7.4 Labor-Market Experience: The United States

So far we have developed the theory behind the natural rate of unemployment. We began by showing that the economy’s steady-state unemployment rate depends on the rates of job separation and job finding. Then we discussed two reasons that job finding is not instantaneous: the process of job search (which leads to frictional unemployment) and wage rigidity (which leads to structural unemployment). Wage rigidity, in turn, arises from minimum-wage laws, unionization, and efficiency wages.

With these theories as background, we now examine some additional facts about unemployment, focusing at first on the case of American labor markets. These facts will help us to evaluate our theories and assess public policies aimed at reducing unemployment.

The Duration of Unemployment

When a person becomes unemployed, is the spell of unemployment likely to be short or long? The answer to this question is important because it indicates the reasons for the unemployment and what policy response is appropriate. On the one hand, if most unemployment is short-term, one might argue that it is frictional and perhaps unavoidable. Unemployed workers may need some time to search for the job that is best suited to their skills and tastes. On the other hand, long-term unemployment cannot easily be attributed to the time it takes to match jobs and workers: we would not expect this matching process to take many months. Long-term unemployment is more likely to be structural unemployment, representing a mismatch between the number of jobs available and the number of people who want to work. Thus, data on the duration of unemployment can affect our view about the reasons for unemployment.

The answer to our question turns out to be subtle. The data show that many spells of unemployment are short but that most weeks of unemployment are attributable to the long-term unemployed. For example, during the period from 1990 to 2006, 38 percent of unemployed people were unemployed for less than 4 weeks, while only 31 percent were unemployed for more than 15 weeks. However, 71 percent of the total amount of time spent unemployed was experienced by those who were unemployed for more than 15 weeks, while only 7 percent of the time spent unemployed was experienced by people who were unemployed for less than 4 weeks.

To see how these facts can all be true, consider an extreme but simple example. Suppose that 10 people are unemployed for part of a given year. Of these 10 people, 8 are unemployed for 1 month and 2 are unemployed for 12 months, totaling 32 months of unemployment. In this example, most spells of unemployment are short: 8 of the 10 unemployment spells, or 80 percent, end in 1 month. Yet most months of unemployment are attributable to the long-term unemployed: 24 of the 32 months of unemployment, or 75 percent, are experienced by the 2 workers who are each unemployed for 12 months. Depending on whether we look at spells of unemployment or months of unemployment, most unemployment can appear to be either short-term or long-term.

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This evidence on the duration of unemployment has an important implication for public policy. If the goal is to substantially lower the natural rate of unemployment, policies must aim at the long-term unemployed, because these individuals account for a large amount of unemployment. Yet policies must be carefully targeted, because the long-term unemployed constitute a small minority of those who become unemployed. Most people who become unemployed find work within a short time.

CASE STUDY

The Increase in U.S. Long-Term Unemployment and the Debate Over Unemployment Insurance

In 2008 and 2009, as the U.S. economy experienced a deep recession, the labor market demonstrated a new and striking phenomenon: a large upward spike in the duration of unemployment. Figure 7-4 shows the median duration of unemployment for jobless workers from 1967 to 2014. Recessions are indicated by shaded areas. The figure shows that the duration of unemployment typically rises during recessions. The huge increase during the recession of 2008–2009, however, is without precedent in modern history.

Figure 7.5: FIGURE 7-4: The Median Duration of Unemployment The median duration of unemployment typically rises during recessions, shown as the shaded areas here, but its spike upward during the recession of 2008–2009 was unprecedented.
Data from: Bureau of Labor Statistics.

What explains this phenomenon? Economists fall into two camps.

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Some economists believe that the increase in long-term unemployment is a result of government policies. In particular, in February 2009, when the depth of the recession was apparent, Congress extended the eligibility for unemployment insurance from the normal 26 weeks to 99 weeks, and it did not allow this program of extended benefits to expire until January 2014. Extending unemployment-insurance benefits is typical during recessions, because jobs are harder to find, but the extension to nearly two years was extraordinary.

Harvard economist Robert Barro wrote an article in the August 30, 2010, issue of the Wall Street Journal titled “The Folly of Subsidizing Unemployment.” According to Barro, “the dramatic expansion of unemployment insurance eligibility to 99 weeks is almost surely the culprit” responsible for the rise in long-term unemployment. He writes:

Generous unemployment insurance programs have been found to raise unemployment in many Western European countries in which unemployment rates have been far higher than the current U.S. rate. In Europe, the influence has worked particularly through increases in long-term unemployment.

Barro concludes that the “reckless expansion of unemployment-insurance coverage to 99 weeks was unwise economically and politically.”

Other economists, however, are skeptical that these government policies are to blame. In their opinion, the extraordinary increase in eligibility for unemployment insurance was a reasonable and compassionate response to a historically deep economic downturn and weak labor market.

Here is Princeton economist Paul Krugman, writing in a July 4, 2010, New York Times article titled “Punishing the Jobless”:

Do unemployment benefits reduce the incentive to seek work? Yes: workers receiving unemployment benefits aren’t quite as desperate as workers without benefits, and are likely to be slightly more choosy about accepting new jobs. The operative word here is “slightly”: recent economic research suggests that the effect of unemployment benefits on worker behavior is much weaker than was previously believed. Still, it’s a real effect when the economy is doing well.

But it’s an effect that is completely irrelevant to our current situation. When the economy is booming, and lack of sufficient willing workers is limiting growth, generous unemployment benefits may keep employment lower than it would have been otherwise. But as you may have noticed, right now the economy isn’t booming—there are five unemployed workers for every job opening. Cutting off benefits to the unemployed will make them even more desperate for work—but they can’t take jobs that aren’t there.

Wait: there’s more. One main reason there aren’t enough jobs right now is weak consumer demand. Helping the unemployed, by putting money in the pockets of people who badly need it, helps support consumer spending.8

Barro and Krugman are both prominent economists, but they have diametrically opposed views about this fundamental policy debate. The cause of the spike in U.S. long-term unemployment remains an unsettled debate.

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Variation in the Unemployment Rate Across Demographic Groups

The rate of unemployment varies substantially across different groups within the population. Table 7-2 presents the U.S. unemployment rates for different demographic groups in 2013, when the overall unemployment rate was 6.2 percent.

Figure 7.6: TABLE 7-2: Unemployment Rate by Demographic Group (2013)

This table shows that younger workers have much higher unemployment rates than older ones. To explain this difference, recall our model of the natural rate of unemployment. The model isolates two possible causes for a high rate of unemployment: a low rate of job finding and a high rate of job separation. When economists study data on the transition of individuals between employment and unemployment, they find that those groups with high unemployment tend to have high rates of job separation. They find less variation across groups in the rate of job finding. For example, an employed white male is four times more likely to become unemployed if he is a teenager than if he is middle-aged; once he is unemployed, his rate of job finding is not closely related to his age.

These findings help explain the higher unemployment rates for younger workers. Younger workers have only recently entered the labor market, and they are often uncertain about their career plans. It may be best for them to try different types of jobs before making a long-term commitment to a specific occupation. If they do so, we should expect a higher rate of job separation and a higher rate of frictional unemployment for this group.

Another fact that stands out from Table 7-2 is that unemployment rates are much higher for blacks than for whites. This phenomenon is not well understood. Data on transitions between employment and unemployment show that the higher unemployment rates for blacks, especially for black teenagers, arise because of both higher rates of job separation and lower rates of job finding. Possible reasons for the lower rates of job finding include less access to informal job-finding networks and discrimination by employers.

Transitions Into and Out of the Labor Force

So far we have ignored an important aspect of labor-market dynamics: the movement of individuals into and out of the labor force. Our model of the natural rate of unemployment assumes that the labor force is fixed. In this case, the sole reason for unemployment is job separation, and the sole reason for leaving unemployment is job finding.

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In fact, movements into and out of the labor force are important. About one-third of the unemployed have only recently entered the labor force. Some of these entrants are young workers still looking for their first jobs; others have worked before but had temporarily left the labor force. In addition, not all unemployment ends with job finding: almost half of all spells of unemployment end in the unemployed person’s withdrawal from the labor market.

Individuals entering and leaving the labor force make unemployment statistics more difficult to interpret. On the one hand, some individuals calling themselves unemployed may not be seriously looking for jobs and perhaps should best be viewed as out of the labor force. Their “unemployment” may not represent a social problem. On the other hand, some individuals may want jobs but, after unsuccessful searches, have given up looking. These discouraged workers are counted as being out of the labor force and do not show up in unemployment statistics. Even though their joblessness is unmeasured, it may nonetheless be a social problem.

Because of these and many other issues that complicate the interpretation of the unemployment data, the Bureau of Labor Statistics calculates several measures of labor underutilization. Table 7-3 gives the definitions and their values as of October 2014. The measures range from 2.8 to 11.5 percent, depending on the characteristics one uses to classify a worker as not fully employed.

Figure 7.7: TABLE 7-3: Alternative Measures of Labor Underutilization

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CASE STUDY

The Decline in Labor-Force Participation: 2007 to 2014

One of the more striking recent developments in the U.S. labor market is the decline in labor-force participation. Figure 7-5 illustrates the phenomenon. From 1990 to 2007, the labor-force participation rate fluctuated in a narrow range between about 66 and 67 percent. But then it started a gradual but significant decline. From the fourth quarter of 2007 to the first quarter of 2014, the labor-force participation rate fell from 66.1 percent to 63.0 percent. As a result of this change, about 7 million fewer Americans were working or looking for work in 2014 than otherwise would have been the case.

Figure 7.8: FIGURE 7-5: The Labor-Force Participation Rate The labor-force participation rate declined significantly from 2007 to 2014.
Data from: Bureau of Labor Statistics.

What explains the decline of 3.1 percentage points in the labor-force participation rate? To answer this question, a natural place to start is to study those individuals not in the labor force to see why they are not working or looking for work. Economist Shigeru Fujita of the Federal Reserve Bank of Philadelphia has done exactly that using the data in the Current Population Survey.

His findings, summarized in Table 7-4, allocate the 3.1 percentage points among five categories:

  • An increase in retired workers accounts for 1.4 percentage points.

  • An increase in disabled workers accounts for 0.8 percentage points.

  • An increase in discouraged workers accounts for 0.4 percentage points.

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  • An increase in those not wanting a job because they are in school accounts for 0.5 percentage points.

  • The “other” category—those outside the labor force who are not retired, disabled, discouraged, or in school, such as full-time parents—accounts for none of the change. In fact, this last category went slightly in the other direction.

Figure 7.9: TABLE 7-4: Decomposing the Change in Labor-Force Participation

With this decomposition in hand, we can discuss some of the forces at work.

According to the numbers in Table 7-4, retirement explains the largest share of the increase in nonparticipation, accounting for almost half the change. The increase in the number of retired workers is largely due to the aging of the large baby-boom generation. The baby boom started in 1946, just after World War II as soldiers returned home and started families, and continued until 1964. The first of the baby boomers turned 62—the earliest age at which a person can start collecting Social Security retirement benefits—in 2008. So far, we have seen just the tip of a sizeable iceberg: as more baby boomers reach retirement age in the years to come, the labor-force participation rate will probably continue to decline.

Another force at work is that during much of the period from 2007 to 2014, the economy was weak. Because of a financial crisis and deep recession (a topic discussed in detail in Chapter 12 and Chapter 20), unemployment, especially long-term unemployment, was high. The lack of good job opportunities during this time certainly increased the number of discouraged workers. But it likely influenced people in many other ways as well. When the options offered by the labor market are poor, the alternatives to work look better by comparison. In particular, the weak labor market may have induced older workers to retire earlier, workers with infirmities to apply for disability benefits more quickly, and students to stay in school longer. All of these effects reduced labor-force participation.

To be sure, these developments are not entirely adverse. For the elderly, retirement is often a welcome change in lifestyle after a lifetime of toil. For the young, staying in school is often a sensible investment in human capital. Yet the decline in labor-force participation does have a cost. With a smaller labor force, the economy naturally produces a smaller output of goods and services, which in turn means a lower level of real GDP.

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