Labor Markets Chris Edmond NYU Stern Spring 2007 1
Today Labor market indicators employment, unemployment, participation Labor supply and demand Cross-country comparisons of labor market outcomes Labor market dynamics 2
Labor market status US Population (296 million) Working Age Population (16+) (226 million) Not Working Age (70 million) Labor Force (149 million) Not in Labor Force (77 million) Employed (141 million) Unemployed (8 million) Source: Bureau of Labor Statistics 2005. 3
Labor market indicators unemployment rate = unemployed labor force = 8 149 = 0.05 participation rate = labor force working age population = 149 226 = 0.66 inactivity rate = not in labor force working age population = 77 226 = 0.34 4
US unemployment rate 12 percentage points 10 8 6 4 2 0 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 Source: Bureau of Labor Statistics 2005. 5
US participation rate 68 percentage points 67 66 65 64 63 62 61 60 59 58 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 Source: Bureau of Labor Statistics 2005. 6
Labor market transitions Average monthly transitions 1996-2003 Employed (122 million) Unemployed (6.2 million) Not in Labor Force (59.3 million) Source: Davis, Faberman and Haltiwanger. 7
Labor market transitions Average monthly transitions 1996-2003 0.96 Employed (122 million) 0.013 0.027 Unemployed (6.2 million) Not in Labor Force (59.3 million) Source: Davis, Faberman and Haltiwanger. 8
Labor market transitions Average monthly transitions 1996-2003 0.96 1.3% of 122 million become unemployed each month 2.7% of 122 million leave the labor force each quarter Employed (122 million) 0.013 0.027 Unemployed (6.2 million) Not in Labor Force (59.3 million) Source: Davis, Faberman and Haltiwanger. 9
Labor market transitions Average monthly transitions 1996-2003 0.96 Employed (122 million) Job-to-job transitions 0.026 0.013 0.027 0.484 Unemployed (6.2 million) 0.283 0.233 0.048 0.024 Not in Labor Force (59.3 million) 0.928 Source: Davis, Faberman and Haltiwanger. 10
First-pass theory Key simplification treat labor like any other commodity Supply and demand supply: households decide how much time to work at any prevailing wage demand: firms decide how much labor time to hire at any prevailing wage equilibrium: supply = demand Problems? 11
Demand for labor Firms demand labor Choose L to maximize profits given wage w Profits = Y wl Fixed Costs Production function Y = AF (K, L) = AK α L 1 α First order condition (1 α)ak α L α w = 0 solving for labor L = L d (w) = ( ) 1/α (1 α)a K w 12
Demand for labor Labor demand curve L = L d (w) = ( ) 1/α (1 α)a K w Intuitive properties at higher wage w, firms want to use less labor higher productivity A or capital K increase ( shift out ) labor demand curve 13
Supply of labor Households supply labor Choose L to maximize utility given wage w Cobb-Douglas utility function over consumption C and leisure 1 L u(c, L) = C θ (1 L) 1 θ, 0 < θ < 1 Budget constraint: consumption equals labor income wl + non-labor income T C = wl + T Eliminate C from utility function and take logs θ log(wl + T ) + (1 θ) log(1 L) First order condition w θ wl + T (1 θ) 1 1 L = 0 solve for labor to get L = L s (w) 14
Supply of labor Labor supply curve L = L s (w) = θ (1 θ) T w Intuitive properties at higher wage w, household wants to work more ( substitution effect ) higher non-labor income T decreases ( shifts in ) labor supply curve ( wealth effect ) 15
Equilibrium 16
Sources of unemployment Why are there unemployed workers, but no unemployed oranges? intrinsic search and matching frictions: it takes time and resources to match workers and jobs, especially at higher levels of skill and specialization extrinsic frictions, due to government policies and other social institutions Simple example minimum wage 17
Frictional labor market Minimum wage Unemployment 18
Labor market outcomes 14 Unemployment rate 12 10 8 USA 6 4 2 0 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 Source: Bureau of Labor Statistics 2004. 19
Labor market outcomes 14 Unemployment rate 12 10 8 USA FRA 6 4 2 0 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 Source: Bureau of Labor Statistics 2004. 20
Labor market outcomes 14 Unemployment rate 12 10 8 6 USA FRA UK 4 2 0 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 Source: Bureau of Labor Statistics 2004. 21
One answer labor market policies Why? employment laws (govern individual employment contracts) industrial relations laws (govern collective bargaining, organization of trade unions) social security laws (provide for disability, old age, maternity, unemployment) 22
Then why now? Problems with this explanation European labor markets were a big success 1950-1970s if labor market policies were so bad, why only problems now? 23
Problems with this explanation Then why now? European labor markets were a big success 1950-1970s if labor market policies were so bad, why only problems now? Possible resolution: turbulence more/bigger shocks in 1970s oil price shocks productivity slowdown, etc maybe flexible markets are better at responding to shocks? 24
What have we learned so far? Labor market indicators employed, unemployed, not in labor force Offsetting income and substitution effects on labor supply Unemployment is the result of frictions extrinsic: government policies, social institutions intrinsic: search and matching (more on this next class) Labor market outcomes differ widely across countries interactions of institutions and shocks 25
Rest of this class Labor market flows ( dynamics ) worker flows job flows Cyclical behavior of unemployment simple model of unemployment data on job finding and separation 26
Labor market states Average monthly transitions 1996-2003 Employed (122 million) Unemployed (6.2 million) Not in Labor Force (59.3 million) Source: Davis, Faberman and Haltiwanger. 27
Labor market flows Average monthly transitions 1996-2003 0.96 Employed (122 million) Job-to-job transitions 0.026 0.013 0.027 Unemployed (6.2 million) 0.283 0.233 0.048 Not in Labor Force (59.3 million) 0.484 0.024 0.928 Source: Davis, Faberman and Haltiwanger. 28
Changes in status by workers Labor market flows accessions: number of workers taking new jobs, whether previous status was employed, unemployed, or not in labor force separations: number of workers leaving current jobs, whether they become employed, unemployed, or not in the labor force worker reallocation: accessions + separations Similarly for firms job creation: sum of all increases in number of employees by individual establishments job destruction: sum of all decreases in number of employees by individual establishments job reallocation: creation + destruction 29
Job and worker reallocation Annual % Firms Workers Creation Destruction Reallocation Accessions Separations Reallocation Denmark 16.0 13.8 29.8 29.0 29.0 58.0 France 12.7 11.8 24.5 28.9 30.7 59.6 Germany (W) 9.0 7.5 16.5 (a) 31.6 30.4 62.0 Italy 11.0 10.3 21.3 34.5 33.6 68.1 Sweden 14.5 14.6 29.1 16.8 17.8 34.6 (b) UK 8.7 6.6 15.3 (a) 37.2 37.6 74.8 USA 13.0 10.4 23.4 45.2 46.0 91.2 Notes: (a) Large manufacturing firms (b) Manufacturing only Source: OECD Employment Outlook, 1994. 30
US manufacturing 15.00 percent per quarter job destruction 10.00 5.00 job creation 0.00-5.00-10.00 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 Source: Davis, Haltiwanger and Schuh. 31
US private sector 9.0 percent per quarter 1.5 8.5 job creation 1.0 8.0 0.5 7.5 0.0 7.0 job destruction -0.5 6.5-1.0 6.0 1993 1995 1997 1999 2001 2003 2005-1.5 Source: Bureau of Labor Statistics, 2006. 32
US private sector 1.50 percent per quarter excess job reallocation 18.00 16.00 1.00 14.00 0.50 12.00 0.00 net employment growth = job creation job destruction 10.00 8.00-0.50 6.00 4.00-1.00 2.00-1.50 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 0.00 Source: Bureau of Labor Statistics, 2006. 33
Summary Job flows job destruction: highly countercyclical (falls in booms, rises in recessions) job creation: weakly procyclical so reallocation countercyclical Worker flows much larger than job flows French data: +1 job = +3 hired 2 separations US: mobility mostly E U E Europe: mobility mostly E E ( segmented or dual labor market, pool of unemployed) 34
Unemployment dynamics Simple model Workers either employed or unemployed u + e = 1 Constant job finding rate f Constant job separation rate s Unemployment dynamics u t+1 u t = se t fu t = s(1 u t ) fu t 35
Unemployment dynamics job finding fu t s job separations s(1 u t ) u 1 u t 36
Steady state Dynamics u t+1 u t = s(1 u t ) fu t To find steady state u, set u t+1 = 0, or 0 = s(1 u) fu so u = s s + f Higher job separation rate s, higher unemployment Higher job finding rate f, lower unemployment Key question: how do policies affect f and s? 37
Response to shocks Finding and separation rates also matter for response to shocks To see this, can write (with some algebra) (u t+1 u) = λ(u t u) where λ 1 (s + f) After shock u 0, unemployment follows (u t u) = λ t (u 0 u) Return to steady state faster if λ small faster if worker reallocation s + f is high! Fluid labor markets help economy return to normal following shock 38
Implications of theory Higher separation rate s raises steady state unemployment u, but increases speed of adjustment λ Higher finding rate f is unambiguously good lowers steady state unemployment increases speed of adjustment How would you describe the US? Europe? high s? low f? mix of the two? Again, key is how labor market policies affect s and f 39
Cyclical behavior of labor markets Simple model has u t+1 u t = s(1 u t ) fu t Better model has time-varying finding and separation rates u t+1 u t = s t (1 u t ) f t u t How do finding and separation rates vary over the business cycle? 40
Job finding rate 1.200 0.120 finding rate f t unemployment rate u t 1.000 0.100 0.800 0.080 0.600 0.060 0.400 0.040 0.200 0.020 correlation at business cycle frequencies = 0.97 0.000 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 0.000 Source: Bureau of Labor Statistics, 2006. 41
Job separation rate 0.060 0.120 0.050 0.100 0.040 separation rate s t 0.080 0.030 0.060 0.020 unemployment rate u t 0.040 0.010 0.020 correlation at business cycle frequencies = 0.65 0.000 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 0.000 Source: Bureau of Labor Statistics, 2006. 42
Cyclical behavior of labor markets How do finding and separation rates vary over the business cycle? job finding rate is very procyclical, higher in booms job separation rate is not so sensitive to the cycle 43
Cyclical behavior of labor markets How do finding and separation rates vary over the business cycle? job finding rate is very procyclical, higher in booms job separation rate is not so sensitive to the cycle in booms, layoffs fall and quits rise in recessions, layoffs rise and quits fall 44
Actual and predicted unemployment 0.120 0.100 unemployment rate u t 0.080 0.060 0.040 0.020 0.000 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Source: Bureau of Labor Statistics, 2006. 45
Actual and predicted unemployment 0.120 0.100 unemployment rate u t 0.080 0.060 0.040 0.020 constant f time-varying s t 0.000 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Source: Bureau of Labor Statistics, 2006. 46
Actual and predicted unemployment 0.120 unemployment rate u t 0.100 constant s time-varying f t 0.080 0.060 0.040 0.020 constant f time-varying s t 0.000 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 Source: Bureau of Labor Statistics, 2006. 47
Cyclical behavior of labor markets Fluctuations in job finding rate f t explain 79% of unemployment fluctuations explain 95% of unemployment fluctuations since 1985 What explains fluctuations in job finding rate? 48
Summary Job flows job destruction: highly countercyclical job creation: weakly procyclical so reallocation countercyclical Worker flows much larger than job flows job finding rate very procyclical layoffs and quits move in opposite directions (separations not as cyclical) so job finding rate drives unemployment fluctuations Fluid labor market may help economy respond to shocks 49