The Frozen Labor Market

The labor market recovery of the past two years ago has not gained enough strength to rule out the possibility of a lost decade.  The recovery is especially weak for less educated workers and for cities devastated by the housing market collapse.  The economy is in better shape than three years ago but we would need to add 10 million full-time jobs to return to pre-recession employment to population ratios.  It is doubtful that 2012 will be much better than 2011 because the labor market appears much less dynamic than it was just a decade ago.

The recovery is weaker than the headlines suggest.  The unemployment rate has fallen by 1.4% over the past two years but this is largely due to workers leaving the labor force; the labor force participation rate has declined by 1.1% since January 2010.  The participation rate has been trending down for years so a small part of this decline was expected.  Nonetheless we should not be encouraged by declining labor force participation during a recovery.

The following figure presents a disconcerting trend: hires and separations have fallen steadily relative to the size of the labor force over the past decade.  The labor market is much less dynamic than it was prior to the Great Recession.  Although companies are laying off fewer workers, they are also hiring fewer workers, and employed workers are reluctant to quit.  Consequently new labor force entrants and job losers face fewer job opportunities and struggle to find a job.

Gross labor market turnover, measured by the sum of hires and separations per labor force participant, has fallen 25% since 2002.  This indicates a labor market that is more sluggish and less dynamic than it was just a decade ago.  Companies may be reluctant to hire because they are uncertain about: (i) the strength of the economic recovery, (ii) health care costs, or (iii) whether temporary tax code provisions will be extended or curtailed.  Hiring rates may also be weak because jobless workers lack the skills and experience that companies demand, or because start-ups can’t obtain financing for their new ventures.  A robust recovery must include much more hiring so that enough jobs are created to employ new graduates and the long-term unemployed.  This won’t happen if the labor market remains as sluggish as it has been since 2008.

Swing States

As I watch the Michigan Primary results on Tuesday night, I will be focused on exit polls about the state of the economy in Michigan.  Do voters in Michigan feel like the economy is on the rebound?  Will voters in other key swing states be optimistic about the economic recovery by November?

Earlier this month Ryan Avent of the Economist posted a chart showing changes in unemployment rates in swing states.  Although the chart seemed to show that labor markets are recovering faster in swing states, this may not be the case.  In an earlier post  I showed that much of Michigan’s drop in the unemployment rate is due to a declining labor force.  Today Tami Luhby of CNN Money made a similar point – the unemployment rate in Michigan and other swing states is falling, in part, because of workers leaving the labor force.

Good news or bad news can cause the unemployment rate to fall.  A better barometer of the labor market in swing states is the percentage change in payroll employment.  The following chart lists swing states and their employment changes over the past four years.

The chart indicates that Nevada, Florida, Michigan and North Carolina have lost the most jobs (in percentage terms) since December of 2007.  Moreover, ten of fourteen swing states have experienced a larger decline in employment than in the rest of the U.S..  Michigan, Florida and Ohio are the only swing states where employment grew faster in the past year than in non-swing states.

If one looks at the percentage change in employment, rather than changes in the unemployment rate, labor markets appear to be weaker in key swing states than in the rest of the U.S.  The strength of the economic recovery, and employment growth, in these fourteen states may determine the outcome of the Presidential election.

Location, Location, Location

This recession, with a weak job market and declining home values, has been especially tough on the middle class.  Two of the most valuable assets of middle class households are human capital and residential housing, which are poorly diversified.  Financial investments can be spread across many securities so that losses from one investment can be mitigated by gains from others.  You can’t trade shares of ownership in your home or human capital to diversify your investment.

Housing has been a poor investment relative to equities since the end of 2006.  The most recent Case-Shiller 20-city price index indicates that home values in these cities declined by 32% over the past five years while the Standard and Poor’s 500 index declined by about 5%.  To make matters worse property values are closely related to employment and wages in a metro area.  Cities hit hard by declining property values have experienced reductions in household wealth, lower consumer spending and falling employment and income.

A simple linear regression of home values on metro area employment (from the BLS) across the 20 Case-Shiller cities indicates that each one percentage point decline in an area’s employment is associated with a 3.2% decline in home values.  This significant positive covariance is statistical evidence that buying a home in the city where you work is putting the bulk of your financial eggs in one basket.

There are 8 Case-Shiller cities that have been hit particularly hard by the recession: Atlanta, Cleveland, Detroit, Las Vegas, Los Angeles, Miami Phoenix, and Tampa.  The following figure indicates that employment fell by 9% and home values by 44% in these cities between the beginning of 2007 and the end of 2011.

There are another 8 Case-Shiller cities where the recession has been somewhat less severe: Boston, Charlotte, Dallas, Denver, New York, Portland, Seattle, and Washington, DC.  The following figure indicates that employment fell by 1.3% and home values by 18% in these cities between the beginning of 2007 and the end of 2011.

For working class households the depth of the recession depends on location, location and location.  Job losses are concentrated in cities with the biggest reductions in household wealth due to declining home values.  Our tax code, with mortgage interest deductions and capital gains exemptions for owner occupied housing, encouraged the middle class to view their home as a means of accumulating wealth.  Decades of policies encouraging investment in residential housing over diversified mutual funds made middle class households especially susceptible to the risk of a housing price bubble.

Although the labor market started to recover over the past two years it is much weaker in cities where many houses are in foreclosure.  Job creation has lagged and the labor force is shrinking in cities with distressed real estate markets.  Will the just announced $26 billion mortgage foreclosure settlement involving five of the largest mortgage servicers and 49 of 50 state attorneys general help?  Critics on the right and left are skeptical. President Obama just unveiled his proposal to offer government assistance to homeowners who are underwater on their mortgage but not in foreclosure.  Critics of this plan fear that it could sink the taxpayer backed Federal Housing Administration and delay the inevitable and necessary process of market clearing.

Regardless of how we navigate our way through the current mess serious tax reform should address the home mortgage interest deduction and capital gains taxes on home ownership.  These reforms would not just broaden the base and lower marginal tax rates they could make working class households less susceptible to the risk of future housing price bubbles.

Steve Rattner is no Clint Eastwood

Clint Eastwood’s compelling halftime in America commercial has generated a lot of buzz.  Regardless of one’s political views about the precedent set by government bailouts of America’s largest corporations, the ad reminds us that we want cities like Detroit to recover.  Ironically the Eastwood commercial was produced in Los Angeles, where the problems of joblessness and depressed real estate values are comparable to Detroit’s.

Today on morning on Morning Joe Steve Rattner, MSNBC economics analyst and former Obama Administration car czar, presented a defense of the automaker bailouts that he helped design.  Steve Rattner’s charts purport to show that the bailouts saved Detroit.  Rattner focused on the unemployment rate rather than job creation or the size of the labor force.  Labor economists know that Detroit’s unemployment rate can fall if enough people either stop searching for work or leave town.  It appears that a shrinking labor force is a big part of Rattner’s story of a Motor City Miracle.

First here is the key chart presented by Rattner that caught my eye:

Here is a chart that I wish Rattner had presented:

Employment in Michigan and Detroit has grown at about the same rate as the rest of the U.S. over the past two years.  A noticeable difference between Michigan and the rest of the U.S. is that the labor force is shrinking in the Detroit metro area and in Michigan.  Whether this is because jobless workers have given up looking for work, older workers have retired, or people have left the state would require further study.

Detroit is healing, but not in a way that is noticeably different than the rest of the country.  Steve Rattner wants to give credit to the automaker bailout for the large decline in Detroit’s unemployment rate over the past two years.  At the same time, he would not conclude that the bailout caused Detroit’s labor force to shrink faster than elsewhere in the U.S.  It is still unclear what precedent the Federal government has set by intervening in the auto industry rather than just letting large corporations file for bankruptcy.  It is also unclear, at this point, how many jobs were “saved” in Michigan and Detroit by this policy.

Why This Recession was Different

It has been four years since private sector employment peaked.  Last week’s jobs report was the best we have seen in months and yesterday’s new jobless claims figures were promising.  It’s a good time to take a look back at the last four years and compare our current situation to previous recessions.

Construction projects and durable goods purchases are delayed in a recession which greatly reduces the demand for workers in these sectors.  From the 1970s through 2008 more than 70% of the jobs lost in recessions were in construction and durable goods.

Only one in 7 jobs heading in to the 2008 recession were in construction and durable goods.  Even though many of the jobs most vulnerable to a downturn were either outsourced or replaced by robots over the past few decades we still lost 8.8 million private sector jobs, or 7.6% of total employment, between January 2008 and February 2010.  Most of the jobs lost were in sectors that previously had been immune to recessions.

The graph below compares employment changes in the construction and durable goods manufacturing sectors in five recessions and recoveries.  In the recessions before 2008 employment in these sectors fell by 10% to 15%.  In the 1970s and 1980s employment recovered after one year of decline.  In the 1990 and 2000 recessions employment fell less sharply for almost two years and only a small fraction of the lost jobs were added back during each recovery.  The 2008 downturn combines the worst features of both types of recessions.  Employment fell sharply for two years until 22% of construction and durable goods jobs were lost.  In the two years since the recovery began job gains have been modest.

The next graph compares employment changes in the rest of the private sector.  In the recessions prior to 2008 employment fell by no more than one or two percent.  It is troubling that employment growth has been less vigorous with each ensuing recovery.  The 2008 recession is different because employment outside of construction and durable goods fell by more than 5% and remains 2.5% below the pre-recession peak two years into the recovery.

The depth of the 2008 labor market downturn is surprisingly severe when one considers the small fraction of jobs in construction and durable goods when the recession began.  More than one in five jobs in construction and durable goods have been lost since 2008, more than in any recession since the Great Depression.  Job losses in recessions used to be concentrated in these sectors and employment used to snap back as the demand for construction projects and durable goods recovered.  If the pattern of recent recoveries holds true few of the durable goods manufacturing jobs that were lost will return to the US.

The 2008 recession is unique because 6 of 10 jobs lost were in relatively recession-proof sectors, such as services, trade, and information.   Increases in durable goods orders will likely restore a small fraction of the jobs lost since 2008.  I expect the labor market to recover slowly over the next few years.

Carolinas and our Manufacturing Base

Unemployment is about 10% in the Carolinas as their regional economy has been hard hit by the recession. The economy is likely to be a key issue when voters go to the polls for the Republican Presidential primary in South Carolina, and later this year when Democrats nominate President Obama for re-election at their convention in Charlotte.

Forty years ago the Carolinas employed the highest fraction of workers in the manufacturing sector, accounting for almost 40% of all jobs. Textiles and apparel manufacturers were the largest employers with more than half of all manufacturing jobs.

When President Obama and the Republican Presidential candidates advocate policies to restore our manufacturing base shuttered steel mills and automobile manufacturing plants in the Rust Belt come to mind. No states have been more adversely impacted by globalization and foreign competition than the Carolinas. China now accounts for 40% of US imports of textiles and apparel, up from 12% two decades ago. Over the same time foreign imports have more than tripled while the US has lost 80% of jobs in the apparel and textile industries.

Today Indiana is the most manufacturing intensive state in the US, with about 19% of private sector jobs in manufacturing. The Indiana legislature is about to debate legislation that would make it the only right-to-work state in the “Rust Belt”. The lesson from the Carolinas is clear. When foreign labor and production costs are sufficiently low, as they are in textiles and apparel, neither tax incentives nor “right-to-work” laws will be enough to preserve manufacturing jobs. Our manufacturing base in the 21st century will be concentrated in industries where skilled labor and sophisticated capital equipment give us a comparative advantage.

Two New NCAA Regulations That Will Improve College Football

Last month Tyler Cowen and Kevin Grier offered an explanation of the persistence of the college football bowl system.  They believe the BCS will continue despite the greater revenue generated by a championship tournament, because schools benefit from bowl game publicity and players gain from the bowl experience. The sparse attendance and low ratings of many lesser bowl games makes me skeptical of their publicity value. There are impediments to change, however, so here I propose two new regulations to ease the transition to a playoff system. First, allow non-bowl teams to hold practices until a national champion has been crowned and second, require teams to evenly split gate receipts for regular season non-conference games.

Practice times and player contact is restricted by the NCAA during the off-season. An important non-financial gain from bowl participation, especially for younger teams with more returning players, is the ability to schedule additional practices. If all teams were allowed the same practice time, regardless of their bowl status, teams would be less interested in participating in minor bowl games.

Defenders of the status quo argue that the bowl system makes college football’s regular season the most compelling in sports; one loss could eliminate a team from BCS title consideration. The status quo also encourages many boring September games because Athletic Directors rationally schedule very weak non-conference opponents. The past 12 participants in the BCS championship game played 45 non-conference games. Two thirds of their opponents were not ranked in the top 80 teams, and one of three was outside the top 125 teams in the country. The implication is clear: to improve chances of advancing to the BCS title game a team should schedule 2/3 of nonconference games against vastly overmatched opponents.

The NCAA encourages non-conference mismatches by allowing a team to keep all gate receipts after paying a nominal fee to a weak opponent to come to its campus. The NCAA should require gate receipts to be split evenly with the visiting team (as in the NFL) for all non-conference games. This simple rule would reduce the financial return to scheduling weak opponents. Teams would also take more scheduling risks with a 16 team playoff because a single loss would not end a team’s title hopes.

Many of the 35 bowl games that are played each year would be interesting inter-conference match-ups if they were played in September and replaced the annual parade of lopsided games. Television revenue would be enhanced by the promise of more and better early non-conference games.

I prefer a 16 team tournament that culminates with a game between the last two surviving teams, whether or not they are the “best” teams in the country. Sports contests are entertaining because upsets are possible and outcomes are uncertain. March Madness would be far less compelling if the selection committee chose the country’s 4 highest seeded teams as the Final Four and replaced the rest of the tournament with 60 meaningless basketball “bowl” games.

The rules changes I have proposed are sensible even with a bowl system. First, colleges and universities would be treated uniformly with respect to gate receipts and practice times, whether or not they are football powers. Second, powerful teams would be discouraged from scheduling games against vastly weaker opponents which should result in better non-conference regular season games.

Answering Tim Harford on the Minimum Wage

In Saturday’s Financial Times Tim Harford asks the question “Can the Minimum Wage Create Jobs?”  The simple answer is yes, but not as many as it destroys. Any policy has winners and losers and the minimum wage is no exception. The losers are young and unskilled workers who become more expensive but no more productive to prospective employers. The winners include semi-skilled workers who compete with minimum wage workers and producers of the capital equipment that companies use to economize on unskilled labor. Crony capitalism is not limited to tax breaks, subsidies and bailouts; the minimum wage can also benefit unions threatened by cheaper non-union workers.

Harford cites the “amazing” and controversial Card and Krueger study which showed that a higher minimum wage didn’t reduce employment in fast food restaurants in New Jersey. Putting aside possible problems with their data discussed by other economists, Card and Krueger looked for job losses at restaurants with the least labor intensive food preparation methods in the history of mankind. (e.g. most have outsourced the task of filling cups with ice and soft drinks to their customers to save labor costs). A higher minimum wage raises the relative cost and price of made-to-order sandwiches in labor intensive competitors and may actually increase demand at fast-food restaurants. The Card and Krueger study says nothing about how a higher minimum wage affects the aggregate employment of unskilled labor.

Harford correctly notes that minimum wage laws attempt to treat a symptom of a larger problem. The real problem is that many young workers lack the skills that employers demand. Unfortunately the minimum wage makes it more difficult for young adults to acquire vocational skills because it makes on-the-job training programs less viable. Companies will provide general training only if workers “pay” for it through a lower wage because a company loses its investment when trained workers (who received full pay) leave. The minimum wage limits the ability of young workers to “pay” for on-the-job training and apprenticeships. This is especially costly if vocational and for-profit schools are ineffective alternatives for developing marketable skills.

The Motor City Needs a New Nickname

Detroit has been called the Motor City for almost a century, but that nickname no longer applies. In 1973 the Big Three automakers had a market share of over 80%, and more than one out of every four workers in the motor vehicle (and parts) manufacturing industry was employed in the Detroit metro area. Today, fewer than one in nine autoworkers are employed in Detroit, even after Federal assistance was provided to two domestic automakers.

The Obama Administration is proposing policies to help “insource” manufacturing jobs back to the US. The case of Detroit tells us that both new and existing manufacturing jobs are likely to re-locate in states with lower taxes and right-to-work laws.

The past 38 years has seen many changes in the auto industry, but the most striking change may be where vehicles are produced in the US. Auto industry employment declined by 70% since 1973 in Detroit, but increased in states outside of Michigan and Ohio.

Forty years ago economists might have argued that Michigan and Ohio had a comparative advantage in motor vehicle production. Factories in the upper Midwest were located close to suppliers of parts and raw materials and had access to the infrastructure that facilitates vehicle shipments. As the fortunes of the Big Three waned, foreign-owned firms had access to a pool of laid off workers with valuable skills and experience.

Nonetheless, in the past three decades new motor vehicle production facilities were built in cities and states that had none of the incumbent advantages of Detroit and Michigan. Foreign-owned firms were instead attracted by the lower taxes and more favorable labor laws in Southern states. I suspect that if manufacturing jobs are “insourced” back to the US in this economic recovery, Southern states will again be the beneficiaries.

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