FRBSF Economic Letter
National labor market conditions are a central concern for both economists
and policymakers. Traditionally, macroeconomists have not paid attention
to patterns of job creation and job destruction but have tried to understand
the labor market in terms of the behavior of economy-wide aggregates,
such as interest rates or aggregate wage levels. However, in recent
years, macroeconomists have begun to pay more attention to developments
at the micro level. In this Letter we discuss some recent work
by a group of economists who study plant level employment in order to
understand macroeconomic developments.
What the microlevel
data show
Work by Davis, Haltiwanger, and Schuh (1996, henceforth DHS) has been
central to the surge of interest in this area. Their empirical analysis
is based on data for manufacturing plants covering the period from the
early 1970s to the mid-1980s. Defining employment increases at new and
growing plants as job creation, and decreases at dying and
shrinking plants as job destruction, they point out a number
of empirical regularities.
A striking feature is that the data are marked by a high rate of job
creation and destruction. On average, close to one out of ten manufacturing
jobs disappears in a given year, while the rate of new job creation
is slightly lower. These changes are quite persistent: a year later,
nearly seven out of ten newly created jobs were still in existence,
and about eight in ten lost jobs were still lost. In addition, job creation
and destruction tends to be concentrated at plants that experience large
changes in employment (those associated with plant shutdowns and startups,
for instance). Another finding is that job destruction varies more noticeably
over the cycle than job creation. Figure
1 shows that job destruction tends to increase sharply during a
recession and then fall back, while job creation does not move as much.
Some questions have been raised about these results. For instance,
some economists have cautioned against relying on data for a single
sector of the economy -- especially manufacturing, where employment
has been shrinking so noticeably. Further, the data cover a relatively
limited span (the 1970s and the 1980s), and it is possible that the
recessions of this period differ fundamentally from previous (or subsequent)
recessions in terms of restructuring and reallocation. Though the issue
is not settled yet, some of the DHS findings have been replicated elsewhere.
For instance, Blanchard and Diamond (1990) rely mainly on data from
the Current Population Survey, which is not restricted to manufacturing
alone, and they confirm the finding about the relative volatility of
job creation and destruction. For example, they find that "...booms
are times of low job destruction rather than high job creation"
(p. 87); similar patterns have been discovered in data for foreign countries
as well.
Proponents of the use of these data suggest they offer two advantages.
First, they provide a means of distinguishing among alternative models
of the economy. That is, they provide details that acceptable models
of the macroeconomy must match. Second, attempts to understand these
data are likely to lead to new ways to think about important macroeconomic
phenomena such as business cycles.
New theories on sector-specific
shocks and the business cycle
These data contradict the simple characterization of recessions as
a period when workers are laid off temporarily and then recalled to
their jobs once demand has recovered. Blanchard and Diamond point out
that these findings also rule out the Schumpeterian view of business
cycles, in which expansions are periods when new inventions are implemented,
leading to high job creation. Instead, the evidence suggests that recessions
are times of restructuring. Based on this understanding, researchers
have recently proposed a number of different models of what happens
over the course of a business cycle.
For example, DHS suggest that the available evidence is consistent
with two theories, which differ in the role assigned to "sector-specific"
shocks as sources of business cycles. In the first, often called the
sectoral shifts theory, recessions are periods that are marked by a
pronounced shift, due to either "tastes or technology," that
alters expected returns across sectors, causing some of them to expand
and others to contract. In subsequent periods, capital and labor have
to be reallocated from the contracting sectors to the expanding ones.
While beneficial for the economy as a whole in the long run, this restructuring
of activity imposes short-run costs in the form of declines in economic
activity. Oil shocks provide an interesting example here: while researchers
typically focus on the aggregate effects of oil shocks, these shocks
are also likely to cause a reallocation of jobs across sectors.
The second theory is that the economy is hit by sector-specific shocks
all the time, but reallocation is concentrated at recessions, because
the opportunity cost of undertaking the needed changes is low at that
point. Here, the predominant sources of business cycles are assumed
to be aggregate shocks, but sector-specific shocks play an important
role in determining how the aggregate shocks will affect the economy.
For example, a shift in monetary policy may induce a sector to carry
out some restructuring that might otherwise be postponed to a later
date. DHS have suggested that the pace of restructuring in the steel
industry over the years from 1973 to 1988 was influenced by the stance
of monetary policy over this period.
Caballero and Hammour (1994) implement some of these ideas in a model
in which recessions are a time of restructuring. They motivate the model
with an example from the motor vehicle industry. At the beginning of
the Great Depression, a substantial segment of the industry was still
based on skilled craftsmanship, even while mass-production techniques
were gradually becoming more important. Over the course of the Depression,
numerous plants shut down -- permanently, in most cases. These shutdowns
were concentrated in the older plants. Thus, the Depression led to a
shakeout in the industry. In the formal model they set up, technological
progress occurs at a constant rate, with the latest technology embodied
in the newest firm. Technological progress pushes prices down over time,
which in turn has the effect of making older plants obsolete. A decrease
in demand causes prices to fall faster than usual, implying a bunching
of plant shutdowns in recessions. Caballero and Hammour show that a
calibrated version of their model is able to replicate the relative
volatility of job destruction and creation found in the DHS data, and
also does a good job of replicating the time path of the data on job
destruction.
While this line of research has some interesting implications in a
number of other fields as well, for reasons of space we will focus on
two areas here: what these studies tell us about the way in which different
kinds of shocks affect the economy, and what they tell us about the
cyclical behavior of labor productivity.
Distinguishing
among different kinds of shocks
Davis and Haltiwanger (1997) show that a "typical" oil price
increase leads to the destruction of over 275,000 manufacturing production
jobs over the first eight quarters following the increase. A very significant
finding is that there is actually 'creation' of nearly 30,000 new jobs
over this period. Over the subsequent eight quarters, the cumulative
job creation continues to build to over 175,000 jobs. The fact that
oil price increases raise both creation and destruction of jobs suggests
that oil shocks alter the pattern of comparative advantage away from
some manufacturing establishments and toward others. As an example,
Davis and Haltiwanger note that the OPEC oil price shock of 1973 shifted
demand away from large cars toward small, fuel-efficient cars. Since
American automobile companies were, by and large, poorly situated to
take advantage of this demand shift, the industry's capacity utilization
and output fell in the wake of the oil shock. However, as documented
by other researchers, "a handful of plants equipped to produce
small cars operated at peak capacity ..." (p. 2).
Employment reacts noticeably differently to a monetary (or credit)
shock. Using a variety of different measures -- including the federal
funds rate and the spread between long- and short-term Treasury bills
-- Davis and Haltiwanger show that job creation and destruction move
in opposite directions in response to such shocks. When the "risk
spread" (that is, the spread between the commercial paper and Treasury
bill rates) goes up, for example, job creation actually falls by more
than 40,000 jobs after four quarters, which is more than half the increase
in job destruction over the same period. Two years after the shock,
job creation is still 10,000 jobs less than would otherwise be the case.
Understanding
the cyclical behavior of labor productivity
Baily, Bartelsman, and Haltiwanger (1996) (BBH hereafter) used micro
data to explore the cyclical behavior of labor productivity. It has
long been noted that average labor productivity declines during recessions
and increases during booms. A common explanation for this finding is
that it reflects "labor hoarding" by firms. During a recession,
output declines, but workers are retained on the payroll since the firm
expects to need them once the recession is over. As noted by BBH, an
implicit part of the labor hoarding explanation is that firms believe
that the decline in output will be short-lived.
The micro data do not offer much support to this explanation for procyclical
productivity. It turns out that much of the decline in labor productivity
during recessions in the 1970s and 1980s was in plants that were permanently
downsizing. It is more likely, therefore, that the decline in productivity
reflected the difficulties associated with restructuring the production
process in response to a permanent reduction in the scale of operations.
"Over time, if the lower level of output is sustained, productivity
can recover (and perhaps ultimately increase) as the production process
is adjusted" (BBH, p. 3).
Conclusions
The line of research pioneered by DHS already has made a number of
significant contributions to our understanding of the macroeconomy.
Their analysis of the data provides a basis on which to judge alternative
theories about the macroeconomy. And it has spurred the development
of models that provide new ways of thinking about macroeconomic phenomena
such as business cycles. Finally, the issues raised by this line of
research highlight implications of policy actions that are usually not
considered in discussions about policy. For instance, when policymakers
act to stabilize the economy, they may need to take into account the
effect of their actions on the pace of reallocation in the economy.
Note that this is not the same thing as saying that very high rates
of job destruction are desirable per se, nor that high unemployment
rates are not wasteful. In any event, this literature has not yet reached
the point of providing clear guidelines for policy; not all the implications
of this way of looking at the economy have been worked out, nor the
various debates resolved. Regardless of how various issues are resolved,
however, it seems fair to say that this work has enriched our understanding
of how the economy functions.
Prakash Loungani
Board of Governors
Bharat Trehan
Research Officer
References
Baily, Martin Neil, Eric J. Bartelsman, and John Haltiwanger. 1996.
"Labor Productivity: Structural Change and Cyclical Dynamics."
NBER Working Paper No. 5503 (March).
Blanchard, Olivier Jean, and Peter Diamond. 1990. "The Cyclical
Behavior of the Gross Flows of U.S. Workers." Brookings Papers
on Economic Activity 2, pp. 85-143.
Caballero, Ricardo J., and Mohamad L. Hammour. 1994. "The Cleansing
Effect of Recessions." American Economic Review (December)
pp. 1350-1368.
Davis, Steven J., and John Haltiwanger. 1997. "Sectoral Job Creation
and Destruction Responses to Oil Price Shocks and Other Shocks."
Mimeo. University of Chicago.
_____, _____, and Scott Schuh. 1996. Job Creation and Destruction.
Cambridge: MIT Press.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
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