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.

Multipliers

We are producing more with fewer workers; U.S. employment is below the pre-recession peak of January 2008 but output (real GDP) is 1.2% higher.  Employment in the private sector and state and local government has declined over the past four years while Federal employment has increased.  Since January 2008:

• Private sector employment declined by 4.5%
• Federal government employment increased by 3.4%
• State government employment declined by 1.6%
• Local government employment declined by 2.8%

Is the decline in state and local government employment a drag on the economy as Paul Krugman has argued?  Or have state and local governments, like the private sector, become more efficient and deliver more and better quality services with fewer employees?  This is impossible to tell from National Income Accounts data which only measure the cost of government spending and not the value of the government services provided.

It is important to put the recent declines in state and local employment into perspective.  In the past fifteen years local government employment has grown almost twice as fast (17.5%) and state government employment has grown slightly faster (10.3%) than private sector employment (9.1%).  State and local government has grown relative to the private sector for decades.

The recovery/stimulus legislation was designed to bolster state and government spending.  However, as John Taylor testified to Congress, state and local governments used stimulus funds largely to reduce borrowing rather than increase expenditures.

Paul Krugman argues for more state and local government spending on goods, services and investment.  (He admits that “safety-net spending … has soared in this slump.”)  Keynesians believe that if spending were $340 billion higher (about 2% of GDP), GDP would be 3% higher due to the “multiplier” effect and the unemployment rate would be 1.5% lower.   A “multiplier” argument is a smokescreen for the real debate about the appropriate size and scope of government.  Some state and local government spending/employment cuts make sense if they eliminate waste and duplication but that is the opposite of what “multiplier” calculations would conclude.

In addition many leading economists such as John Cochrane and John Taylor are skeptical of large multipliers for stimulus spending.  More importantly, the “multiplier” argument says nothing about which programs should be expanded and whether any programs should be cut.  The emptiness of a “multiplier” justifcation for government spending is clear when one recognizes that Keynesians believe that government reductions in waste and fraud would lower GDP and raise the unemployment rate.

One of the most important election issues is the debate over the proper size and scope of government.  The debate would be more informative if it focused on the direct costs and benefits of government programs, assumed that programs must be paid for even if financed through bonds, and did not rely on possible “multiplier” effects to justify spending.

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.

Turning the Corner

When I saw last Friday’s encouraging jobs report I knew it would be controversial.  An increase in payroll employment of 243,000 is good news, but any January report contains a large seasonal adjustment because it is typically the weakest month of the year for employment.  The Bureau of Labor Statistics generates a new seasonal adjustment factor every month, to allow for changing economic conditions, but it means that no two January adjustments are the same.  Skeptics, such as Zero Hedge, correctly observed that the past two January seasonal adjustments have been especially large which might account for 100k of the job gain reported last week.

The Bureau of Labor Statistics is faced with an incredibly challenging task.  It must generate a near real-time count of the country’s total payroll and report it as if January was no different than June.  I know things are out of hand when Rush Limbaugh and Rachel Maddow are commenting on the appropriateness of the government’s seasonal adjustment process.  It is unfortunate that last week’s solid report was obscured by an opaque statistical methodology.   I prefer a more transparent method for presenting high-frequency changes in payroll employment.  My approach shows slow and steady improvement in the aggregate labor market throughout 2011.

First, I consider average payroll employment over a quarter year to mitigate the noise in any single month’s report.  Second, I compare year-over-year percentage changes in quarterly employment rather than use a confusing and complicated method for removing seasonal effects.  The following figure presents these changes in payroll employment for all of 2011 and January 2012.

Employment grew by 1% annually in the first half of 2011 and by 1.2% and 1.3% in the third and fourth quarters.  The January jobs report is encouraging because it reflects a 1.5% annual employment growth rate.  Of course the next two monthly reports will have to be equally strong to maintain a growth rate of 1.5% for the entire first quarter of 2012.

Quarterly year-over-year changes eliminate some of the noise in monthly reports and their evolving seasonal adjustments.  Conventional wisdom, fueled by noisy monthly reports, is that the labor market recovery sputtered in the second half of 2011.  In fact, the labor market has been improving slowly and steadily.  There are problems to be sure.  Annual employment growth of 1.5% is better than we have seen recently but it’s painfully slow given the deep recession.  More importantly, as I will show in future posts, the labor market remains especially weak for less skilled workers and in areas hit hard by the real estate crisis.