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Labor Markets

Chris EdmondNYU 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)

Not in Labor Force(77 million)

Labor Force(149 million)

Employed(141 million)

Unemployed(8 million)

Source: Bureau of Labor Statistics 2005.

3

Labor market indicators

unemployment rate =unemployedlabor force

=8

149= 0.05

participation rate =labor force

working age population=

149226

= 0.66

inactivity rate =not in labor force

working age population=

77226

= 0.34

4

US unemployment rate

0

2

4

6

8

10

12

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

percentage points


5

US participation rate

58

59

60

61

62

63

64

65

66

67

68

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

percentage points


6

Labor market transitions

Average monthly transitions 1996-2003


Not in Labor Force

(59.3 million)

Unemployed(6.2 million)

Source: Davis, Faberman and Haltiwanger.

7



Not in Labor Force

(59.3 million)


0.0270.013

0.96



8



Not in Labor Force

(59.3 million)


0.0270.013

0.96

2.7% of 122 million leave the labor force each quarter

1.3% of 122 million becomeunemployed each month



9




Not in Labor Force

(59.3 million)


0.96

0.0270.013

0.928

0.048

0.0240.484

0.283

0.233

Job-to-job transitions0.026


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!L1!!

• First order condition

(1! !)AK!L!! ! w = 0

solving for labor

L = Ld(w) =!

(1! !)Aw

"1/!

K

12

Demand for labor

• Labor demand curve

L = Ld(w) =!

(1! !)Aw

"1/!

K

• 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"(1! L)1!", 0 < " < 1

• Budget constraint: consumption equals labor income wL + non-labor income T

C = wL + T

• Eliminate C from utility function and take logs

" log(wL + T ) + (1! ") log(1! L)

• First order condition

"w

wL + T! (1! ")

11! L

= 0

solve for labor to get L = Ls(w)

14

Supply of labor

• Labor supply curve

L = Ls(w) = " ! (1! ")T

w

• Intuitive properties

– at higher wage w, household wants to work more(‘substitution e!ect’)

– higher non-labor income T decreases (‘shifts in’) labor supply curve(‘wealth e!ect’)

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 matchworkers 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

Unemployment

Minimum wage

18

Labor market outcomes

0

2

4

6

8

10

12

14

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

USA

Unemployment rate


19


0

2

4

6

8

10

12

14

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

USA

FRA

Unemployment rate


20


0

2

4

6

8

10

12

14

1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

USA

FRA

UK

Unemployment rate


21

Why?

• One answer — labor market policies

– 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

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?

• 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

• O!setting income and substitution e!ects 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 di!er 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



Not in Labor Force

(59.3 million)



27

Labor market flows



Not in Labor Force

(59.3 million)


0.96

0.0270.013

0.928

0.048

0.0240.484

0.283

0.233

Job-to-job transitions0.026


28

Labor market flows

• Changes in status by workers

– accessions: number of workers taking new jobs, whether previous status wasemployed, unemployed, or not in labor force

– separations: number of workers leaving current jobs, whether they becomeemployed, 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 estab-lishments

– job destruction: sum of all decreases in number of employees by individualestablishments

– 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

-10.00

-5.00

0.00

5.00

10.00

15.00

1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992

percent per quarter

job creation

job destruction

Source: Davis, Haltiwanger and Schuh.

31

US private sector

6.0

6.5

7.0

7.5

8.0

8.5

9.0

1993 1995 1997 1999 2001 2003 2005

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

job creation

job destruction

percent per quarter

Source: Bureau of Labor Statistics, 2006.

32

US private sector

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

percent per quarter excess job reallocation

net employment growth= job creation ! job destruction


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

ut+1 ! ut = set ! fut

= s(1! ut)! fut

35

Unemployment dynamics

u 1

s

ut

job findingfut

job separationss(1 ! ut)

36

Steady state

• Dynamics

ut+1 ! ut = s(1! ut)! fut

• To find steady state u, set "ut+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 a!ect 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)

(ut+1 ! u) = #(ut ! u)

where

# $ 1! (s + f)

• After shock u0, unemployment follows

(ut ! u) = #t(u0 ! u)

• Return to steady state faster if # 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 #

• 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 a!ect s and f

39

Cyclical behavior of labor markets

• Simple model has

ut+1 ! ut = s(1! ut)! fut

• Better model has time-varying finding and separation rates

ut+1 ! ut = st(1! ut)! ftut

• How do finding and separation rates vary over the business cycle?

40

Job finding rate

0.000

0.200

0.400

0.600

0.800

1.000

1.200

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

0.000

0.020

0.040

0.060

0.080

0.100

0.120

finding rate ft unemployment rate ut

correlation at business cycle frequencies = !0.97


41

Job separation rate

0.000

0.010

0.020

0.030

0.040

0.050

0.060

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

0.000

0.020

0.040

0.060

0.080

0.100

0.120

separation rate st

unemployment rate ut

correlation at business cycle frequencies = 0.65


42



– job finding rate is very procyclical, higher in booms– job separation rate is not so sensitive to the cycle

43



– job finding rate is very procyclical, higher in booms– job separation rate is not so sensitive to the cycle

" in booms, layo!s fall and quits rise" in recessions, layo!s rise and quits fall

44

Actual and predicted unemployment

0.000

0.020

0.040

0.060

0.080

0.100

0.120

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001



45


0.000

0.020

0.040

0.060

0.080

0.100

0.120

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001

constant ftime-varying st



46


0.000

0.020

0.040

0.060

0.080

0.100

0.120

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001


constant stime-varying ft

constant ftime-varying st


47


• Fluctuations in job finding rate ft

– 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– layo!s 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

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