TOPIC 2

The Supply Side of the Economy

Goals of Lecture 2

• Introduce the supply side of the macro economy.

• Discuss how countries grow and why some countries grow faster than others.

• Discuss labor productivity o What does it mean? o How does it respond coming out of recessions? • Determine how wages are set in an economy. Determine why people work.

• Understand where unemployment comes from.

2

The Production Function

• GDP (Y) is produced with capital (K, price-weighted) and labor (N, hours): Y = A F(K,N) • Sometimes, I will modify the production function such that: Y = A F(K,N, other inputs) – where other inputs include energy/oil!

• Realistic Example is a Cobb Douglas function for F(.): Y = A K .3 N .7

A

is Total Factor Productivity (TFP), an index of efficiency (technology)

MUST READ: NOTES 3 (my text posted on the teaching page) on the aggregate production function

3

Measurement

• Y is GDP (measured in dollars). As noted above, we want to measure Y in “real” dollars.<>.

• For our Cobb Douglas production function (previous slide), N and K are both measured in dollars.

– N often is measured in total wage bill – K often is measured as the replacement cost of capital • However, in practice, N can be measured in different ways (hours worked, number of workers).

– Wage bill is the preferred method (takes into account “skill” differentials).

– However, we will often talk about standard of livings which is income per capita (Y/N ; where Y is income and N is some population measure).

4

Features of the Aggregate Production Function

Define MPN = Marginal Product of Labor = dY/dN Define MPK = Marginal Product of Capital = dY/dK

Math Note: You should be comfortable taking these simple partial derivatives– if you are not, practice this for the quizzes and exams.

Diminishing Marginal Products

From Cobb-Douglas: MPN = .7 A (K/N) .3 = .7 (Y/N) Fixing A and K, MPN falls when N increases MPK = .3 A (N/K) .7 = .3 (Y/K) Fixing A and N, MPK falls when K increases

Complementarity Across Inputs

Increasing A or K, increases MPN Increasing A or N, increases MPK 5

Two Measures of Productivity

•

Labor Productivity = Y/N = A (K/N) .3

Driven by A and K/N (usually reported in press) •

Total Factor Productivity (TFP) = A = Y/F(K,N)

• Basically TFP is a ‘catch-all’ for anything that affects output other than K and N. – Work week of labor and capital – Quality of labor and capital – Regulation – Infrastructure – Competition – Specialization – Innovation (including innovation in management practices) – Changes in “discrimination” or “culture” • • Some components of TFP tends to be pro-cyclical (Definition of Pro-cyclical: Variable increases when Y is high, decreases when Y is low) 6

Sub-Section A

Economic Growth

Growth Accounting

Y = A K .3

N .7

(our production function) %ΔY = %ΔA + .3%ΔK + .7%ΔN Output, in a country grows from

: Growth in TFP (see entrepreneurial ability, education, roads, technology, etc.) Growth in Capital (machines, equipment, plants) Growth in Hours (workforce, population, labor participation, etc).

Perhaps, we care about growth in Y/pop or Y/N (per capita output). %Δ(Y/pop) = %ΔA + .3%Δ(K/pop) + .7%Δ(N/pop) or %Δ(Y/N) = %ΔA + .3%Δ(K/N)

8

Productivity During Recession

Y/N evolves by

: Y falling (holding N constant) decreases Y/N N falling (holding Y constant) increases Y/N

In recessions, both Y and N fall.

The question of interest:

Does Y or N fall more during a recession?

9

Output Per Worker (All Sectors): 1970Q1 – 2012Q2

10

Output Per Worker: Coming Out of Recessions

From Mulligan (2009): What Caused The Recession of 2008? Hints from Labor Productivity 11

Output Per Worker (Manufacturing): 1970Q1 – 2012Q2

12

Summary

During recent recessions

: N falls more than Y Y/N (a measure of productivity) actually increases We are producing more stuff – with less workers – during the recession!

Note: The fact that productivity increases during recent recoveries is directly linked to the fact that recent recoveries have been “jobless” (discussed in lecture 1). The economy recovers but employment lags.

Why are there jobless recoveries?

13

The Role of Investment and Growth

Does a

one time increase in investment today

increase Y/N today? YES!

Does a

one time increase in investment today

into the future? No!

cause a sustained increase in Y/N Back of our mind equations: S = I + NX (From the first lecture). Notice the link between saving and investment.

Definition of Capital Stock Evolution K(t+1) = (1-δ) K(t) + I(t) or ΔK(t, t+1) = I(t) - δ K(t) All else equal (i.e. holding N constant), increasing I causes K tomorrow to increase causing K/N tomorrow to increase (i.e. Y/N tomorrow increases). 14

Time Path of Capital Stock: One Time Increase in I

K No investment No investment t+1 time Suppose there is a one time increase in investment at time t (perhaps due to an investment tax credit). Suppose no investment either prior to or after the tax credit.

15

Can Higher Investment Lead to Infinite Growth?

Does a

sustained increase in investment

increase Y/N today? YES!

Does a

sustained increase in investment

cause a sustained increase in Y/N? No!

Suppose I is fixed at a high level and that K initially is sufficiently small.

K grows if I > δ K: But, notice that δK is also growing each period. (Summary: To start, higher I will lead to higher K and Y/N will increase).

Eventually, however, I will converge towards δK More and more of the investment is going to replace outdated capital and the capital stock will grow by smaller and smaller rates. The increase in Y/N will converge back to zero.

Summary:

High levels of investment will increase the capital stock and output, but both K and Y will eventually converge to a fixed level. 16

Time Path of K: Permanent Increase in I

K The new level of investment has successively less effect due to growing depreciation of the capital stock.

No investment t+1 time Suppose there is a permanent increase in investment at time t. Suppose no investment prior to t. In all periods after t, the level of investment remains fixed at the level in t.

17

Can Higher Investment

Growth

Cause Infinite Growth?

If a one time increase in I gives an increase in Y, why not continuously raise I to higher and higher amounts??? Answer: Diminishing MPK!!!

MPK = .3 A (N/K) .7

; As K increases, MPK falls. As K goes to infinity, MPK goes to zero (Y stops increasing).

Suppose, we keep rising I (each year), K will increase by the amount of I (after controlling for depreciation), but Y will increase by continuously smaller and smaller amounts. Remember Y = C + I + G + NX. I/Y (investment rate) is bounded by 1 (if you invest all your output). This caps the increase in I. I cannot grow forever!

Continuously increasing I will NOT lead to sustained economic growth! NOTE: Investment decisions are NOT made in the dark (i.e. something must drive firm investment!!!!!)

Reading: Notes 5 of the text

18

What Causes Sustained Growth ?

Sustained Increases in the growth of A are the only thing that can cause a sustained growth in Y/N.

Empirically, when a country exhibits faster Y/N growth …..

33% typically comes from growth in K/N 67% typically comes from growth in A (where N = employment (not hours) - limited data).

19

Growth Across Countries

Most developed economies grow at the same rate that the “technological frontier” grows.

Some helpful definitions:

Convergence

– countries inside of the technological frontier move towards the technological frontier.

Divergence

– countries inside of the technological frontier grow at a rate less than the technological frontier.

Reading: Article 96 from the reading list

20

Distribution of World GDP in 2009 (IMF, $)

21

Distribution of World GDP in 2009 (IMF, $)

Top 10 Median Bottom 10

Qatar Luxembourg Singapore Norway Brunei UAE U.S.

Hong Kong Switzerland Netherlands 88,559 81,383 56,522 52,013 48,892 48,821 47,284 45,736 41,663 40,765 Ecuador China Albania El Salvador Tonga Guyana Namibia Algeria Turkmenistan Ukraine 7,776 7,519 7,453 7,430 7,275 6,964 6,953 6,950 6,785 6,712 Togo Malawi Sierra Leone Niger Cent. Afric. Repub.

Eritrea Zimbabwe Burundi Liberia Congo 858 827 807 755 745 681 434 411 392 328 22

Some Data: Distribution of World GDP in 2000

From Barro, 2003 – includes 147 countries. Horizontal axis is a log scale.

All data are in 1995 U.S. dollars.

23

Some Data: Distribution of World GDP in 1960

From Barro, 2003 – includes 113 countries. Horizontal axis is a log scale.

All data are in 1995 U.S. dollars.

24

Growth Rate of GDP Per Capita: 1960 - 2000

From Barro, 2003 – includes 111 countries.

25

Relative Growth Rate of GDP Per Capita: 1960 - 1988

U.S. is anchored at 1 in both years. Countries above the line have made gains relative to U.S.

26

Convergence of Income Across U.S. States: 1940 - 1980

Historical Trends in Convergence Unadjusted 1940-1960 MS NC SC TN LA KS NE WV TX UT VA MO AZ CO FL WI IN VT ME NH MT WY OR WA PA MD IL RI MA NJ CA NY NV CT 2000 4000 6000 8000 Per Capita Income 1940 Fitted values 10000 gr_ipc_40_60 12000 DE 27

Convergence of Income Across U.S. States: 1980 - 2000

MS Recent Trends in Convergence Unadjusted 1980-2000 MA NH AR NC GA VT SC ND SDTN ME AL KY UT ID WV NM LA NE IA AZ OK RI MN VA PA WI KS OR MI CO NY MD WA IL DE MT NJ NV CA WY CT 15000 20000 Per Capita Income 1980 Fitted values gr_ipc_80_00 25000 28

The Importance of Economic Growth Baseline:

Y/person in U.S. grows roughly by 2%/year (real). Assume a constant growth rate of 2% per year (real) for next 30 years.

After 30 years, U.S. Y/person will be 81% higher than today.

Scenario 1: Major recession today

Suppose U.S. Y/person contracts 3% this year and next and then grows at 2% for next 28 years.

After 30 years, U.S. Y/person will be 64% higher than today.

29

The Importance of Economic Growth Scenario 2: Major recession today and we fight it using tax and spending policy with little detriment to future growth

Suppose U.S. Y/person grows at -1% this year, 0% next and then grows at 1.9% for next 28 years.

After 30 years, U.S. Y/person will be 68% higher than today.

Take Away: Y/person in the future is HIGHER relative to doing nothing!

68% > 64% 30

The Importance of Economic Growth Scenario 3: Major recession today and we fight it using tax and spending policy with BIG detriment to future growth

Suppose U.S. Y/person grows at -1% this year, 0% next and then grows at 1.7% for next 28 years.

After 30 years, U.S. Y/person will be 59% higher than today.

Take Away: Y/person in the future is LOWER relative to doing nothing!

59% < 64%

Conclusion

: Fighting recessions today may have affects on future growth.

Benefits of fighting recession depends on whether the policies used to prevent the recession affect future growth!

31

Bonus Section

New Research Project: “The Allocation of Talent and Economic Growth” (Trying to Shed Light on the Black Box of TFP Growth)

Measuring TFP (A)

The way TFP (A) is usually measured is via a statistical decomposition (referred to as the “Solow Residual”).

Remember our assumed production function: Y = AK .3

N .7

•

Math Note:

We are going to transform the production function to make it a little easier to work with (

you should get comfortable with this

) by taking the logs: ln(Y) = ln(A) + α 0 ln(K) + α 1 ln(N) (where α 0 = 1 – α 1 ≈ 0.3) (1) • • Given that we measure Y, K and N in the data, we can estimate (1) using standard regression techniques.

ln(A) is the constant from the regression. This is our standard TFP measure.

33

Measuring TFP

Because A (TFP) is a catch-all term for anything that affects production, the assumed production function does not impose any structure on how to measure the components of TFP.

Economists are very good at measuring the extent to which TFP changes over time within a country.

It is much harder to measure “why” TFP has changed over time.

Economists try to measure this by using detailed firm-level and household-level data to measure production and wages. 34

Our Project Question 1

: How much of the observed TFP growth in the U.S. since 1960 is due to better labor market outcomes (including human capital formation) for blacks and women? growth!

o A better allocation of resources leads to higher economic o and blacks There have been HUGE changes in the allocation of women in the labor market since 1960.

Question 2

: How much of the convergence of the U.S. south to the U.S. north is due to a decline in discrimination of the south?

35

Occupational Sorting Over Time: An Overview

• Fraction of group (white men, white women, black men, black women) aged 25-55 working in the following occupations:

Executives, Mgmt, Architects, Engineers, Math/Computer Science, Natural Scientists, Doctors, and Lawyers

.

White Men White Women Black Men Black Women

1960

21.2% 3.0 (7.3)

2006-2008

23.5% 17.4 (21.0) 2.8 14.6

1.0 (2.1) 13.0 (15.2) Data: U.S. Census and American Community Survey

Occupational Sorting Over Time: An Overview

• • Where were the other groups working in 1960?

53% of working white women worked in Nursing, Teaching, Sales, Secretarial and Office Assistances, and Food Prep/Service.

o The comparable number for white men was 14% (mostly sales) •

55% of working black men worked as Freight/Stock Handlers, Motor Vehicle Operators, Machine Operators, Janitorial Services, and Personal Services.

o The comparable number for white men was 19% •

47% of working black women worked in Household Services, Personal Services, and Food Prep/Services.

o The comparable number for white men was 2%

Wage Gaps Over Time: An Overview

• Log difference in annual earnings of full time workers, conditional on experience, hours and occupation controls (relative to White Men)

1960 1980 2008

White Women Black Men Black Women -0.56

-0.37

-0.82

-0.47

-0.21

-0.47

-0.26

-0.16

-0.31

Findings Macro Implications:

o 15% − 20% of total wage growth in the U.S. between 1960 and 2008 was due to declining frictions for white women, black women, and black men. (

Shines some light into the black box of TFP growth

) o Other interesting results: - Wage growth in the 1970s and the 2000s would have been negative absent the labor market improvements for blacks and women.

- About 40% of the convergence of the south to the northeast between 1960 and 1980 is due to declining labor market frictions.

- Not much remaining room for growth from this mechanism.

190 180 170 160 150 140 130 120 110 100

Results/Counterfactuals: Model 1 Counterfactual 1: 1960 δ’s Counterfactual 2: 2008 δ’s -15%

190 180 170 160 150 140 130 120 110 100

+9

1960 1970 1980 1990 2000 2006-8 1960 1970 1980 1990 Keep Deltas at 1960 Levels 2000 2006-8 Base Model Set Deltas at 2008 Levels Base Model • Base Model Prediction: 76.6% income increase (1.2 percent/year) • Increase explained by changing δ’s: 12.2 percentage points (chained weighted, avg.) •

Percent of growth explained by changing δ’s: ~20%

1,600

Relationship Between Change in Y/N (N = # of Men Aged 25 - 55) and Change in Racial Wage Gap For Those Same Men Years: 1960-1980

1,500 1,400 1,300 1,200 y = 0,5513x + 1,2029 R² = 0,4683 1,100 Each obs. is a U.S. State. The states with the biggest decline in racial wage gaps grew the fastest during that period (in terms of Y/N) 1,000 -0,100 0,000 0,100 0,200 0,300

Decline in Black White Wage Gap 1960-1980

0,400 0,500 41

Sub-Section B

The Labor Market

Labor Market: Firm Profit Decisions

• In a competitive market, a firm can sell as much Y price p , and can hire as much N as it wants at the going as it wants at the going wage w .

• Facing w and p , a profit maximizing firm will hire N to the point were MPN = w/p (the benefit from an additional worker (in terms of additional output) must equal the cost which they are paid). <<

This is straight from micro

>> • With Cobb-Douglas: MPN = .7 Y / N = .7 A (K/N) .3

• If firms maximize profits: w/p = .7 Y / N = .7 A (K/N) .3

• If MPN • If MPN > w/p then the firm can increase profits by increasing N . < w/p then the firm can increase profits by decreasing N .

Reading: Notes 4 from the supplemental notes 43

w/p *

The Labor Demand Curve

N* real wage MPN = N d N

44

Notes on the Labor Demand Curve

• N d slopes downward (N d = MPN = .7

A * (K/N) .3

) • N d rises with A and K (assumed complementarity across inputs) • Assumption: Y is not Fixed! Firms optimally choose N, K, Y and (to some extent) A to maximize profits.

• Caveat: Who says that there is a demand for more Y?

– Need to look at the demand side of economy (introduced last -discussed in depth throughout the course). 45

The Other 1/2 of the Labor Market: Labor Supply

• Labor Supply (N s ) Results from Individual Optimization Decisions • Households compare benefits of working (additional lifetime resources) with cost of working (forgone leisure) • Factors Affecting Labor Supply – The Real Wage (w/p) – The Household’s Present Value of Lifetime Resources (PVLR) – The Marginal Tax Rate on Labor Income (t n ) – The Marginal Tax Rate on Consumption (t c ) – Value of Leisure (reservation wage) - non- ‘work’ status (VL) – The Working Age Population (pop) 46

w/p

The Labor Supply Curve

N s (PVLR, t c , t n , pop, VL) N

47

Labor Supply Notes (Most Derived From Scratch in Lecture)

• In terms of ‘wages and earnings’, there is both an

income

and

substitution

effect - we will look at them separately – BUT in the real world, they often occur jointly!!!!

• The Real Wage - HOLDING PVLR fixed: A higher w/p encourages individuals to substitute away from leisure and toward work (leisure becomes more expensive). This is a substitution effect. << This is why the labor supply curve slopes upwards !!>> – Estimating this substitution effect is difficult since PVLR is not easily held constant. Estimates range from 0 - 2% (For a 1% increase in after-tax w/p holding PVLR fixed, labor supply either increases by 0% or 2%). Very Wide Range – little consensus. • PVLR = initial wealth + present discounted value of earnings – A higher PVLR induces individuals to work less (lower N s ) for a given after-tax wage, allowing them to enjoy more leisure ( If leisure is preferred to work – as I get richer, I can afford to work less ). – PVLR is net of taxes and non-work governmental transfers and inclusive of all other transfers. 48

Labor Supply Notes

• Marginal tax rate on labor income - Should have same substitution effect as the before tax real wage. Studies of the 1986 U.S. Tax Reform found that only high-earning married women worked more in response to lower marginal income tax rates.

• Marginal tax rate on consumption - see above • Value of Leisure - If leisure/no-work becomes more/less attractive, households will less/more (reservation wage). (Welfare programs, child care, etc.).

• Working Age Population: Usually defined as 16-64. (Includes changes in Labor Force Participation Rates) 49

Recap on Labor Supply

• Substitution Effect: – For a given PVLR, a higher after tax wage increases N S . (This is why Labor Supply Curve Slopes Upward) • Income Effect – For a given after-tax wage, higher PVLR decreases N s .

• Evidence: – Weak Consensus is that, with equal (%) increase in PVLR and the after-tax wage, N s falls (income effect dominates). 50

w/p w/p

*

Temporary Increase in A

N s (PVLR, t c , t n , pop, VL) N* N d (A,K) N

51

w/p w/p

*

Permanent Increase in A

N s (PVLR, t c , t n , pop, VL) N* N d (A,K) N

52

Can Technological Progress Destroy jobs?

Facts: A, N, w/p are trending up over time.

N/pop is trending down (except in U.S. since 1980).

Higher A countries have higher w/p and lower N/pop.

Implications: Adjusting for pop, higher A goes with lower N.

Higher A reduces N d and destroys jobs? - NO!

Labor Demand Increases.

Higher A increases PVLR and reduces N s is to fall.

- The Effect on Labor Supply 53

w/p w/p

*

Permanent Increase in Population

N s (PVLR, t c , t n , pop, VL) N* N d (A,K) N

54

Population and Jobs

1000000

More People = More Jobs

100000 10000 1000 100 100 1000 10000 100000 1000000

1990 Working-Age Population (000s)

55

w/p w/p

*

Temporary Increase in Taxes (t c or t n )

N s (PVLR, t c , t n , pop, VL) N* N d (A,K) N

56

w/p w/p

*

Permanent Increase in Taxes (t c or t n )

N s (PVLR, t c , t n , pop, VL) N* N d (A,K) N

57

Labor Market Equilibrium (in long run!)

• • • • • • We define Long Run Equilibrium in macroeconomics as occurring when the labor market clears.

By definition, long run macro equilibrium exists when N = N*.

• • At N*, labor demand = labor supply. So, by definition, all workers who want a job (the suppliers) are able to find a firm looking for a worker (the demanders).

Implies that cyclical unemployment = zero at N*.

Long run equilibrium is characterized by zero cyclical unemployment!

• It is an equilibrium in that there is no incentive for

real wages

to change at N* Real wages (w/p) has two components: nominal wages (w) and the price level (p).

Note: Y* (by definition) = A K .3

(N*) .7

Y* is the long run equilibrium level of output (output where labor market is in equilibrium) 58

Our First Aggregate Supply Curve….

• • • • • • • Suppose prices (p) increase. What happens in the labor market?

In terms of equilibrium, nothing happens!

Increasing prices have no effect on labor demand (A and K do not change).

Increasing prices have no effect on labor supply (taxes, population, etc. do not change).

• • • You may ask “Doesn’t PVLR change when prices increase???” No!

As long as nominal wages adjust, real wages will be unchanged when p increases.

The % change in prices will be match exactly by the % change in nominal wages – real wages will not change (so PVLR will not change).

No effect on labor supply.

Key: Because real wages will not change, changes in prices will have NO effect on the labor market (i.e., it will have no effect on N*).

Conclusion: Changing prices will have NO effect on Y* (since N* is constant).

59

p

Our First Aggregate Supply Curve…… LRAS – Long Run Aggregate Supply Curve

Y* Y • • If labor market clears, changes in prices will lead to equal changes in nominal wages.

As a result, there will be no change in N* and hence, no change in Y*.

Leads to a vertical LRAS curve. Prices do not affect production in the long run!

60

What Shifts Y*? (the LRAS)

• • • • Anything that affects the labor market will affect Y*!

If N* increases, Y* will shift to the right.

If N* decreases, Y* will shift to the left.

– – – – – Summary: Y* will shift right if: A increases K increases population increases labor income taxes fall (and income effect is small relative to substitution effect) labor income taxes rise (and income effect is large relative to substitution effect)

Note: The long run aggregate supply curve (LRAS) is NOT the labor supply curve. We have lots of different markets in this class. There will be lots of different supply and demand curves. You need to keep track of them!

61

Things to Remember!

•

The demand side of the economy is NOT important for determining Y*!

– – – All we need to know is A, K and N and we know Y*!

The demand side of the economy is not important for economic growth!

• Key: If I ever ask you about what determines Y* (i.e., output/income/expenditure in the long run), you should think about A, K and the labor market.

As a rule, K will be fixed unless I tell you otherwise (for simplicity, you will see why soon).

•

Why do we care about the demand side of the economy?

– – – In the long run, prices will be determined by demand.

Also, LRAS is dependent on labor market being in equilibrium. In the short run, labor market need not be in equilibrium.

Demand will determine output in the SHORT RUN! 62

Summary….

• In the long run – when labor markets clear.

– Supply side of economy (labor market, K, A, other inputs like oil) determines output.

– Demand side of economy (C+I+G+NX) will determine prices.

• In the short run – when labor markets do not clear: – Demand and Supply jointly determine prices and output (think of the simple examples I gave graphically in the lecture for topic 1).

– • • • Three outstanding issues (we will get to them soon): When is the labor market NOT in equilibrium?

What does the supply curve look like when labor market doesn’t clear?

What determines demand?

63

When are Labor Markets in Disequilibrium?

• Labor market is in disequilibrium when labor demand is not equal to labor supply.

• Any time labor demand = labor supply, there is no cyclical unemployment (by definition)!

• Nominal wages do not adjust to clear the labor market – We refer to this as ‘sticky’ wages.

– Because of wage contracts (and uncertainty), nominal wages do not always adjust immediately.

– Need a model for short-run disequilibrium --- we will do that in Topic 6.

64

Cyclical Unemployment in Labor Markets

•

When do we get cyclical unemployment in our models?

• Cyclical unemployment occurs when there are no jobs available (labor demand) for those with the skills and the desire to work (labor supply) at current wages.

• Cyclical unemployment occurs

only

in disequilibrium! (when desired labor demand < desired labor supply - at given wages) N s a w’/p’ b Unemployment N(1) N(0) N d 65

What Have We Learned So Far?

• There are microeconomic fundamentals to the supply side of the economy – – Capital accumulation, Labor and TFP are important for production AND Growth!!!

• Some countries grow faster than others because they have rapid growth in TFP or K/N.

• Only growth in TFP can lead to sustained growth in Y/N • How Labor Markets Work - The Role of Taxes, Technological Progress, Capital Accumulation, And Demographics on Wages and Employment.

• Demand is not important for determining long run output (i.e., income, standard of livings, etc.). Supply (production) is the only thing that determines output in the long run!

66

Manufacturing Busts, Housing Booms, and the U.S. Labor Market During the 2000s

Kerwin Kofi Charles University of Chicago Harris School of Public Policy And NBER Erik Hurst University of Chicago Booth School of Business and NBER Matthew J. Notowidigdo University of Chicago Booth School of Business and NBER December 2012

Goal of Paper



Try to explain why employment rate changed within the U.S. during the 2000s (both prior to and during the recession)



Focus on two phenomena that hit the economy

.

o o Massive decline in manufacturing employment Housing boom and bust 

Assess how those phenomena affected employment rates (and other labor market outcomes)

.



Run counterfactuals shutting off the labor market effects of each of the phenomenon. Our focus is on manufacturing decline.



Look at the effects of these factors on human capital attainment.

What I Hope To Convey 1.

Structural shifts are having real effects on the U.S. economy during the 2000s.

o o o About 40% of increase in non-employment during 2000s can be attributed to the decline in manufacturing.

Most of this effect occurred along the “out of the labor force” margin and not the “unemployment” margin.

Manufacturing plus housing explain about 35% of increase during the recession.

2.

Labor market was weaker in the 2000-2007 period than we thought.

o o o Housing boom “masked” deterioration of U.S. labor market.

2000-2007 period marked by secular decline in one sector and a temporary boom in another sector.

Implication: 2007 may not be a good benchmark to evaluate cyclical changes in economic variables of interest.

What I Hope To Convey 3.

The net effect of housing booms/busts on labor markets was small over the entire decade.

o The bust reduced employment but the boom raised employed

4.

Housing boom deterred college attainment during 2000-2007 period.

5.

At least some of the increase in non-employment during the recession is NOT do to “cyclical forces”.

Medium-Run/Long-Run Increase in Non-Employment?



Labor market adjustments occur in the medium/long-run:

o o Workers could choose to acquire skills which could increase market wage. Workers could choose to move to different labor markets.



Adjustments take time (hence more than a short-run/cyclical story).



Our force is different from traditional mismatch stories.

o For us, people are just moving up and down labor supply curve in response to labor demand shocks (market wage < reservation wage).



Our results suggest that temporary government policies to stimulate labor demand will NOT have lasting effects on employment.

o Only implies to the 30-40% of non-employment increase we identify.

Intuition of the Model: Labor Supply and Labor Demand

Labor Supply Wages (W/P) 1 (W/P) 2 N 2 N 1 Labor Demand N

•

Empirical model Changes in Labor Market Outcomes at Local Level

( 

L k

)  

k f

( 

D M

, 

D H

, 

D O

, 

k k k

(1) (2) (3) (4) 

k

)

Definitions

: (1) (2) (3) (4) Effect of Manufacturing Labor Demand Change (through all channels) Effect of “Housing Related” Labor Demand Change Effect of “Other” Labor Demand Change (not proxied by first two) Effect of Labor Supply Change

Note: k denotes a local labor market (e.g., MSA)

L k

could be employment rate, wages, employment in a sector, etc.

What We Estimate

 

k

 0  1

D k M

(1)  2

P k H

(2)  

X k

(3)  

D k O



k

error term 

k

What is term (1)?

o o Predicted change in manufacturing employment within MSA Prediction is based upon initial industry mix in the MSA (3-digit o Interact that share with the change in employment in that 3 digit o Formally, 

D k M



i



s i



m i

Predicted vs. Actual Change in Manufacturing

What We Estimate

 

k

 0  1

D k M

(1)  2

P k H

(2)  

X k

(3)  

D k O



k

error term 

k

What is term (2)?

o o o o Actual change in house prices within the MSA during period House prices are determined by lots of factors.

Note: We purge the house price measure of the predicted manufacturing change.

What are house prices capturing?

(via Other local labor market shocks.

Effect of national housing demand shocks on labor markets

construction

or “

wealth effect

”)

House Price Movements Determined By Housing Demand Shocks (Positive relationship between prices and quantities)

Data/Timing For Main Results

•

2000 Census and 2005-2007 and 2009-2010 ACS

o o o Most of our analysis comes using Census/ACS data.

All of our analysis starts in 2000 (as a result) Focus on individuals aged 21-55.

•

FHFA metro house price indexes

•

Base estimation: 2000 – 2007 period

o o o Start in 2000 because of data limitations.

Want to focus on pre-recessionary period to get estimated responses.

Interesting to focus on the boom period (highlights masking).

•

Examine Other Time Periods (2007-2010 ; 2000-2010)

Estimates from the Empirical Model: Some Graphical Results

Change in non-employment rate for non-college men, 2000-2007

Increase in Non-employment Worse Manufacturing Shock

Change in non-employment rate for non-college men, 2000-2007

Change in average wage for non-college men, 2000-2007

Change in average wage for non-college men, 2000-2007

Change in non-employment rate for non-college men, 2000-2010

Change in non-employment rate for non-college men, 2000-2010

Other Results



Find sizeable effects of manufacturing decline on employment of non college women.

o o No effect of housing boom on construction.

Sizeable effect of housing boom on non-construction employment.



Smaller effects of housing boom and manufacturing decline on employment of college men and women.



Manufacturing shock resulted in some out-migration of individuals.

o A one-standard deviation manufacturing shock reduced population by about 3%.



Results hold instrumenting for housing price changes.



The extent of the masking occurs both within and across individuals.

Counterfactuals

Estimated Effect of Manufacturing Decline on Non-Employment

0,080 0,070 0,060 0,050 0,040 0,030 0,020 0,010 0,000 -0,010 -0,020 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0,080 0,070 0,060 0,050 0,040

~42% Explained

0,030 0,020 0,010 0,000 -0,010 -0,020 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0,080 0,070 0,060 0,050 0,040 0,030 0,020 0,010 0,000

Manufacturing Decline

-0,010 -0,020 2000 2001 2002

Housing Cycle (Construction and Other)

2003 2004 2005 2006 2007 2008 2009 2010 2011

0,080 0,070 0,060

Data

0,050 0,040 0,030 0,020 0,010 0,000

Manufacturing Housing + Manufacturing

-0,010 -0,020 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0,080 0,070 0,060

Data

0,050 0,040 0,030

34% During Recession

0,020 0,010 0,000

Manufacturing Housing + Manufacturing

-0,010 -0,020 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Education

Propensity to Have At Least One Year of College (Age: 18 29)

Did Housing Boom Delay College Attendance?

 Use same local labor market design to answer this question.

 The answer is YES!

 Places that had large housing booms had a large reduction in the propensity to attend at least one year of college.

o o Nearly all the action was on two year colleges (community colleges, technical schools, trade schools, etc.).

Found effects for both men and women.

 During the bust, this trend reversed (but, not completely).

 Estimates can explain about 80% of the time series change.

Other Results

Other Results

• Counterfactual analysis for wages for less-skilled men implies “missing”

3.3% decline

, coming primarily from lack of downward wage adjustment during bust period.

•

Decomposing non-employment results into unemployment and non participation

.

o o Bartik instrument primarily affects non-participation Suggests much of the medium run forces we are identifying are on non-participation.

o Rethink earlier work on sector shifts on labor markets (Lilien (1982), Abraham and Katz (1986)). All such tests were on unemployment – not non-employment!

•

Other boom/bust cycle: 1980s housing boom

– Preliminary results indicate broadly similar results