The Fed on Unemployment

From the FOMC Minutes:

A number of participants noted that the current sluggish pace of employment growth was insufficient to reduce unemployment at a satisfactory pace. Several participants reported feedback from business contacts who were delaying hiring until the economic and regulatory outlook became more certain. Participants discussed the possible extent to which the unemployment rate was being boosted by structural factors such as mismatches between the skills of the workers who had lost their jobs and the skills needed in the sectors of the economy with vacancies, the inability of the unemployed to relocate because their homes were worth less than their mortgages, and the effects of extended unemployment benefits. Participants agreed that factors like these were pushing the unemployment rate up, but they differed in their assessments of the extent of such effects. Nevertheless, many participants saw evidence that the current unemployment rate was considerably above levels that could be explained by structural factors alone, pointing, for example, to declines in employment across a wide range of industries during the recession, job vacancy rates that were relatively low, and reports that weak demand for goods and services remained a key reason why firms were adding employees only slowly.

A recent speech by the chair of the Minneapolis Federal Reserve sparked a debate about the nature of the unemployment in the US. Here are the key paragraphs:

If one digs deeper into the data, the situation seems even more troubling. Since December 2000, the Bureau of Labor Statistics has been keeping data on the job openings rate, which is defined as the number of job openings divided by the sum of job openings and employment. It has also been keeping track of the layoffs/discharges rate, which is the fraction of employed people who have been laid off or discharged in a given month. The job openings rate rose by around 30 percent between July 2009 and July 2010. The layoffs/discharges rate has fallen by over 10 percent over the same period.

Nonetheless, despite this apparent increase in the demand for labor from employers, the unemployment rate actually went up slightly from July 2009 to July 2010, from 9.4 percent to 9.5 percent. And other measures of labor market performance actually tell an even bleaker story. From July 2009 to July 2010, the employment/population ratio fell from 59.3 percent to 58.4 percent. At the same time, the seasonally adjusted labor force participation rate fell from 65.4 percent to 64.6 percent. This was the biggest July-over-July fall in the 60-plus year history of that statistic.

What he is noting here is the number of job openings is increasing while the pace of job discharges is decreasing. This indicates that employers are increasing their hiring plans. This has led some to conclude that US unemployment is structural, meaning there is a mis-match between what employers want in an employee and the skills the employee brings to the table. The logic continues that this mis-match is the cause of the high unemployment rate.

The Boston Fed also did research into this issue and found the following:

Some hypothesize that a more robust recovery is impeded by dislocations in the labor market. Indeed, history shows that even with a relatively mild recession there can be significant dislocations. The 2001 recession provides a good example. As Figure 1 shows, information technology and manufacturing were two industries that saw significant declines in employment in that downturn. The end of the “dot-com” euphoria and structural shifts in the manufacturing sector caused those two industries to be disproportionately affected, while we had only modest declines in the cyclical construction industry, and increases in employment in several industries. Similarly, the 1990 recession had a decline in employment of more than 5 percent in only the construction industry, when overbuilding in several regions of the country led to a significant readjustment in construction-industry employment.

In fact, in each of the three previous recessions there was a decline of 5 percent or more in no more than two industry categories – as the figure shows – with many industries experiencing little or no net job loss over the course of the recession. Structural shifts across industries are not uncommon in recessions – and also, some structural dislocation seems inevitable as it will always take some time for capital and labor to flow to those industries with the greatest opportunities.

In rather stark contrast, the most recent recession is far less a reflection of dislocation in a few industries but rather reflects a general decline in almost all industries. As the chart on the far right shows, in this recession there has been a peak to trough loss of employment of 5 percent or greater in construction, manufacturing, retail trade, wholesale trade, transportation, information technology, financial activities, and professional and business services. To me, this does not suggest that the driver is structural change in the economy increasing job mismatches – although no doubt some of that exists – but instead I see here a widespread decline in demand across most industries.

Here is the accompanying chart

What the Boston Fed is arguing is the breadth of job losses indicates this is not a structural realignment, but instead a far more in-depth recession. Structural realignment means there is a significant issues/problem hitting a few industries and not the economy as a whole. The Boston Fed's research indicates that in several of the earlier recession, a limited number of industries lost jobs. For example, the .com bust lowered the demand for technology workers, while the real estate bust of the early 1990s lowered the demand for construction workers.

Personally, I believe the Boston Fed's research is more compelling, as does the Federal Reserve, which noted:

Nevertheless, many participants saw evidence that the current unemployment rate was considerably above levels that could be explained by structural factors alone, pointing, for example, to declines in employment across a wide range of industries during the recession, job vacancy rates that were relatively low, and reports that weak demand for goods and services remained a key reason why firms were adding employees only slowly.

However, this does not mean the structural argument is completely wrong. For example, I think it is highly doubtful we'll see a big upswing in construction anytime soon, largely because of the huge overhang in existing home inventories. As such, there is a structural component to the construction industry's unemployment situation. But I also think the breadth of the job losses indicates the structural reasons for unemployment are in the minority.