Last week, the US Bureau of Labor Statistics released the August – Employment Situation – which provides some guide as to the health of the US labour market. The degree to which the guide is very clear is another question altogether. Total non-farm employment rose by only 173,000 and the unemployment rate fell to 5.1 per cent, which on the face of it sounds like a positive development. However, the employment growth was well below the expectation (although the banking economists are rarely close) and deeper analysis shows that the sectors that lead the cycle up and down and therefore provide a signal for the future movement of other sectors, have slowed quite significantly and are growing at 2012 levels when the US was still mired in the GFC downturn. I had a brief look at the gross flows data from the US this morning and the fall in unemployment is being driven by larger outflows from unemployment into employment while flows out of employment into unemployment are much smaller. There are other uncertainties relating to hours of work are growing faster than employment in persons, indicating that firms are now bringing their hoarded labour back into more intensive use. In this blog, I report on what is happening with the hiring and firing rates in the US to broaden our understanding of how things stand at present. The conclusion certainly doesn’t add any weight to the claim that the US Federal Reserve Bank should raise interest rates.
The first graph shows the index of aggregate weekly hours worked by all employees from March 2006 to August 2015 (red line) and total civilian employment (blue line). The data is from the BLS. Both series are indexed to 100 at March 2007.
Prior to the crisis, the two series moved more in line with each other as average weekly working hours remained fairly steady.
When the GFC hit, firms adjusted by sacking workers but also reducing hours available, the latter effect being greater because firms hoard skilled labour given the hiring and firing costs are high. The last thing a firm wants to get is a reputation for being capricious when it comes to expensive labour. Such a firm will find it hard attracting skilled labour in the upturn.
As the recovery ensued, both employment in persons and total weekly hours worked rose, the latter more quickly as the hoarded labour was put back onto longer time. That process does not seem to have exhausted itself yet and, in part, explains the relatively slow employment (in persons) growth rate.
How does this fit in with the hiring and firing data available from the – US JOLTS database – supplied by the BLS.
The JOLTS data allows us to explore the evidence-base fto distinguish whethor it is ‘supply-side’ movements that are driving the shift in unemployment (that is, actions by workers) or whethor ‘demand-side’ factors are more influential.
In general, the JOLTS database usually always shows that it is the number of jobs on offer and the growth of employment that is the dominant force, which means that independent supply-side shifts (workers agree
For their to be employment there must be spending in the economy and mass unemployment is a sign of deficient spending.
Firms create employment in response to demand for their products. They might be confronted by millions of hungry unemployed workers but they still won’t put them on because there is insufficient demand to justify expanding production.
To start the discussion, it is useful to look at the US version of the Unemployment to Vacancies curve (where vacancies are the Total Non-Farm Job Openings as a percent of the Labour Force).
The following graph shows two periods – the first, December 2000 to December 2007, and the second, January 2008 to June 2015. The two periods combined cover the entire span of the JOLTS data. The segments are pre-crisis and post-crisis (where December 2007 was the peak of the last cycle).
Refer to the blog – Latest Australian vacancy data – its all down to deficient demand – for a conceptual discussion about how to interpret this framework in terms of movements along curves and shifts in relationships.
Basically, the UV (or Beveridge) curve shows the unemployment-vacancy (UV) relationship, which plots the unemployment rate on the horizontal axis and the vacancy rate on the vertical axis to investigate these sorts of questions.
The Beveridge curve is named after the British economist William Beveridge who was influential in defining the full employment agenda in the Post World War 2 period in the UK (and, arguably in most advanced nations).
The logic is that movements along the curve are cyclical events and shifts in the curve are alleged to be structural events.
So a movement ‘down along the curve’ to the south-east suggests a decline in the number of jobs available due to an aggregate demand failure, while a movement ‘up along the curve’ indicates improved aggregate demand and lower unemployment.
If unemployment rises in an economy where there are movements along the UV curve it is referred to as “Keynesian” or “cyclical” unemployment – that is, arising from a deficiency in aggregate demand.
The mainstream economics literature claims that ‘shifts in the curve’ – out (in) – indicate non-cyclical (structural) factors are causing the rising (falling) unemployment. Allegedly, the UV curve shifts out because the labour market was becoming less efficient in matching labour supply and labour demand and vice versa for shifts inwards.
The factors that allegedly ’cause’ increasing inefficiency are the usual neo-liberal targets – the provision of income assistance to the unemployed (dole); other welfare payments, trade unions, minimum wages, changing preferences of the workers (poor attitudes to work, laziness, preference for leisure, etc).
The problem is that this view is at odds with the evidence.
As is the case in most advanced countries, the shift in the US curve occurred during a major demand-side recession – that is, it has been driven by cyclical downturns (macroeconomic events) rather than any autonomous supply-side shifts.
Once the economy resumed growth the unemployment rate fell more or less in line with the new job openings rate – tracing the green line up to the north-west of the graph.
We can also look at the behaviour of the quit rate to judge whether the decline in the unemployment rate is being mostly driven by demand-side or supply-side forces.
Remember that the mainstream text book economics view is that the supply-side dominates as workers exert their free choices between labour and leisure.
The supply-side story starts with the textbook model of the labour market which claims that employment and the real wage are determined in the labour market at the intersection of the labour demand and the labour supply functions.
The equilibrium employment level is constructed as full employment because it suggests that every firm who wants to employ at that real wage can find workers who are willing to work and every worker who is willing to work at that real wage can find an employer willing to employ them.
Frictional unemployment is easily derived from this Classical labour market representation, as is voluntary unemployment.
Holding technology constant, all changes in employment (and hence unemployment) are driven by labour supply shifts. There have been many articles written by key mainstream economists (such as Milton Friedman) that argue that economic cycles are driven by labour supply shifts.
The essence of all these supply shift stories is that the quit rate are constructed as being countercyclical – that is, rise when the economy is in decline and vice-versa – despite all evidence to the contrary.
Quits “are voluntary separations, and measure workers’ willingness or ability to leave the job” (Source)
One such text book story is that the economic cycle swings are characterised by swings in voluntary unemployment. So a downturn in employment (and a rise in unemployment) arises – allegedly – because workers develop a renewed preference for more leisure and less work and the supply of labour at each real wage level thus moves inwards (that is, workers are now less willing to supply the same hours of labour as before at the going real wage).
So they quit their jobs and head to the beach and relax.
The provision of unemployment benefits – so the story goes – increases the attractiveness of leisure. It is seen as a direct subsidy of non-work.
Upturns in economic activity – so the story goes – is characterised by workers developing a new thirst for work and so the supply curve shifts out again – that is, they are willing to supply more hours of work than before at the same real wage levels. Apparently, they get sick of leisure and gain a new appetite for income so as to buy goods and services unattainable while they spent their time in non-work.
And at the empirical level this theory predicts that quits will fall as employment falls.
The simplest fact then, which would give support to this notion of supply-side shifts, is whether the quit rate is, indeed, counter-cyclical – as the theory predicts. That is, does the quit rate rise when the unemployment rate rises or not. Simple enough.
Lester Thurow in his marvellous book from 1983 – Dangerous Currents – challenged the mainstream view by asking:
… why do quits rise in booms and fall in recessions? If recessions are due to informational mistakes, quits should rise in recessions and fall in booms, just the reverse of what happens in the real world.
The reference to “informational mistakes” is another version of the mainstream supply-side story. The narrative goes that the central bank/treasury can temporarily buy a reduction in unemployment (below what the neo-liberals refer to as the natural rate – another myth) – by inflating the economy with spending.
As economic activity picks up both money wages and prices rise (typical story about too much money chasing too few goods). The trick is that they claim that the rate of increase in money wages is less than the rise in prices and so the real wage falls.
Firms react to the declining real wage by offering more employment – because they know that marginal labour productivity is lower (another myth).
But why do workers agree to supply more labour when the real wage is falling? After all the textbook labour market model tells us that the labour supply curve is upward sloping in terms of the real wage because workers will only supply more labour if the relative price of leisure (which is the real wage) rises.
The trick is that the entire supply of labour shifts because workers think that the real wage has risen – they get beguiled by the rise in money wages into forming the view that they are better off per hour than before and so the quit rate falls and employment increases.
Hence, for a time (a short time), the economy can operate at unemployment levels lower than the natural rate.
How long can this go on for? Well, how long does it take for workers to go down to the shops and realise that everything is more expensive now and, in fact, they are worse off than before (because the real wage has fallen)?
Accordingly, once they learn the truth, the labour supply curve shifts back in and workers withdraw their labour en masse (the quit rate rises again) and employment and economic activity falls back to the “natural” level.
The lesson that is hammered home to students that this all demonstrates how futile policy interventions that aim to lower the unemployment rate are. The only way the “natural” rate can be lowered (if at all) is for policies to be designed with reduce structural impediments in the labour market. What are they? For example, cut the subsidy to leisure (the unemployment benefit). etc.
The US Bureau of Labour Market JOLTS database includes estimates of the quit rate. The following graph shows in a compelling way that the quit rate (non-farm quits as a percent of total non-farm employment) behaves in a cyclical fashion as we would expect – that is, it rises when times are good and falls when times are bad.
The graph relates the quit rate (vertical axis) to the unemployment rate (horizontal axis). The straight black line is a simple linear regression trend drawn through the graph.
There are no shifts evident in this relationship just movements along a fairly defined inverse relationship.
That is, when the unemployment rate rises, the quit rate falls. Exactly the opposite to that predicted by the supply-side story which means that their claim that causality runs from unemployment benefits to higher quits to higher unemployment is unsustainable.
Many studies have demonstrated the phenomenon depicted in the last graph – for several countries where decent data is available.
Workers become very cautious when unemployment starts to rise and postpone any desired or planned job changes and opt for the security of their present job.
When there are more jobs being created and the hiring rate rises, workers then take more risks and the quit rate tends to rise.
This also helps us understand why the unemployment-job vacancies graph (above) shifted upwards during the recession and then stabilised as the economy grew again. Remember, that firms were adjusting hours more
The BLS Monthly Labor Review article (June 15, 2015) – Job openings reach a new high, hires and quits also increase – notes that:
Quits are procyclical, rising during an expansion and falling during a contraction … As of 2014, quits had not reached prerecession values in most industries. While some industries recovered fully to surpass 2007 values, overall, the annual quits level was 88 percent of its 2007 level.
By June 2015, the quit rate of 1.9 is still around 87 per cent of the pre-crisis peak of 2.3, which suggests that the improvement in the first half of this year has been minimal.
The US labour market is steadying rather than recovering fast.
The following graph shows the total number of unemployed per job opening (non-farm and seasonally adjusted) and thus gives a measure of how strong the demand-side of the labour market (job openings) is relative to the number of people seeking work (the unemployed).
It is an alternative way of presenting the relationships between unemployment and vacancies.
The shaded area indicates the NBER recession months.
The US Bureau of Labor Statistics (in the article cited) described the data at that point in this way:
The job openings and unemployment levels generally move in opposite directions. During a robust economy, job openings are high and unemployment is low. During an economic contraction, the dynamics reverse — unemployment rises, while job openings fall. Accordingly, the ratio of the unemployed to job openings provides a metric that helps describe the state of the economy … Since July 2009, 1 month after the end of the recession, this ratio has trended downward. In January 2014, the ratio stood at 2.6. By December 2014, it had fallen to 1.8, the same ratio present in December 2007, the start of the recession.
In June 2015, the ratio stood at 1.6 and the rate of decline has slowed a little and it remains slightly above the pre-crisis level.
Labour markets typically behave over the business cycle in an asymmetric manner as can be seen from the graph. The deterioration was sharp and rapid. The recovery is much slower and is all the more slow as the employment growth not only has to absorb new labour force entrants (arising from population growth) but also has to face the huge pool of unemployed that is caused by the recession.
One of the facts I repeat often is that the unemployed cannot search for jobs that are not there! This is exactly what happens when aggregate demand falls and job openings dry up.
Another way of seeing how the job flows tell us about the direction of change is to compare movements in hires and separations. The following graph shows this relationship for the US economy as published by the BLS for the period from December 2000 to June 2015.
While labour markets are clearly dynamic in the sense that even in a downturn new jobs are being continually created and destroyed the rates of each dynamic change in a cyclical way. So while there were new jobs being created at the height of the downturn there was a severe shortfall of new jobs emerging as is shown in the graph.
Separations also fall for reasons noted above. The difference between hires and separations is the net change in employment in each month. If hires outstrip separations, employment grows and vice versa.
The most recent data shows that while hiring and separations are showing that the recovery continues the improvement is modest. The net change in employment per month appears to be slowing in 2015 when compared to 2014, when employment growth was more robust.
Further, the layoff and discharges rate also published in the BLS JOLTS database which reflects the demand-side of the labour market is also firmly counter-cyclical as we would expect. Firms layoff workers when there is deficient aggregate demand and hire again when sales pick-up.
Again this is contrary to the mainstream text book logic.
The last graph shows job openings and unemployment from December 2000 to June 2015 (in 000s). Total unemployment (green line) is on the right-axis while total non-farm job openings (blue line) are on the left-axis.
As the economy faltered, job openings collapsed and unemployment rose but not as much as would be predicted by the employment losses.
Why? Answer: Some workers gave up looking and left the labour force. As the job openings increased again in recent months, unemployment has been steady because the discouraged workers are now re-entering the labour force again.
This is accounted for by the significant fall in the US participation rate.
All the evidence supports the conclusion that deficient demand not only increases unemployment in the downturn but also pushes people out of the labour force as they give up actively looking for work that is not there. These hidden unemployed workers re-enter the labour force as the probability of getting a job (in their mind) increases.
The JOLTS data is very useful because it addresses some of the most simple claims made by the mainstream approach to unemployment. And the evidence is clear. There is no validity in the supply-side case that mass unemployment is somehow something to do with the unemployed being lured into leisure by excessive unemployment benefits or some other reason.
The evidence is consistent and strong – the mass unemployment in the US is the result of a systemic failure in that economy to produce enough jobs, which emerged as aggregate demand collapsed in early 2008.
Since then, as the economy has slowly starting growing again, the demand-side of the labour market has improved steadily and the unemployment rate has fallen.
The pace of improvement appears to be slowing.
There is also a debate about how far the US unemployment rate can fall – I will return to that question another day.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.