis

When the economy begins to sink—like the Titanic after the iceberg struck—firms begin to cut costs any way they can; tossing employees overboard is the most direct way. For every worker tossed overboard in a sinking economy prior to 1986, about 1.5 are now tossed overboard. Why are firms so much more aggressive in cutting employment costs? My "disposable worker hypothesis" (Gordon 2010) attributes this shift of behaviour to a complementary set of factors that amounts to "workers are weak and management is strong." The weakened bargaining position of workers is explained by the same set of four factors that underlie higher inequality among the bottom 90% of the American income distribution since the 1970s—weaker unions, a lower real minimum wage, competition from imports, and competition from low-skilled immigrants.

But the rise of inequality has also boosted the income share of the top 1% relative to the rest of the top 10%. In the 1990s corporate management values shifted toward more emphasis on shareholder value and executive compensation, with less importance placed on the welfare of workers, and a key driver of this change in attitudes was the sharply higher role of stock options in executive compensation. When stock market values plunged by 50% in 2000–02, corporate managers, seeing their compensation collapse with profits and the stock market, turned with all guns blazing to every type of costs, laying off employees in unprecedented numbers. This hypothesis was validated by Steven Oliner et al (2007), who showed using cross-sectional data that industries experiencing the steepest declines in profits in 2000–02 had the largest declines in employment and largest increases in productivity.

Why was employment cut by so much in 2008–09? Again, as in 2000–02, profits collapsed and the stock market fell by half. Beyond that was the psychological trauma of the crisis; fear was evident in risk spreads on junk bonds, and the market for many types of securities dried up. Firms naturally feared for their own survival and tossed many workers overboard.

Three million missing jobs due to altered management response to recession

Figure 3 provides the results of a simple experiment regarding the loss of jobs.

  • Labour-market responses to business-cycle shortfalls were quite different when estimated with regressions over the 1954–1986 ("early") and 1986–2011 ("late") sample periods.
  • Responses of employment and other labour market variables were much larger in the "late" period (as predicted by the disposable worker hypothesis).

Given the decline in the output gap, simulated employment fell short by 9.82 million with the "late" dynamic adjustment behaviour, quite close to the 10.39 million actual shortfall. Yet with the "early" coefficients employment fell by a substantial but significantly smaller total of 6.72 million.

Figure 3. Actual vs hypothetical and dynamic simulation employment 2007 Q4—2011 Q2

Thus labour's weakened bargaining situation with changes in management behaviour toward greater emphasis on cost-cutting in recessions accounts for roughly 3 million lost jobs in the current jobless recovery. The other 6.72 million would have been lost even with the earlier responses because the output gap was so large.

Why is aggregate demand so weak? The double hangover explanation

This explains the outsized job cuts that came in response to the recession. But we are still left with the question of explaining why the output gap is still so negative 2 years after the NBER business-cycle trough (June 2009).

America's double hangover goes back to the consumption binge that accompanied the 2000–06 housing bubble.

  • The residential construction industry was building houses at a pace much higher than the underlying rate of household formation.
  • Housing demand was boosted by speculators who bought new condominiums hoping to "flip" them for easy profits and by mortgage brokers who were out combing the weeds for low-income families to whom they could peddle dangerous adjustable-rate interest-only mortgages.
  • Consumption of all types, particularly of durable goods like autos and appliances and services like nail salons and child tutoring, grew faster than income, implying an ever-declining personal saving rate.

Households could use not only their own income to buy consumer goods and services but could finance expenditures in excess of income through second mortgages and refinancing that allowed them to drain cash from their appreciating residences.

Once the bubble burst and house prices began to tumble, the double hangover began.

  • The first hangover was the excess supply of housing.

This led to a glut of unsold houses and condos that put continuous downward pressure on home prices. Foreclosures added to the glut; each foreclosure raises the supply of vacant housing units by one unit while increasing the demand for housing units by zero, because the foreclosed family has by definition defaulted on its mortgage and cannot obtain credit for several years into the future. Many homeowners avoided foreclosure but were "underwater," with houses now worth less than the face value of the mortgage and thus faced the hapless choice of draining resources to pay the mortgages or defaulting, with the consequence of a ruined credit rating.

  • The second hangover was the impact of excessive indebtedness.

Just as consumption could exceed income as debts were being run up, so the second hangover required consumption to be below income while debts were paid off. The ratio of total household indebtedness to personal disposable income rose from 90% in 1995 to 133% in 2007 and has since fallen just to 120%. Year after year of saving and underconsumption will continue as households continue to pay off debts.

Just as hangovers have negative impacts on family members and job performance, so the double hangover of the slump in residential housing investment and in personal consumption expenditures has spilled over to other components of GDP. Nonresidential investment was hit as firms supplying consumers and home builders reduced their need for new computers, machinery, factories, office buildings, and hotels. State and local governments, by law required to balance their current budgets, began to lay off school teachers and other employees.

Translating lost spending into lost jobs

Table 1 lists the major components of spending and the subcomponents and displays the percentage shortfalls in output. Then we use the shares of each subcomponent in the total output shortfall to calculate the jobs shortfall for each subcomponent. Notice that this method treats all components of spending as equally labour-intensive, an acceptable approximation for this exercise.

  • The shortfall of consumer-services spending is the largest subcomponent; it translates into 3.59 million missing jobs.2
  • Next come the 2.17 million lost jobs in residential construction (on top of those lost between 2006:Q1 and 2007:Q4),
  • The 1.76 million in nonresidential structures,
  • 1.65 million in consumer durables,
  • 1.47 million in state and local government, and
  • 1.38 million in equipment and software.
The overall simulated job shortage would have been 11.88 million but for the helpful performance of net exports. Its positive contribution brings the figure to a smaller but still unfortunate 10.39 million.

Table 1. Contribution of GDP components to output gap and employment shortfall 2011:Q2

Vox-gordon

Conclusion

A change in labour market dynamics accounts for about 3 million of the over 10 million missing jobs in mid-2011. This shift can be traced to weakness of labour and growing assertiveness of management. But even with the labour-market institutions of 1955 through 1985, the weakness of aggregate demand in the recession and recovery would have cost roughly 7 million jobs instead of the 10 million jobs that are actually missing compared to normal economic conditions such as occurred in 2007.

The recession itself is usually and correctly traced to the collapse of the housing bubble and the post-Lehman financial panic. But the recovery has been unusually weak, completely unlike the economy's rapid bounce-back in 1983–84, and this requires an explanation as well. The best place to start is the double-hangover approach, which explains not just the collapse of residential structures investment but also the continued and growing weakness in consumer spending. Perhaps the most surprising result of this essay is that the spending component responsible for the largest share of the missing jobs is not residential investment but consumer spending on services.

This is not the place to talk about remedies.

  • The spending decomposition shows that fiscal policy has failed in that the government spending sector has made the output gap shortfall worse, not better.
  • The double-hangover theory helps to explain why monetary policy is impotent, no matter how much quantitative easing is attempted.

Authors including Hall (2011) focus on the zero lower bound as the crux of the Fed's problem and ignore the complementary problem of low interest-insensitivity of consumers who are trying to pay off old debt instead of taking on new debt.

The failure of consumer and investment spending (IS) to respond to an ever-lower 10-year government bond rate, which fell below 2.3% this past week, demonstrates that the problem is an IS curve that is very steep if not vertical at an output level far below that necessary to generate a normal level of employment. The vertical IS curve is just as relevant for understanding today's economy as that of the 1930s, and it plays an essential role in the twelfth edition of my macro textbook (2012) in explaining why monetary policy may at times be impotent, just as it did in the first edition more than three decades ago.

References

Estev√£o, Marcello and Evridiki Tsounta (2011), 'Has the Great Recession Raised US Structural Unemployment?', IMF Working Paper, WP/11/105, May.

Gordon, Robert J (2003), 'Exploding Productivity Growth: Context, Causes, and Implications', Brookings Papers on Economic Activity. 2:207-279.

Gordon, Robert J (2010), 'Okun's Law and Productivity Innovations', American Economic Review Papers and Proceedings,100(2):11-15.

Gordon, Robert J (2012), Macroeconomics, 12th edition. Pearson/Addison-Wesley.

Hall, Robert E (2011), 'The Long Slump', American Economic Review,101(2):431-469.

Okun, Arthur M (1962), 'The Gap between Actual and Potential Output', Proceedings of the American Statistical Association, in Edmund S Phelps (ed.), Problems of the Modern Economy. Norton, 1965.

Oliner, Stephen D, Daniel E Sichel, and Kevin J Stiroh (2007), 'Explaining a Productive Decade', Brookings Papers on Economic Activity, 1:81-137.

Footnotes

1 This is defined as the employment rate (ratio of employment to the labour force) times the labour-force participation rate.

2 Compared to the jobs that would be available if the economy were operating at potential real GDP as in 2007:Q4

TANF at 15: A Weak Safety Net Getting Weaker

Posted: 22 Aug 2011 12:33 AM PDT

Today is the anniversary of welfare reform:

TANF at 15: A Weak Safety Net Getting Weaker, CBPP: Monday will mark the 15th anniversary of the Temporary Assistance for Needy Families (TANF) block grant (i.e., "welfare reform").  Here are some highlights of TANF as we know it today.
TANF's role in providing income support to poor families has declined dramatically

Most of the employment gains realized in the early years of TANF have disappeared

TANF has failed to provide an adequate safety net to needy families during this long and difficult recession

Krugman: Stop Worrying and Learn to Love Inflation

Posted: 22 Aug 2011 12:24 AM PDT

Paul Krugman is taking a break from his column today (Arrrr!), so here's a summer rerun. Can you guess when he wrote this?:

Stop worrying and learn to love inflation, by Paul Krugman: ...depression economics - the kinds of problems that characterized much of the world economy in the 1930s but have not been seen since - has staged a stunning comeback.
Five years ago hardly anybody thought that modern nations would be forced to endure bone-crushing recessions for fear of currency speculators; that a major advanced country could be persistently unable to generate enough spending to keep its workers employed; that even the Federal Reserve would worry about its ability to counter a financial market panic. The world economy has turned out to be a much more dangerous place than we imagined. For the first time in two generations, failures on the demand side of the economy - insufficient private spending to make use of the available productive capacity - have become the clear and present limitation on prosperity for much of the world.
Economists and policymakers weren't ready for this. The specific set of silly ideas known as 'supply-side economics' is a crank doctrine, which would have little influence if it did not appeal to the prejudices of wealthy men; but over the past few decades there has been a steady drift in thinking away from the demand side to the supply side of the economy. The truth is that good old -fashioned demand-side macroeconomics has a lot to offer in our current predicament - but its defenders lack all conviction.
Paradoxically, if the theoretical weaknesses of demand-side economics are one reason we were unready for the return of depression-type issues, its practical successes are another. Central banks have repeatedly managed demand - cutting rates to keep spending high - so effectively that a prolonged slump due to insufficient demand became inconceivable. Except in the very short run, then, the only limitation on economic performance was an economy's ability to produce - that is, the supply-side. ...
The question of how to keep demand adequate to make use of the capacity has become crucial. Depression economics is back. ... The free-market faithful tend to think of Keynesian policies - deliberate efforts by governments to stimulate demand - as the enemy of what they stand for. But they are wrong. For in a world where there is often not enough demand to go around, the case for free markets is a hard case to make. ...
The right perspective is to realize how very much good free markets and globalization have done; the point is to preserve those gains. One cannot defend globalization merely by repeating free-market mantras as economy after economy crashes. If we want to see more nations making the transition from abject poverty to the hope of a decent life, we had better find answers to the problems of depression economics. ...
I don't like the idea that countries will need to interfere in markets - to limit the free market in order to save it. But it is hard to see how anyone who has been paying attention can still insist that nothing of the kind needs to be done, that financial markets will always reward virtue and punish only vice.
One of the most important obstacles to sensible action, however, is prejudice -by which I mean the adherence of too many influential people to orthodox views that are no longer relevant to our changed world. ...
This brings us to the deepest sense in which depression economics has returned. The quintessential economic sentence is supposed to be 'There is no free lunch'; it says that there are limited resources; to have more of one thing you must accept less of another. Depression economics, however, is the study of situations where there is a free lunch, if we can figure out how to get our hands on it, because there are unemployed resources that could be put to work.
In 1930, John Maynard Keynes wrote that 'we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand'. The true scarcity in his world - and ours - was therefore not of resources, or even virtue, but understanding.
Originally published, 6.20.99

Then, as now, he points to inflation as the answer to a liquidity trap:

So what should we be doing differently? ... Japan, having fallen in its liquidity trap - unable to recover by means of conventional monetary policy, because even a zero interest rate is not low enough - and having exhausted its ability to spend its way out with budget deficits, must now radically expand its money supply. It must convince savers and investors that its current deflation will turn into sustained, though modest, inflation. Once the Japanese make up their mind to do this, the results will startle them. ... There is no economic evidence suggesting that inflation at the ... 4 per cent rate I believe Japan should target, does any noticeable harm; and the things advanced countries need to do to counter depression economics do not involve any compromise of the commitment to free markets. ...

links for 2011-08-21

Posted: 21 Aug 2011 10:01 PM PDT

"Less Educated Americans Turning Their Backs on Religion"

Posted: 21 Aug 2011 09:45 AM PDT

This is not what I would have predicted:

Less educated Americans turning their backs on religion, EurekAlert: While religious service attendance has decreased for all white Americans since the early 1970s, the rate of decline has been more than twice as high for those without college degrees compared to those who graduated from college...
"Our study suggests that the less educated are dropping out of the American religious sector, similarly to the way in which they have dropped out of the American labor market," said lead researcher W. Bradford Wilcox, a professor of sociology at the University of Virginia.
The study focuses on whites because black and Latino religiosity is less divided by education and income. Most whites who report a religious affiliation are Catholics, evangelical Protestants, mainline Protestants, Mormons, or Jews. ...
In the 1970s, among those aged 25-44, 51 percent of college-educated whites attended religious services monthly or more, compared to 50 percent of moderately educated whites, and 38 percent of the least educated whites. In the 2000s, among those aged 25-44, 46 percent of college-educated whites attended monthly or more, compared to 37 percent of moderately educated whites, and 23 percent of the least educated whites.
Wilcox views this disengagement among the less educated as troubling because religious institutions typically provide their members with benefits—such as improved physical and psychological health, social networks, and civic skills—that may be particularly important for the less educated, who often lack the degree of access to social networks and civic skills that the college-educated have.
"Today, the market and the state provide less financial security to the less educated than they once did, and this is particularly true for the moderately educated—those who have high school degrees, but didn't graduate from a 4-year college," Wilcox said. "Religious congregations may be one of the few institutional sectors less educated Americans can turn to for social, economic, and emotional support in the face of today's tough times, yet it appears that increasingly few of them are choosing to do so." ...
Indeed, the study points out that modern religious institutions tend to promote a family-centered morality that valorizes marriage and parenthood, and they embrace traditional middle-class virtues such as self-control, delayed gratification, and a focus on education.
Over the past 40 years, however, the moderately educated have become less likely to hold familistic beliefs and less likely to get and stay married, compared to college-educated adults. During the same period, wages have fallen and rates of unemployment have risen markedly for moderately educated men, while wages have remained stagnant for moderately educated women. For the least educated—those without high school degrees—the economic situation has been even worse, and they have also become less likely to hold familistic beliefs and less likely to get and stay married, compared to college-educated adults.
Because less educated whites are now less likely to be stably employed, to earn a decent income, to be married with children, and to hold familistic views, it makes sense that they also do not as often attend services at religious institutions that continue to uphold conventional norms, Wilcox said. ...

There's more to this, I think, it says something about how virtues are increasingly being assigned and emphasized in a way that allows people to blame others for their misfortune -- they don't have the "traditional middle-class virtues" like us, if they did they'd be fine -- but I can't quite put my finger on it.

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