Can sectoral reallocation explain the jobless recovery?

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1 Can sectoral reallocaton explan the jobless recovery? Danel Aaronson, Ellen R. Rssman, and Danel G. Sullvan Introducton and summary Recent employment trends are puzzlng. 1 Hstorcally, the number of nonfarm jobs has grown rapdly followng the end of a recesson. For nstance, durng each of the fve recessons of the 1960s, 1970s, and 1980s, t took less than four months for employment to exceed ts level at the end of the recesson ( the trough ). On average, 26 months nto those recoveres, employment was 5.4 percent hgher than at the end of the recesson and 3.6 percent hgher than at the prevous expanson s peak. Employment growth was much weaker after the recesson of the early 1990s, when t took 14 months for the number of jobs to return to the level reached at the trough and an addtonal nne months before t exceeded the prevous expanson s peak. Even 26 months nto that recovery, employment was only 1.8 percent above the trough. Moreover, job growth has been even more dsappontng snce the most recent recesson. As of January 2004, 26 months nto ths recovery, nonfarm payrolls are actually 0.5 percent below those of November 2001, the date the Natonal Bureau of Economc Research says the recesson ended. Many analysts have attrbuted ths surprsngly weak employment performance to an ncreased need for sectoral reallocaton. Accordng to ths theory, an acceleratng pace of structural change has greatly ncreased the number of workers forced by job loss to make major career transtons. Because securng a new job n a dfferent economc sector often takes a sgnfcant amount of tme, the theorzed ncrease n the need for sectoral reallocaton s thought to have temporarly rased unemployment and restraned employment growth. It s mportant to note that sectoral reallocaton s not new, nor n the long run s t a bad thng. In a wellfunctonng economy, the growth n nternatonal trade, shfts n product demand, and productvty growth that vares across sectors all mply that resources constantly need to be reallocated from one part of the economy to another. Recent research shows that such reallocaton s an mportant contrbutor to overall productvty growth and, thus, to rsng lvng standards. 2 Consequently, n the long run, reallocatng workers to ther most productve use greatly benefts the economy. However, n the short run, reallocaton s costly. 3 Workers dsplaced from contractng sectors of the economy need to spend tme searchng for new jobs. Ths can take substantal tme and resources, especally f workers old sklls do not match those demanded by frms n expandng sectors. Thus, an ncreased need for sectoral reallocaton may temporarly ncrease the economy s natural rate of unemployment and lower ts rate of employment growth. The noton that the U.S. s currently experencng an ncreased need for sectoral reallocaton s at least superfcally consstent wth a number of recent developments. In partcular, certan segments of the economy, most notably manufacturng, have seen partcularly large declnes n employment. 4 In addton, there has also been much dscusson of possble ncreases n outsourcng, offshorng, and other employment practces that could ncrease worker dsplacement. Especally promnent have been clams, largely undocumented to date, that, because of the development of the Internet, workers n many servce and techncal occupatons that were formerly relatvely solated from nternatonal competton are now beng replaced by workers n countres such as Inda or Chna. Danel Aaronson s a senor economst and economc advsor, Ellen R. Rssman s an economst, and Danel G. Sullvan s a vce presdent and senor economst at the Federal Reserve Bank of Chcago. The authors would lke to thank Bll Lncoln for research assstance and Bhashkar Mazumder and Crag Furfne for ther helpful comments and suggestons. 36 2Q/2004, Economc Perspectves

2 It s not clear, however, that the need for sectoral labor reallocaton s especally great rght now. As we have noted, reallocaton s always occurrng n a dynamc economy, and whle t s true that manufacturng has been ht hard recently, ths sector s always severely mpacted by recesson. 5 Moreover, the loss of jobs to foregn competton s hardly new. There has been a long hstory of concern over job losses to Japan, Korea, Mexco, and a host of other countres, even whle employment has contnued to expand. In ths artcle, we reconsder the case for sectoral reallocaton s role n the jobless recovery. We begn by revewng prevous work on measures of sectoral reallocaton. Ths ncludes evdence on the extent of worker dsplacement, reasons for unemployment, and job creaton and job destructon, as well as statstcal models of reallocaton based on readly avalable ndustry-level employment data. We offer a crtque of these measures, wth a partcular emphass on the recent contrbuton of Erca Groshen and Smon Potter (2003), the study most often cted by those who dentfy sectoral reallocaton as the cause of the recent jobless recovery. Fnally, we offer new evdence of the extent of sectoral reallocaton based on the methodology of Rssman (1997). Our concluson s that there s lttle evdence of an ncrease n sectoral reallocaton. Groshen and Potter have unearthed some nterestng clues about what factors may be leadng to jobless recoveres, but we do not beleve that the statstc that they dentfy the correlaton between employment growth rates durng and after recessons s a partcularly close proxy for sectoral reallocaton. In addton, we fnd that other, more tradtonal measures of sectoral reallocaton based on changes n ndustry employment shares actually rose less durng the most recent two recessons than n prevous recessons. Moreover, those measures declned to normal levels relatvely promptly once the recent recessons ended. These results hold even after approprate adjustments for busness cyclcal effects and are not partcularly senstve to the treatment of such factors as long-run trends n ndustry employment shares. Ths negatve result for reallocaton across ndustres does not necessarly mply that other forms of reallocaton have not been more sgnfcant recently. It s possble, for example, that there has been an ncrease n the number of workers forced to make major career transtons, but that those transtons have nvolved changng occupatons or geographc regons, rather than ndustres. However, t would be somewhat surprsng f there were a major ncrease n labor reallocaton that dd not result n a marked ncrease n ndustral reallocaton, and there s some lmted evdence that the level of overall reallocaton of workers across frms s currently relatvely low. Thus, economsts should contnue to look for other explanatons for the dsappontng employment growth of the last two years. Measures of sectoral reallocaton Although the concept of sectoral reallocaton s easly stated, measurng ts extent s very dffcult n practce. Ideally, one would lke to dentfy those workers or categores of workers who have lost ther jobs because of structural change and to know to what extent those workers sklls dffer from those necessary to fll avalable openngs. Unfortunately, such deal data do not exst and economsts have been forced to rely on proxy measures that they hope are proportonal to the amount of unemployment caused by sectoral reallocaton. These have most often been based on transformatons of ndustry-level employment totals. Such s the case wth the measure proposed by Groshen and Potter (2003), as well as those of Llen (1982) and Rssman (1997). Before turnng to such measures, however, we brefly dscuss some other data that mght shed lght on how the extent of necessary structural reallocaton has vared over tme. Dsplacement rates Perhaps the best source of data on the number of workers negatvely mpacted by structural change n recent years s the Dsplaced Worker Survey (DWS), a bennal supplement to the Bureau of Labor Statstcs (BLS) Current Populaton Survey that asks respondents f they have lost a job n the past three years. 6 Job losses are assgned to sx possble reasons. In most cases, job loss s attrbutable to one of the three standard reasons plant or company closng down or movng, poston or shft beng abolshed, and nsuffcent work and therefore may be the consequence of structural change. Aaronson and Sullvan s (1998 and 2003) analyss of the DWS shows that the fracton of hgh-tenured workers sufferng job loss was relatvely hgh n the late 1990s, especally gven what were otherwse very favorable labor market condtons. Ths fndng s suggestve of a relatvely hgh degree of sectoral reallocaton durng that perod. Unfortunately, the DWS data are only avalable through Moreover, avalable tabulatons only provde dsplacement rates for the combned tme perod and, thus, do not permt an analyss at the shorter tme horzons that would be necessary to evaluate the role of dsplacement n contrbutng to weak employment growth followng the recesson. 7 Federal Reserve Bank of Chcago 37

3 Reasons for unemployment Fgure 1 shows the percentage of the labor force reported unemployed due to temporary and permanent layoffs. As Groshen and Potter (2003) note, the last two recessons dd not see the knd of sgnfcant ncrease n temporary layoffs that was typcal of prevous recessons. They nterpret ths fndng as beng consstent wth structural change havng played a more promnent role n the last two recessons. The declnng usage of temporary layoffs, from whch workers can be quckly recalled, may have played some part n reducng the speed wth whch employment declnes are reversed after recessons. But, even n earler recessons, only a mnorty of unemployed workers were on temporary layoff and the fall n the proporton of the unemployed on temporary layoff sn t large enough to explan a major porton of the declne n post-recesson employment growth. For nstance, the number of workers on temporary layoff fell by the equvalent of 1.3 percent of total household employment n the two years after the 1982 trough, compared wth drops of only 0.3 percent and 0.1 percent, respectvely, followng the 1991 and 2001 recessons. Whle that s a substantal change, t s not large compared wth the dfference n overall employment growth followng the 1982 and subsequent recessons, whch was roughly 8 percent n the two years after the 1982 trough but only 1.3 percent after the 1991 trough and only 0.6 percent after the 2001 trough. Moreover, t seems more reasonable to dentfy sectoral reallocaton not wth a low level of temporary percent FIGURE 1 Percent of labor force unemployed because of permanent and temporary layoff Percent labor force unemployed b/c of temporary layoff Note: NBER dated recessons are shaded n gray. Source: Bureau of Labor Statstcs. Percent labor force unemployed because of permanent layoff layoffs, but rather wth a hgh level of permanent layoffs. And, as fgure 1 shows, durng the last two recessons, the fracton of the labor force unemployed due to permanent layoffs dd not rse to hstorcally hgh levels. In fact, the peak n permanent layoffs durng the early 1990s recesson was far below that of the recesson, and the peak of permanent layoffs durng the most recent recesson was also below that of the 1975 recesson. Thus, we do not vew the data on reasons for unemployment as offerng support for the theory that sectoral reallocaton s the cause of the jobless recoveres Job reallocaton data The Bureau of Labor Statstcs new Busness Employment Dynamcs data offer another perspectve on sectoral reallocaton. These data buld on prevous work by Davs and Haltwanger (1990) and Davs, Haltwanger, and Schuh (1996) quantfyng the extent of job creaton and job destructon n the manufacturng sector usng data from the Longtudnal Research Database of the Center for Economc Studes of the Census Bureau. In ths work, job creaton refers to the total ncrease n quarterly employment at manufacturng establshments that ncrease ther employment or are newly opened, and job destructon refers to the total declne n quarterly employment at establshments that decrease employment or close. The net ncrease n employment s the dfference between job creaton and job destructon, whle the sum of job creaton and job destructon s referred to as total job reallocaton. Davs and Haltwanger (1990) and Davs, Haltwanger, and Schuh (1996) examne job creaton and job destructon over the busness cycle. They fnd that manufacturng job destructon s strongly countercyclcal but that manufacturng job creaton s only mldly procyclcal. Unfortunately, ther data do not seem to have been updated past Moreover, the data s narrow focus on manufacturng does not allow an assessment of reallocaton across all ndustral sectors. 8 Recently, however, the Bureau of Labor Statstcs began releasng quarterly statstcs on job creaton and job destructon for the entre economy. A weakness of ths mportant new data source s that t only begns n 1992, so t covers only the most recent recesson. Whle ths means we cannot use t to determne whether the behavor of job creaton or destructon durng the current cycle s unusual, the new Busness Economc Dynamcs data 38 2Q/2004, Economc Perspectves

4 offers some mportant clues about the nature of the current perod of weak employment growth. As fgure 2 dsplays, the rate of job destructon (as a share of employment) surged durng the recesson, but the most recent data, for the second quarter of 2003, show that job destructon has fallen to the lowest level snce What has prevented net employment growth from beng more robust s a contnung low level of job creaton. 9 Ths fndng seems at odds wth the hypothess that the current perod s one of extensve job reallocaton. Indeed, total job reallocaton, as measured by the sum of job creaton and job destructon s at ts lowest level n the ten-year hstory of the seres. To square the results n fgure 2 wth an mportant role for sectoral reallocaton n the post-recesson perod, one could argue that the job destructon that occurred durng the recesson created an unusual degree of msmatch between the sklls of those out of work and those requred n expandng frms and that, consequently, the economy s stll heavly affected by those job losses. Ths s possble, but there s lttle evdence to support t. 10 Dsperson n ndustry growth rates As we have noted, most prevous research over the last twenty years has utlzed readly avalable ndustry-level employment data to attempt to dentfy the extent of sectoral reallocaton. The semnal paper s Llen (1982). Llen reasons that n the absence of sectoral reallocaton, all ndustres employment wll grow at the same rate. By contrast, when labor s beng reallocated across ndustres, expandng ndustres wll grow faster than average and contractng ndustres wll grow more slowly. FIGURE 2 Job creaton and job destructon gross job gans and losses as a share of payroll employment Gross job gans Source: Bureau of Labor Statstcs. Gross job losses Ths reasonng leads Llen to propose a measure of sectoral reallocaton based on the standard devaton across ndustres n employment growth rates: 1/ 2 L 2 I t st( gt g t), = 1 σ = where g t s employment growth n ndustry at tme t, g t s aggregate employment growth, and s t s the share of total employment n ndustry at tme t. 11 If all sectors grew at the same rate, Llen s measure would be zero. The measure s always postve and larger when ndvdual ndustry employment growth rates dverge more from the average. The dea s that changng shares of workers n ndustres should closely parallel the need for reallocaton. Fgure 3 shows the Llen measure of sectoral reallocaton from the frst quarter of 1960 through the thrd quarter of Clearly, Llen s measure of sectoral reallocaton s countercyclcal; there s more movement of employment across ndustres durng recessons than expansons. Ths s consstent wth the noton that the need to reallocate workers mples an ncrease n costly search that reduces output and rases unemployment. The fgure also shows that Llen s measure of sectoral reallocaton rose durng the most recent recesson, as well as the prevous one that occurred n the early 1990s. However, the ncrease n hs measure of reallocaton was not nearly as great as n the prevous fve recessons. Moreover, the reallocaton measure declned relatvely quckly after the last recesson and has been at qute a low level over much of the most recent jobless recovery. 13 These results clearly run counter to the dea that the jobless recovery s the result of extensve sectoral reallocaton. Abraham and Katz (1986) crtcze the Llen measure of sectoral reallocaton as confoundng cyclcal wth sectoral changes. They note that busness cycles exert a predctable pattern of effects on the dstrbuton of employment across ndustres. In partcular, employment growth n goodsproducng ndustres typcally declnes more durng economc downturns than employment growth n servce-producng sectors. Ths pattern mples ncreased dsperson n ndustry employment growth durng contractons and reduced dsperson durng expansons, even f there s no actual mpact of reallocaton on total employment. Consequently, sectoral reallocaton Federal Reserve Bank of Chcago 39

5 percent FIGURE 3 Llen measure of sectoral reallocaton Note: NBER dated recessons are shaded n gray. as measured by Llen captures both the process of sectoral reallocaton and the normal employment flows of the busness cycle. Hence, we cannot be certan that a hgh measured value of dsperson n employment growth s a sgnal of anythng other than low economc actvty. Some authors, ncludng Loungan, Rush, and Tave (1990) and Rssman (1993), have attempted to control for the cyclcalty of ndustry employment growth n order to create a measure that reflects only sectoral reallocaton. The essental noton s that cyclcal effects are temporary, whereas structural change s permanent. 14 Loungan et al. focus on dsperson n stock prces wth the belef that stock prces are forward lookng and are good predctors of ndustres that are wanng or waxng. Furthermore, stock prces are assumed to be unaffected by short-term factors. Rssman nstead decomposes changes n employment shares nto temporary or short-term movements versus permanent or long-term movements. Even after controllng for cyclcal varaton n ths way, Rssman notes that sectoral reallocaton seems to ncrease around the tme of busness cycle contractons. Groshen and Potter s measure of ndustral reallocaton The study most often cted by those who dentfy sectoral reallocaton as the cause of ths jobless recovery s that of Groshen and Potter (2003), henceforward GP. 15 Ther measure uses data smlar to that employed by Llen, but t dffers from prevous measures n several respects. One dstncton s n ts utlzaton of data at the hgher, two-dgt, degree of dsaggregaton, for whch there are 70 ndustres. 16 However, the bgger dfference s n how the ndustry data are used. Rather than measurng dsperson n ndustry growth rates, GP measures the correlaton across ndustres n growth rates over two perods of tme durng a recesson and durng the year followng a recesson. r Let g be employment growth n ndustry durng a partcular recesson e and let g be the ndustry s employment growth rate n the year followng the recesson. 17 Also let g r and g e be the correspondng aggregate employment growth rates. GP s measure of sectoral reallocaton s the proporton of employment accounted for by ndustres wth ether g r > r and e > e g g g or g r < r and e < e g g g. 18 That s, they measure the proporton of employment that s accounted for by ndustres that are ether growng faster than average n both perods or growng more slowly than average n both perods. 19 As shown n table 1, GP dentfy sectoral reallocaton wth an ndustry s presence n quadrant 1 (greater than average job growth durng both the recesson and early recovery) or quadrant 4 (less than average job growth durng both the recesson and early recovery). If, across ndustres, the correlaton between growth n the two perods s hgher, then ther measure wll tend to be hgher. Indeed, ther measure s sometmes called the quadrant correlaton, because t s based on the proporton of observatons n the varous quadrants n table 1. GP motvate the quadrant correlaton as a measure of structural change by notng that structural changes tend to be long-lved phenomena that are not quckly reversed. Thus, n ndustres n whch structural adjustments are especally sgnfcant, g r r and e e g g g wll tend to have the same sgn. That s, f structural change s postvely mpactng an ndustry, t wll tend to experence above-average employment growth n both perods. Conversely, f structural change s negatvely mpactng an ndustry, t wll tend to experence below-average employment growth n both perods. Thus, ntutvely, f the proporton of ndustres n whch g r r and e e g g g have the same sgn s hgh (quadrants 1 and 4), then employment fluctuatons may be domnated by structural nfluences. The frst row of table 2 shows the values of the GP measure for the last four recessons, where the double dp recessons of 1980 and are combned nto one long recesson. 20 Clearly, durng the last two cycles, a hgher fracton of workers were n ndustres 40 2Q/2004, Economc Perspectves

6 TABLE 1 Groshen and Potter sectoral reallocaton Job growth n year after recesson Job growth n recesson r r r r Greater than average Less than average ( g < g ) Greater than average ( g > g ) e e ( g > g ) Quadrant 2 Quadrant 1 G&P sectoral reallocaton Less than average Quadrant 4 Quadrant 3 e e ( g < g ) G&P sectoral reallocaton n whch employment growth was ether above average n both the recesson and recovery or below average n both perods. For the 1975 and recessons, the proportons were 42 percent and 44 percent, respectvely, whle for the and 2001 recessons, the fgures were 67 percent and 70 percent, respectvely. Are dfferences of the above magntude statstcally meanngful or could they be the result of random fluctuatons? 21 One very rough way to gan an apprecaton of the uncertanty n the GP measure s to compute the statstc for slghtly dfferent perods. Thus, row 2 of the table shows the same statstc computed usng the busness cycle peak for the start of the recesson and the busness cycle trough for the start of the expanson, rather than the month after these two dates as n GP. 22 Makng ths small change to the defnton of the statstc changes the values for the varous recessons by between two and ten percentage ponts. Clearly, the GP statstcs are subject to substantal varablty. However, the dfference n the GP statstc between the recessons of the 1970s and the 1980s and those of the 1990s and 2000s s of a somewhat larger magntude. Thus, the ncrease n table 2 does lkely represent an actual change rather than a purely random fluctuaton. Whle the GP statstc has some ntutve appeal, there are reasons why t s not lkely to be a close proxy for sectoral reallocaton. In partcular, t s not senstve to the magntude of the across-ndustry varablty of employment growth. That s, the value of the statstc does not depend on how far above or below average the varous ndustry growth rates are. Ths s a major weakness because the need for sectoral adjustments s lkely to be greater when ndvdual ndustres are growng at rates that dffer more from average. To see the sgnfcance of the GP statstc s nsenstvty to scale, consder two scenaros for an economy wth three ndustres, called A, B, and C. In the frst scenaro, ndustry A s employment growth durng the recesson s 2.1 percent, whle ts growth durng the followng year s 1.9 percent. For ndustry B, the fgures are 2.0 percent and 2.0 percent, respectvely, and for ndustry C, they are 1.9 percent and 2.1 percent, respectvely. If the ndustres each start wth one-thrd of the employment, then the total growth rates would be 2.0 percent and 2.0 percent (approxmately) and the GP statstc would be equal to two-thrds. 23 In the second scenaro, the three ndustres agan start wth employment shares of one-thrd, but the growth rates are 12 percent and 8 percent for ndustry A, 2 percent and 2 percent for ndustry B, and 8 percent and 12 percent for ndustry C. In the second scenaro, average growth rates are stll 2.0 percent and 2.0 percent (approxmately) and the GP statstc s agan two-thrds. However, the amount of sectoral reallocaton s lkely to be much greater n the second scenaro, n whch more than 6 percent of total employment has shfted from ndustry A to ndustry C, than n the frst scenaro n whch the shft n employment s only about one-tenth of a percent. Thus, the GP statstc msses TABLE 2 Groshen Potter and related statstcs for recent recessons Md-1970s Early 1980s Early 1990s 2001 Groshen Potter statstc 42% 44% 67% 70% Standard recesson and expanson datng 52% 46% 65% 75% GP12 statstc (quadrant correlaton for 12-month forward 52% 36% 66% 66% and backward growth rates) at recesson trough Federal Reserve Bank of Chcago 41

7 an aspect of ndustry growth rates that can be mportant for assessng sectoral reallocaton. Emprcally, dfferences over tme n the varablty of employment growth rates are lkely a very sgnfcant concern. Indeed, the Llen measure, shown n fgure 3, showed that the across-ndustry standard devaton n employment growth rates was much hgher durng the early recessons than the later ones. Thus, the GP statstc, whch s nsenstve to ths knd of varaton, does not accurately reflect the relatve degree of sectoral reallocaton n the earler and later recessons. Nether can one pont to a hstorcal track record n whch the GP statstc s hghly correlated wth employment growth. Of course, employment growth n the expansons followng the last two recessons was much lower than employment growth n the prevous recessons. So, the fact that the GP statstc was hgher n the latter two recessons s suggestve of a negatve relatonshp between t and employment growth n the early part of expansons. However, four data ponts do not seem adequate to judge the relatonshp between the GP statstc and employment growth. In order to get a clearer pcture of the relatonshp between the GP statstc and employment growth, we computed a verson of the GP statstc for each date, regardless of whether t corresponded to a recesson trough. Specfcally, for each month t, let g b be employment growth n ndustry between t and f t 12 and let g be the ndustry s employment growth from t to t Also let g b and g f be the correspondng aggregate growth rates. Then, we computed GP12 t, the percentage of employment n ndustres n whch ether b b f f b b f f g > g and g > g or g < g and g < g. Values of GP12 t for the months correspondng to the recesson troughs are shown n 1.0 the thrd row of table 1. Because recessons typcally last about 12 months, these values 0.8 are smlar to those n the other rows. 24 Fgure 4 shows the value of the GP statstc snce In addton, the versons of the GP statstc shown n table 1 are marked wth squares at the dates of recesson troughs. Several ponts are clear from 0.4 fgure 4. Frst, 70 percent s a farly typcal 0.2 value for GP12. Thus the values recorded for the trough of the last two recessons are 0.0 not unusual when judged relatve to the full hstory of data. Second, hgh values of the GP12 statstc often occur durng perods of rapd employment growth such as the late 1990s. Thus a hgh value of GP12 n recent months would not necessarly have led one to expect poor employment growth. Thrd, the GP12 statstc typcally ncreases farly sharply durng the frst several months of an expanson. The current expanson does not seem to an excepton to that rule. Fnally, n addton to droppng around the tme of a recessonary trough, the statstc tends to drop some tme near the peak of the busness cycle, often a few months before. The drop that occurred before the most recent recesson s reasonably comparable to prevous pre-recesson drops. Thus, f we were to use the GP12 statstc to judge sectoral reallocaton near the peak, we would fnd no dfference n ths recesson. To conclude, our analyss of the GP statstc suggests that, whle t may have dentfed some ntrgung dfferences between the two most recent recessons and those that preceded them, there are several reasons why t s unlkely to provde an accurate assessment of the extent of sectoral adjustment n the economy. A better measure of sectoral reallocaton Rssman (1997) develops an alternatve methodology for assessng the extent of sectoral reallocaton that s smlar to the Llen measure, but wth an allowance for cyclcal fluctuatons that addresses the crtcsm of Abraham and Katz. Her measure s based on a decomposton of the tme seres of ndustry employment share growth rates nto three components. Fgure 5 llustrates ths decomposton for a partcular ndustry, durable manufacturng. Ths chart shows percent structural change FIGURE 4 Percent structural change over tme Trough of recesson estmate Revsed GP estmate Our orgnal estmate from GP method Publshed GP estmate Note: NBER dated recessons are shaded n gray. 42 2Q/2004, Economc Perspectves

8 employment growth n durable manufacturng less aggregate nonfarm employment growth for 1961 to the present. 25 Negatve numbers ndcate that the ndustry s employment share s fallng, whle postve numbers ndcate that ts employment share s rsng. The frst factor n the decomposton reflects the long-term trend of employment nto growng sectors and out of declnng sectors. In durable manufacturng, there s a clear long-run declne n employment share. Ths s shown by the black lne, whch ndcates that on average over the last 43 years employment growth n durable manufacturng was 2 percent per year lower than aggregate employment growth. Both technologcal progress and ncreased mports have contrbuted to ths trend. The movement of employment out of durable manufacturng s structural n the sense that reallocaton s occurrng. However, gven ts predctablty and relatvely slow pace, the trend loss of jobs s perhaps not as dsruptve to employment or output growth as are unpredctable, dosyncratc changes n employment share. Second, as noted by Abraham and Katz (1986), there are predctable movements of employment nto and out of certan ndustres over the busness cycle. For example, n durable manufacturng, there s a clear procyclcal pattern to growth n the ndustry s share of employment. Due to a lull n demand for durable goods, employment falls sharply durng recessons and, once demand pcks up, ncreases durng recoveres. A smlar procyclcal pattern occurs n the other goods-producng sectors of the economy. In the servce-producng sectors, the opposte occurs. Agan, arguably, fluctuatons n employment shares due to the busness cycle may not be overly dsruptve because they are reversed farly quckly as the economy recovers. Whle job matches are destroyed, smlar ones are recreated wthn a farly short perod. Durng the nterm, the unemployment rate rses because workers are lad off. However, as the economy mproves and condtons return to normal, the unemployed are able to locate new work relatvely quckly wthout havng to nvest n the acquston of new sklls or to move n search of work. The thrd general bass for sectoral reallocaton, and lkely the most dsruptve for labor markets, s unantcpated movement of workers across ndustres. That s, reallocaton across sectors that occurs for reasons unrelated to the busness cycle or long-term secular reasons. These movements could be thought of as transformatonal changes to a frm or ndustry due to restructurng, reorganzatons, or other factors that mght shft nputs to more valuable sources. Employment changes lke these are lkely to be the most dsruptve to the labor market because they are not predcable (unlke longterm trends) but are permanent features of the landscape (unlke cyclcal trends). The above dscusson suggests a general model of ndustry employment growth net of aggregate employment growth gven by the followng: 1) ln s t g t g t = a + C t + e t, where the share of employment n ndustry at tme t s gven by S t and there are = 1,, I ndustres n the economy. Accordng to ths specfcaton, net ndustry employment growth depends upon a long-term trend captured by the term a. (For durable manufacturng, we would expect ths term to be around 2.0, reflectng the sector s long-term employment declne.) For expandng ndustres, a s postve. The cyclcal component for the th ndustry s gven by the term C t. We more formally descrbe the procedure used to generate estmates of C t below. Fnally, the dosyncratc movement n employment growth n ndustry relatve to aggregate employment growth s captured by the term e t These dosyncratc shocks reflect unantcpated permanent changes n the ndustry s employment share that are unaccounted for by ether the ndustry s FIGURE 5 Manufacturng durables employment growth less aggregate employment growth (4 quarter growth rates) percent Note: NBER dated recessons are shaded n gray. Federal Reserve Bank of Chcago 43

9 long-term trend or the busness cycle. The dosyncratc shocks are assumed to be serally uncorrelated and uncorrelated wth each other, have mean 0, and constant varance of σ 2. By gnorng the cyclcal component, as Llen (1982) does, we would overstate the mportance of the dosyncratc term. Put more smply, f we dsregard the effect of the busness cycle on durable manufacturng, for example, we nterpret all varaton n durable manufacturng s employment share as sectoral reallocaton even f some of t s clearly related to the busness cycle and s temporary. By carefully modelng the effect of the busness cycle on ndustry employment growth, we are able to address the Abraham and Katz (1986) crtque and control for the effect of the cycle on the ndustral composton of employment. Ths does not mean that sectoral reallocaton wll not be correlated wth the busness cycle. In fact, sectoral reallocaton may occur when the opportunty cost s lowest, that s, durng recessons. However, t s mportant to frst obtan a good measure of the cycle C t and ts effect upon the ndustry. There are many possble ways to measure the busness cycle, C t. One possblty s to let the cyclcal component be measured by devatons of real gross domestc product (GDP) growth from trend. Ths measure s easly calculated and would be approprate f the employment cycle were concdental wth ths measure. However, as documented earler, employment growth has been slow to recover, unlke other measures of cyclcal actvty. 26 By usng an output-based measure of economc actvty such as detrended real GDP growth to capture the cycle, we may msmeasure the cycle and msnterpret the results. For example, suppose that the most approprate measure of the cycle for analyzng changes n ndustry employment growth s an actvty-based measure, but nstead an output-based measure s employed. Now suppose that the two measures concde for much of the perod wth the excepton of the most recent expanson, durng whch the two dverge. For an ndustry lke durable manufacturng that s countercyclcal, the output-based measure would attrbute current low net employment growth to negatve shocks e t. In contrast, the actvty-based measure would attrbute the same low net employment growth n durable manufacturng to low economc actvty. Whch of these measures to use becomes a dffcult and pvotal queston. Rssman notes that busness cycles however defned are characterzed by comovements n economc actvty across ndustres. 27 Thus, durng a recesson goods-producng ndustres tend to shrnk and servce-producng ndustres to grow n employment share. She uses these comovements across ndustres to dentfy and calculate an alternatve measure of the cycle. Ths measure does not rely on nformaton about output, such as real GDP, nor does t depend upon aggregate employment growth. Instead, t depends upon the dstrbuton of employment shares across ndustres and how these employment shares shft relatve to one another over tme. The dea s to let the cycle be descrbed by certan consstent patterns of shfts n the dstrbuton of employment across ndustres. As currently specfed, equaton 1 cannot be estmated wthout further restrctons. Rssman (1997) suggests the followng, whch s based upon work by Stock and Watson (1989): 2) C t = b (L)C t 3) C t = φ 1 C t-1 + φ 2 C t-2 + u t. There s a common cycle C t that follows an AR(2) process. The cycle s permtted to affect each ndustry dfferently through the parameters of b (L), whch s a polynomal n the lag operator. Ths specfcaton offers a great deal of flexblty n characterzng the effect of the cycle on an ndustry s net employment growth. The cycle s permtted to have a leadng effect n some ndustres whle t lags n others. The magntude of the effect of the cycle on an ndustry s employment growth s also permtted to vary. The Kalman flter s used to obtan estmates of the parameters of the model. 28 Estmates of the cycle can be constructed easly from the parameter estmates. Detals of the estmaton can be found n Rssman (1997). 29 Sectoral reallocaton s the result of both longterm trends (the a 's ) and unantcpated shocks (the ε t's ). Yet, these long-term trends have been occurrng for many, many years. For example, the share of employment n goods-producng ndustres has been fallng steadly snce the 1950s. So sectoral reallocaton has been a feature of the economc landscape for decades. For sectoral reallocaton to explan the unusually low current employment growth, t must be that currently the dosyncratc shocks are abnormally large. Analogous to Llen (1982), Rssman proposes a measure of sectoral reallocaton based on the estmates of e t. Specfcally, 4) * * 2 t st t 1/ 2 σ = 1ˆ ε. 44 2Q/2004, Economc Perspectves

10 * The term s t 1 s ndustry s acyclc employment share at tme t 1. These employment shares are hypothetcally what the ndustry s employment share would have been f the employment cycle was held constant at a value of 0, mplyng neutral growth. These acyclc employment shares would depend only on the ndustry s long-term trend and dosyncratc shocks. The ˆε t s are estmates of the dosyncratc shocks for each of the ndustres obtaned from the Kalman flter estmaton exercse. The dsperson measure ncludes servces. 30 The calculaton reles upon unantcpated varaton n the composton of ndustry employment growth. Long-term structural change affects the measure only through ts effect on the acyclcal employment shares. Because of ts constructon, the measure drectly addresses the Abraham and Katz crtque of Llen s construct. An alternatve measure that s somewhat n between those proposed by Llen and Rssman s gven by: 1/2 + * 2 5) σ ˆ ˆ t = st 1( a +εt). Ths measure calculates varaton n the composton of ndustry employment growth that s unrelated to the normal shfts that occur as the result of the cycle. It s a broader measure of sectoral reallocaton n that t ncludes long-term change n ndustry employment shares as a sectoral shft. Ths s reflected both n the weght and n the ncluson of a separately. 31 Fgure 6 shows these two dfferent summary measures of sectoral reallocaton. The frst, the orange lne n fgure 6, s a four- * quarter movng average of the σ, where t the weghts are smoothly declnng and sum to one. 32 Frst, note that sectoral reallocaton concdes wth the busness cycle (even after nettng out typcal cyclcal movements across ndustres), suggestng that restructurng and reorganzaton s more common durng bad tmes when t may be less costly or that worker reallocaton actually contrbutes to aggregate downturns. The last recesson was not an excepton. The structural component of sectoral reallocaton rose from an average of 1.38 n 2000 to 2.14 durng the trough quarter. But the level of sectoral reallocaton fell back to pre-recesson levels wthn two quarters of the end of the recesson. Furthermore, the peak was sgnfcantly lower than t has been n percent prevous recessons. 33 In fact, ths measure has been n declne snce the md-1980s. Ths s consstent wth other research suggestng a fall n economc volatlty startng from the md-1980s. 34 The black lne n fgure 6 plots a more comprehensve measure of sectoral reallocaton by ncludng the long-term trend components along wth the dosyncratc shocks. Ths measure s found n equaton 5. The lne shown s agan a four-quarter movng average. Whle ths measure peaks durng the most recent recesson, the level of sectoral reallocaton suggests no unusually large ncrease durng ether of the two recent jobless recoveres, at least relatve to the 1970s and 1980s. Concluson Our fndngs do not support the theory that the need to reallocate labor across ndustral sectors has been partcularly great durng the last two recessons or the jobless recoveres that followed. We base ths concluson prmarly on two peces of evdence. Frst, we do not beleve that the wdely cted statstc that Groshen and Potter dentfy provdes an accurate assessment of the extent of sectoral adjustment n the economy. Conceptually, ther proposed measure does not capture the cyclcal element of ndustry employment dynamcs that s lkely to be an mportant component of sectoral reallocaton. Moreover, emprcally, ther measure s subject to substantal varablty, dependng on the exact perod over whch t s computed. Small changes n the length of the wndow, the datng of busness cycle turnng ponts, or the weghtng of the ndustres may lead to dfferent FIGURE 6 Sectoral reallocaton measures (4 quarter movng average) σ Note: NBER dated recessons are shaded n gray. σ* Federal Reserve Bank of Chcago 45

11 results. The second pece of evdence comes from expandng the work of Rssman (1997). After controllng for cyclcal varaton n ndustry employment growth, we fnd that reallocaton of employment across ndustres has declned, not ncreased, over the past two busness cycles. That, of course, does not necessarly mply that other forms of sectoral reallocaton have not been more sgnfcant. It s possble, for example, that there has been an ncrease n the number of workers forced to make major career transtons, but that those transtons have nvolved changng occupatons or geographc regons, rather than ndustres. However, t would be somewhat surprsng f there were a major ncrease n a form of labor reallocaton that dd not result n a marked ncrease n ndustral reallocaton. For example, suppose that the occupatonal mx has shfted to favor more hghly sklled workers. By focusng on the ndustral mx rather than the occupatonal mx, the analyss may mss an mportant aspect of the reallocaton pcture. However, to the extent that ndustres dffer n ther occupatonal mx, echoes of occupatonal reallocaton would be found n the ndustral composton of employment as well. Fnally, the fact that job destructon and creaton as measured n the Busness Employment Dynamcs data are both at low levels seems nconsstent wth a major role for any form of labor reallocaton. Whatever forces are depressng hrng at ths stage of the busness cycle are felt across a broad spectrum of ndustres, occupatons, and geographc areas. Thus, the lack of more sgnfcant employment growth snce the end of the last recesson remans a puzzle, and economsts should contnue to look for other explanatons Q/2004, Economc Perspectves

12 NOTES 1 See Aaronson, Rssman, and Sullvan (2004), also n ths ssue, for a more extensve dscusson of the jobless recovery. 2 Bartelsman and Doms (2000) extensve revew of recent productvty studes notes that a large part of aggregate productvty growth s due to worker reallocaton. 3 For estmates of the effects of dsplacement on ndvdual workers earnngs, see, for example, Jacobson, LaLonde, and Sullvan (1993a and 1993b). 4 Employment n the manufacturng sector has fallen by approxmately 15.5 percent snce the start of the recesson, ncludng a 9.5 percent fall snce the recesson ended. Ths compares wth declnes of 1.8 percent and 0.6 percent, respectvely, for the economy as a whole. 5 The recesson of the early 1990s s sometmes referred to as the servce sector recesson, but even n that downturn, manufacturng was dsproportonately affected. Manufacturng employment fell by 3.2 percent, whle employment n the nonmanufacturng sectors fell by 0.7 percent. Durng the frst two years of that jobless recovery, total nonmanufacturng employment grew by 1.9 percent but manufacturng employment fell by 2.0 percent. Manufacturng fared even worse n earler recessons. 6 The 1984 to 1992 surveys ask about the pror fve years. 7 Aaronson and Sullvan construct annual measures of dsplacement for the perod Ths requres some addtonal assumptons about the rate at whch workers forget nstances of dsplacement. See Aaronson and Sullvan (2003) for more detals. 8 Foote (1998) constructs data on job creaton and destructon for the state of Mchgan and fnds that Davs and Haltwanger s concluson may not generalze beyond the manufacturng sector. In partcular, he fnds that for ndustres that are growng as a share of employment job creaton vares more than destructon over the busness cycle. 9 The fndng that the weak employment growth of the recent perod s due more to weak hrng than hgh levels of layoffs s supported by another new data source, the Job Openngs and Labor Turnover Survey, whch began only n December These data show a fall n hrng and layoffs snce that date. On a postve note, hrng rates have mproved recently, wth the year-overyear hrng rate turnng postve durng fall 2003 for the frst tme snce the begnnng of the survey. 10 To some extent, unusually hgh unemployment duraton over the last two years s consstent wth ncreased msmatch. The medan spell of unemployment was over ten weeks durng much of 2003, ts hghest level snce One mtgatng factor to the matchng story s the ncreased use of the Internet for job search, whch lkely has mproved matchng effcency. See Autor (2001) for a dscusson. However, see Kuhn and Skuterud (2004) for emprcal evdence to the contrary. 11 Industry employment growth s related to ts share of employment by the followng mathematcal relatonshp: ln(s t ) = ln(e t / e t ) = g t g t. 12 Ths measure dentfes sectors at the one-dgt standard ndustral classfcaton (SIC) level. There are ten such ndustres: mnng; constructon; durables manufacturng; nondurables manufacturng; transportaton and publc utltes; fnance, nsurance, and real estate; retal trade; wholesale trade; servces; and government. 13 Ths descrpton of the reducton n varablty has been noted by other researchers as well (for example, McConnell and Perez- Quros, 2000, and Stock and Watson, 2003). Stock and Watson (2003) note that the standard devaton of the growth rate of GDP, averaged over four quarters, was one-thrd less durng 1984 to 2002 than t was durng 1960 to Ths declne n volatlty s wdespread across sectors wthn the U.S. It s also found n the other Group of 7 economes, although the tmng and detals dffer from one country to the next. 14 Fgura (2002) surveys the research and proposes an alternatve way to measure reallocaton, employng the same data that Davs and Haltwanger use to examne job creaton and destructon. He uses a low-pass flter to dentfy permanent employment movements and concludes that permanent reallocaton of jobs across plants accounts for about 30 percent of the cyclcal fluctuatons n aggregate employment. 15 A Google search of Groshen and Potter show well over a hundred references to ther paper, ncludng the Atlantc Magazne, Chrstan Scence Montor, CNN, The Economst Magazne, The Tmes of London, Mam Herald, San Francsco Chroncle, Seattle Tmes, USA Today, Wall Street Journal, Washngton Post, and the Weekly Standard. 16 GP nclude 67 two-dgt SIC prvate sector ndustres and three government sectors. Prvate ndustres excluded from the analyss are agrcultural producton (SIC codes 1 and 2), agrcultural servces (7), forestry (8), fshng (9), postal servce (43), mscellaneous servces not elsewhere classfed (89), and nonclassfed establshments (99). Data from the three government sectors federal, state, and local are taken from the monthly payroll survey. In earler years (pre-1988), there are eght fewer ndustry groupngs. We have computed versons of the Llen measure usng the set of ndustres tracked by GP. Qualtatvely, the results look very smlar to those n fgure 3. Moreover, computng the GP measure usng data at the one-dgt level of aggregaton yelds results smlar to those GP obtan wth two-dgt dsaggregaton. Thus, the level of dsaggregaton s not the prmary dfference between GP s results and the dsperson-based measures of sectoral reallocaton that we have prevously dscussed. 17 GP s measure s actually based on a recesson perod that starts one month after the busness cycle peak and an 11-month post-recesson perod that begns the month after the busness cycle trough. Thus, perod r does not nclude the frst month of the recesson and perod e does not nclude the frst month of the expanson. 18 Employment s measured at the peak. 19 Some reports on ther work ncorrectly descrbe ther measure of the fracton of ndustres n the structural category as consstng entrely of ndustres that are shrnkng n both perods. In fact, on average from 1970 to 2003, roughly half of the employment n ths category s accounted for by ndustres n whch employment growth s above average n both perods; and growth that s postve, but below average, s treated the same as outrght employment declnes. Federal Reserve Bank of Chcago 47

13 20 The numbers n table 2 reflect correctons made after the publcaton of ther artcle. The largest dfference between the corrected numbers and the numbers actually publshed n ther paper s for the recesson. As publshed, the fgure for the frst jobless recovery was 57 percent, closer to those of early recessons than the recesson of In the corrected data, t s much closer to the latter. The 2001 fgure publshed n GP s 79 percent, a bt hgher than the corrected fgure of 70 percent reported n table It s not mmedately obvous how best to compute a standard error for the GP statstc. We have done some smulatons n whch we generate random data smlar to that underlyng the GP statstc under the assumpton that employment growth n the two perods s jontly normally dstrbuted wth varances and covarances that match the actual data. We fnd that the standard devaton of the randomly generated GP statstcs s between 8.1 percentage ponts and 9.4 percentage ponts, dependng on the perod. Assumng the fgures for the dfferent perods are ndependent, the t-statstc for a comparson of one of the early recessons to one of the late recessons s typcally about 2.5. Ths seems to accord reasonably well wth the hghly nformal dscusson of ths paragraph. 22 As noted n footnote 17, GP s statstc s computed for perods that leave out the frst month of the recesson and recovery. 23 The two-thrds fgure arses because ndustry A grows slghtly less than average durng the recesson and recovery (quadrant 4) and ndustry C grows slghtly faster than average durng both perods (quadrant 1), but ndustry B grows at the average rate n both perods. Snce they all have equal employment shares, the GP statstc s equal to two-thrds. 24 The bggest dfference s for the combned recesson, whch s the one whose length dffers the most from 12 months. 25 Recall that ln(s t ) = g t g t. 26 In fact, the NBER notes that n defnng an expanson or recesson t focuses on aggregate economc actvty, whch s captured well by real GDP. However, defntons that emphasze the fracton of productve resources that are beng used are also vald. Such defntons would place more weght on employment numbers and the unemployment rate and gve a dfferent vew of the current state of the economy. 29 Identfyng restrctons are needed to obtan estmates. The results presented here set the varance of the busness cycle shock to unty, thereby settng the scale of the measure of the cycle. To set the tmng of the cycle and ts sgn, the cycle s assumed to enter the durable manufacturng equaton only contemporaneously. All other ndustres have current and two lags of the cycle n ther specfcaton. We drop servces to avod the constrant that employment shares sum to one. (Ths s analogous to the dummy varable problem.) We also drop mnng because t s qute small n terms of total share but, due to strke actvty, hghly volatle. To check whether results are dependent upon the use of durable manufacturng to determne the tmng of the cycle, we carred out the same analyss usng retal trade nstead of durable manufacturng to dentfy the cycle. Results were smlar. Therefore, only results that employ durable manufacturng parameter restrctons n the dentfcaton scheme are reported n the text. 30 Although we omtted servces from the orgnal estmaton procedure, we generated an estmate for servces from a lnear regresson of the same form as for the other ndustres. 31 Generally, σ + * t > σt, although t s possble that the opposte occurs f, for example, expandng ndustres have large negatve shocks and declnng ndustres have large postve ones. 32 * * * * The smoothed value σt ( S) s gven by σt = 0.4* σt + 0.3* σt 1 + * * 0.2* σ + 0.1* σ. t 2 t 3 33 The contracton and expanson quarters are 25 percent and 53 percent lower n the two most recent recessons. When we take nto account the laggng nature of ths measure, partcularly n the earler years, by assgnng the frst year of expansons as contractng perods, the dfference between pre- and post-1985 s roughly 40 n both expanson and contracton perods. 34 See, for example, McConnell and Perez-Quros (2000) and Stock and Watson (2003). 35 The Aaronson, Rssman, and Sullvan (2004) artcle, also n ths ssue, brefly revews some alternatve theores of the jobless recovery. 27 The term comovement as used here s taken to mean that two or more varables move together but not necessarly n the same drecton. 28 Rssman (1997) provdes detals. 48 2Q/2004, Economc Perspectves

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