Are shocks to U.S. firm performance transmitted to their workers?

Posted on by Bridget Ansel
Misty Thurston stitches suits for firefighters at Globe Manufacturing Co. in Pittsfield, N.H. A new paper looks at whether fluctuations in employers’ revenue affects workers’ earnings.

The most important source of income for most families is earnings from work. If the firms where they work are subject to fluctuations in revenue, and if these fluctuations are passed on to workers through a shift in their earnings, families could experience a significant volatility in income. Income instability—how much incomes fluctuate up and down over time— has grown significantly over the past few decades, making it difficult for millions of families to plan financially for the future.

Given the concern that Americans may now be subject to greater financial risk and economic insecurity, a new paper by Chinhui Juhn of University of Houston and her coauthors investigates whether changes in market demand faced by employers are important sources of volatility in workers’ earnings, or are workers insulated from these shocks?

The researchers’ results suggest that most firms try to insulate workers from shocks to firm performance. Workers in the bottom fifth of earners within a firm are the most “insured” against firm-level shocks while the top 5 percent experience more volatility, probably because performance pay incentives outweigh insurance concerns for higher-paid workers.

By using a set of firm-level revenue data linked to administrative records on employee earnings and characteristics for the United States, the researchers examine the extent to which shocks to firm performance influence change earnings for workers who stay on the job. Do firms actually shield workers from financial risk, providing both employment and insurance?

The authors find that the extent to which worker earnings are insulated varies by the size of the change in revenue, the type of worker, and the type of industry. Interestingly, changes in earnings vary by relative rank of a worker in the firm. The highest paid workers (the top 5 percent of earners) have the greatest earnings volatility among continuing workers or “stayers.” Some economists posit that this relationship is a feature of performance pay, rent sharing, or the shift to bonus pay.

The literature on performance pay suggests that workers who have large and direct impacts on firm performance face the largest trade-offs between having wages that are tied to firm revenues, which incentivizes hard work, and having “wage insurance” that reduces risk through consistent pay regardless of firm revenues. Ideas about performance pay are similar to the rent-sharing hypothesis, which contends that firms share excess profits with their workers in the form of higher relative wages. Diego Comin of Dartmouth College, Erica Groshen of the U.S. Bureau of Labor Statistics and Bess Robin of the Federal Reserve Bank of New York find that the relationship between firm and average wage volatility has been more positive over time. They attribute this to a shift in the composition of jobs toward those with bonus pay. But the measure of average wage volatility here masks the variation in worker characteristics.

Juhn and her coauthors find that higher-wage workers in manufacturing and professional services are the ones who experience the most volatility in earnings. Revenue fluctuations to a manufacturing firm have an insignificant effect on the bottom 20 percent of its workers, but the top 5 percent of that firm’s workers do have a positive elasticity of nearly three percent. That is, their wages will respond to a 10 percent gain (or loss) in firm revenue by moving up (or down) by 3 percent. The pattern is more pronounced for professional service firms. A 10 percent change in their revenue has no effect for the bottom 20 percent of workers’ earnings, but for the top 5 percent of workers, wages will respond to shocks at a rate of 9 percent.

One limitation of the study is that it focuses solely on workers who continue to be employed at the same firm after the demand shock. Unique shocks to firm outcomes can potentially affect the earnings volatility of those who stay, yet they also affect the likelihood that employees stay at their current job. The lack of movement in earnings for the bottom fifth of workers may be a result of a drop in employment or layoffs rather than the firm providing full “wage insurance” to its workers.

The researchers see the small estimates of performance transmissions to workers’ earnings as supporting the claim that firms are partially insuring their workers and insulating employee wages from shocks to the demand they face. For the workers who stay, being able to anticipate earnings can be enormously important, especially low-wage workers who lack the tools and resources to deal with unstable earnings.

But the authors also note that shocks to local labor markets or employment may in fact be more important than firm performance to workers’ earnings volatility, suggesting that whether or not a worker is still employed may matter more for maintaining a stable income than changes in firm revenue.

Can women’s “sagging middle” help explain the fall in U.S. labor force participation rates?

Posted on by Bridget Ansel

Labor force participation rates in the United States have been falling since 2000. Just 62.5 percent all Americans were in the labor force (defined as either working or actively looking for work), the lowest rate in nearly 30 years. This trend has many policymakers, including President Trump, concerned. The slowdown is the main factor behind the Congressional Budget Office’s prediction that the U.S. economy will grow substantially more slowly over the next decade than it has in recent history, at a rate of about 2 percent per year as compared to 3.2 percent annual average growth in adjusted GDP between 1950 and 2015. Policymakers looking to accelerate economic growth need to take the causes and consequences of the declining labor force participation rate seriously.

Much of the overall decline in labor force participation can be explained by the aging of the U.S. population, as large cohorts of older workers retire and smaller cohorts of younger workers take their place. But the graying of America can’t explain away the decline in the labor force participation rate for prime-age workers ages 25-54, which has been falling since 2000. Key to understanding the overall decline in labor force participation may be the decline in women’s labor force participation, which is often overlooked in the national conversation.

Rising labor force participation rates among prime-age women was a key factor driving up overall labor force participation rates during the second half of the 20th century, and thus a key driver of economic growth. But, beginning around 2000, women’s labor force participation rates stalled out, and, as a result, the overall labor force participation numbers began their downward slide. Moreover, while men’s labor force participation rates have been flat or falling across other wealthy economies, the dip in labor force participation rates among American women since 2000 is unique—the United States is one of only seven of 35 OECD countries with a declining prime-age female labor force participation rate.

A new Journal of Economic Perspectives paper from Claudia Goldin of Harvard University and Joshua Mitchell of the U.S. Census Bureau provides some compelling new evidence for those looking to understand the causes of declining prime-age labor force participation. The authors focus their analytic lens on prime-age women, providing a careful analysis of changes in women’s labor force participation from the 1950s through the present. Using multiple datasets, including multiple survey data sources matched to administrative data on Social Security earnings records and W-2s, the authors show that delayed marriage and childbirth has had a profound impact on women’s employment patterns over time. The delay in marriage and childbirth, they suggest, has fundamentally shifted the trajectory of women’s labor force participation over the life cycle.

Women born prior to 1940 had very low labor force participation rates in their mid-20s through their mid-30s, presumably because many mothers delayed labor force participation until their children were no longer young. Beginning with the cohort born in the 1940s, more women entered the labor force in their 20s, and the share of women in the labor force increased steadily until beginning to taper when the women hit their early 50s. But, beginning with cohorts born in 1960, a distinct “sagging middle” emerges: Women work from their mid-20s through their early 30s, but a substantial share exit the labor force in their mid-30s through their mid-40s.

Goldin and Mitchell argue that this “sagging middle” comes from the delay in childbirth, which they attribute to women’s rising human capital attainment and the “power of the Pill” (oral contraceptives). While most of these women who leave the labor force in their 30s and 40s rejoin in their mid-40s, this “sagging middle” provides a clue as to why overall women’s labor force participation numbers have been declining in recent years.

The new problem of the sagging middle is particularly acute for college-educated women, whose labor force participation levels are higher than their non-college-educated peers, but for whom this mid-career detachment from the labor force seems to have lasting implications for labor force participation. Women’s labor force participation rates have always dipped in the years following the birth of a child. But Goldin and Mitchell find that while participation rates for earlier cohorts fully recovered following a dip in the 10 years following childbirth, newer cohorts of college educated woman are not recovering to their pre-birth participation rates.

In fact, the rates of labor force participation for six or more years following the birth are lower for the most recent observable birth cohort than for the previous cohort. All of this suggests that college-educated women are less likely to work following the birth of a child than in the past, which has the potential to drag down the overall labor force participation rate.

A wide range of policy solutions could go a long way to increasing the labor force participation rate for women with children, including those with college degrees—many of whom would likely have a non-negligible impact on fathers’ labor force participation as well, if designed properly. For instance, multiple studies suggest that job-protected and paid leave will increase women’s labor force participation, as would policies such as flexible work arrangements that could help stave off women quitting their jobs during pregnancy.

Yet Goldin and Mitchell caution that life-cycle labor force participation rates for women in the United States and the United Kingdom look remarkably similar, despite the absence of paid leave in the former and a protected and paid parental leave policy in the latter. In contrast, life-cycle women’s employment patterns in France and Denmark have continued to increase with age, suggesting that the lower cost and higher quality of childcare might be the more important of the two for making a noteworthy difference in women’s labor force participation over the course of a lifetime.

Americans’ feelings about the U.S. economy make sense

Posted on by Bridget Ansel
Shuttered storefronts in downtown Logan, W.Va.

A common conundrum for economists is the ongoing disconnect between macroeconomic outcomes and how Americans report feeling about the economy. The U.S. economy is growing at a respectable, although lackluster, rate of 1.9 percent; the unemployment rate recently hit an 8 year low of 4.8 percent; and household incomes grew by a record 5.2 percent last year (the latest data we have). Yet public opinion polls report that 54 percent of Americans view the nation as being on the wrong track, and that in early November more people “saw the economy as getting worse than getting better.”

New York Times reporter Neil Irwin offers two alternative reasons for what’s “rotten in many people’s economic lives.” He reports that the economy is either too volatile or it’s not dynamic enough. He notes there is evidence that points in both directions. On the one hand, jobs appear to be more precarious than in the past. But on the other, the economy is creating fewer start-ups and fewer people are moving. The point Irwin is making is that these various conditions don’t show up in the regularly released data.

The assumption embedded in these explanations, however, is that it’s the pattern that matters, not the conditions themselves. If policymakers could reduce turnover among employees and increase the entry of new firms, then workers would not be so frustrated. But is there a logical reason to assume that — all else being equal — more or less employment and business dynamism would create economic stability for workers and their families?

An alternative explanation is that people simply see the U.S. economy on the wrong track because even though the economy is growing, many people don’t see any gains in their own lives. And this explanation definitely doesn’t show up in our regularly produced statistics.

A new data series on economic growth built by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez and Gabriel Zucman of the University of California-Berkeley seeks to fix this gap in our data. By matching survey data to administrative records and matching that to National Accounts data, such as gross domestic product, the three economists allow policymakers to see how income growth looks across income groups.

They find evidence for why people feel that the economy is on the wrong track. Between 1980 and 2014, average national income per adult grew by 61 percent in the United States. Yet virtually none of that economic growth accrued to those in the bottom half of the income distribution. Over that 34-year period, the average pre-tax income of the bottom half of individual income earners grew by a paltry one percent, after adjusting for inflation. Those at the top gained substantially from economic growth as their incomes rose by 121 percent for the top 10 percent, 205 percent for the top one percent, and 636 percent for the top 0.001 percent.

People aren’t oblivious to this trend. They can tell that they work hard but attaining economic security has become harder to do. If policymakers could track this data alongside the GDP data each quarter, then there would be no question why Americans feel that the economy is on the wrong track. They would learn that GDP grew by 1.9 percent but also who in the United States took home those gains. Policymakers and the public alike then would be able to understand how these gains or lack of gains look for families.

One thing economists and other social scientists know is that families up and down the income ladder struggle in ways some of those in earlier generations did not because they have less time. Many Americans lost the “silent partner” who took care of family life while one adult—typically Dad—was the breadwinner. The combination of dual-earning families and families with only one parent means that very few families—less than one in four—have that luxury today.

Of course, this doesn’t tell policymakers why the gains from growth aren’t being shared. And, so the New York Times’ Irwin’s is asking the right question. Is it that reduced job turnover also reduces a worker’s ability to bargain over the gains of growth? Or, does the stranglehold by established businesses on the entry of new businesses allow those who are already ensconced in jobs to hold on to the gains? Globalization and automation are certainly factors, but we need to know more about why these trends in the United States (but not in many of our major economic competitors) means that workers no longer gain from economic growth.

Must-Read: Richard Baldwin: Trump’s Anachronistic Trade Strategy

Posted on by Brad DeLong

Must-Read: Richard Baldwin: Trump’s Anachronistic Trade Strategy: “Trump has aggressively lashed out against globalization…

…appointed the famously protectionist trade litigator Robert Lighthizer to be US Trade Representative. And the other two members of his trade triumvirate – Commerce Secretary-designate Wilbur Ross and White House trade adviser Peter Navarro – are no less protectionist…. Many working- and middle-class Americans believe that free-trade agreements are why their incomes have stagnated over the past two decades. So Trump intends to provide them with “protection” by putting protectionists in charge….

Old-fashioned protectionism will not boost American industrial competitiveness even if it saves a few thousand jobs in sunset sectors…. Ripping up trade agreements and raising tariffs will do nothing to create new, high-paying factory jobs… [but] only inflict further harm on workers…. Twenty-first-century globalization is knowledge-led, not trade-led…. “Knowledge offshoring” is what has really changed the game….

If the Trump administration imposes tariffs, it will turn the US into a high-cost island for industrial inputs…. Instead, the US needs to restore its social contract so that its workers have a fair shot at sharing in the gains generated by global openness and automation…. Over the last two decades… globalization has continued, but the social contract has been torn up. Trump’s top priority should be to stitch it back together; but his trade advisers do not understand this…

Must-Read: Nick Bunker: What’s Behind the Decline in U.S. Interest Rates?

Posted on by Brad DeLong

Must-Read: Nick Bunker explains Eggertsson, Mehrotra, and Robbins to us:

Nick Bunker: What’s Behind the Decline in U.S. Interest Rates?: “Eggertsson, Mehrotra, and Robbins decompose the roughly 4 percent decline in the natural rate of interest since 1970…

…The decline in mortality helped push down the natural rate by about 1.8%-points… [as] individuals had to save more for retirement, thus increasing the supply of savings…. Fewer children reduces the demand for loans… [another] 1.8%-point decline…. Slower productivity growth… 1.9%-points…. The increase in government debt… [+]2%-points…. The declining labor share… 0.5%-points… the declining price of capital goods… 0.4%-points)….Secular stagnation might be around for quite a time to come.

Should-Read: Martin Sandbu: Donald Trump’s Love of Manufacturing Is Misguided

Posted on by Brad DeLong

Should-Read: Martin Sandbu: Donald Trump’s Love of Manufacturing Is Misguided: “Donald Trump and his economic team love manufacturing…

…Peter Navarro’s attacks on Germany and stated goal to repatriate international supply chains…. The high productivity of manufacturing means a country with a large proportion of its workforce in factories needs to ship a lot of its output abroad: it will simply be producing too many goods for its own population to consume…. On a global level, there are… only so many manufacturing jobs to be had…. There are three countries that have traditionally been goods producers to the world: Germany, Japan and China…. The economic nationalism of President Trump and Messrs Navarro and Bannon can be described as Germany-envy….

But… manufacturing machismo itself is a handicap when it comes to grasping the opportunities for a thriving economy. By far the largest number of jobs to be created in the US over the next decade will be in services, in particular the caring professions…. Regardless of trade, automation is reducing the need for manufacturing jobs everywhere. As the economist Brad DeLong pointed out in a recent essay, that is true in Germany, too, which has seen a fall in factory employment almost as sharp as in the US (the same holds for Japan)…. Many German workers have faced long wage stagnation. And all the big industrial economies have chosen to internationalise their supply chains….

It gets worse. If the factory fetishists are obsessed enough to throw themselves into a battle for a steadily shrinking type of employment, they may well find that their most obvious weapons are doubled-edged at best. Suppose the Trump administration forced through changes in the North American Free Trade Agreement so as to repatriate all parts of the car production process, the most salient of the supply chains Mr Navarro says he wants to bring back. The result will be to make US-produced cars more expensive. How is that going to help expand American car exports?… Protectionist policies are likely to shrink imports and exports, leaving the protected economy worse off than before and in no better position even by the misguided measures of the manufacturing fetishists themselves.

Should-Reads: February 14, 2017

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Peter Orszag: Here’s How Trump Will Change Obamacare

Posted on by Brad DeLong

Should-Read: Peter Orszag: Here’s How Trump Will Change Obamacare: “I expect to see Republicans stage a dramatic early vote to repeal…

…just for show…. The Republicans’ desire to hold an early partisan vote repealing the ACA… seems too strong to resist. The repeal will probably be set to become effective in the future, perhaps 2019 or 2020. This vote will probably be closer than many people think…. For the White House, however, the closeness of the vote will be a feature rather than a bug, because it will create the impression that the vote is significant….

The hard work of a creating comprehensive replacement is then likely to get bogged down in legislative muck. But the administration can use its expansive waiver authority to allow states to experiment with both Medicaid and the individual insurance markets. As these 50 flowers bloom, President Trump could at some point declare victory and assert that the ACA has been sufficiently reformed…. In response to any particular complaint in a specific state, the administration could simply shrug its shoulders and direct the inquiry to the relevant governor.

Should-Read: Anton Cheremukhin et al. (2013): Was Stalin Necessary for Russia’s Economic Development?

Posted on by Brad DeLong

Should-Read: Joachim Voth and I both focused on how Tsarist industrialization was hindered by monopoly power in manufacturing, and on the absence of a special bonus for the Stalinist construction of a heavy industrial sector in Magnitogorsk and elsewhere very far in the interior. The destruction of monopoly power via planning–along with the destruction of the peasant-collective barriers to mobility–was a big plus that largely offset the inefficiencies of central planning. The creation of a heavy industrial complex in Magnitogorsk was a priceless asset for the world come World War II.

Anton Cheremukhin et al. (2013): Was Stalin Necessary for Russia’s Economic Development?: “We construct a large dataset that covers Soviet Russia during 1928-1940 and Tsarist Russia during 1885-1913…

…We use a two-sector growth model to compute sectoral TFPs as well as distortions and wedges in the capital, labor and product markets. We find that most wedges substantially increased in 1928-1935 and then fell in 1936-1940 relative to their 1885-1913 levels, while TFP remained generally below pre-WWI trends. Under the neoclassical growth model, projections of these estimated wedges imply that Stalin’s economic policies led to welfare loss of -24 percent of consumption in 1928-1940, but a +16 percent welfare gain after 1941. A representative consumer born at the start of Stalin’s policies in 1928 experiences a reduction in welfare of -1 percent of consumption, a number that does not take into account additional costs of political repression during this time period. We provide three additional counterfactuals: comparison with Japan, comparison with the New Economic Policy (NEP), and assuming alternative post-1940 growth scenarios….

The country significantly lagged behind advanced capitalist economies, the US and UK. However, Russia’s industrialization proceeded at a speed similar to some other industrializing economies, in particular, Japan…. Most importantly, as noted by Gerschenkron (1962), reallocation of labor to industry was hindered by the prevalence of communal rather than individual ownership of land… the institutions of obschina….

The eminence of cartels (syndikaty), especially post 1899-1902 recession, in the capital goods industries (steel, coal, iron, railroad engineering). These cartels were to a large extent foreign owned. Syndikaty established prices and the market quotas. The cartelization of an important part of the heavy industries likely played an additional role in restricting the size of the manufacturing sector relative to a competitive market….

Modeling the decline in U.S. interest rates

Posted on by Bridget Ansel
Stock trader Mark Puetzer follows stock information on electronic screens at the New York Stock Exchange.

A trend as important and complex as the long-term decline in interest rates is going to attract multiple explanations, with many economists eagerly offering up their own recent models in search of answers. Understanding why interest rates have declined so much may help us understand where interest rates will head and how policy might boost the natural rate of interest. A recent paper that builds a model of secular stagnation points toward changes in demographics and declining productivity growth as the major culprits behind the decline in U.S. interest rates. But it might be worthwhile thinking through the decline in interest rates in a different framework.

A model like the one used in a paper by economists Lukasz Rachel and Thomas Smith of the Bank of England thinks of the interest rate as being determined by the interaction of desired investment and desired savings. Think of a supply-and-demand graph where the upward-sloping curve is desired savings, or the supply of savings, and the downward-sloping curve is desired investment, or the demand for savings. The horizontal axis here is savings as a share of gross domestic product and the vertical axis is the interest rate.

The Rachel and Smith paper finds that the decline in the global interest rate of interest is due about equally to a decline in both desired savings and desired investment. The result is a lower interest rate, but with no significant change in the savings as a share of gross domestic product.

But note that the analysis is just for the global interest rate. In their paper, Rachel and Smith show how the trends are slightly different for high-income countries and emerging economies. Both groups of countries saw interest rates decline, but savings as a share of GDP increased among emerging economies while declining among high-income economies. If the price and the quantity of something is down, then this means that declining “demand” (in this case desired investment) has shifted more than “supply” (desired savings). The trend holds up for the United States specifically as interest rates and investment and savings as a share of GDP have both trended downward since the 1980s.

Increased desired savings are likely to play a role as well as the U.S. population has aged. There also is the possibility that increased income inequality, particularly the rise of the top 1 percent, has increased desired savings, according to a paper by economists Adrien Auclert at Stanford University and Matthew Rognlie at the Massachusetts Institute of Technology. Increases savings by corporations also have also contributed to a shift in the savings schedule.

But if the decline in desired investment is at the heart of declining interest rates in the United States, then it may be more worthwhile to dig into the causes of that trend. One potential cause– highlighted by Rachel and Smith’s analysis – is the declining relative price of investment goods. If investment goods are less expensive, then companies will need to spend less for a given investment project. The result is that there’s a downward shift in the schedule for desired investment.

A second potential cause is the increased spread between the risk-free interest rate (the rate of the presumed safest asset) and the return on capital. This higher difference means that a decline in interest rates is less likely to reduce the required return on investment and spur investment. The result is less investment for every given interest rate level, or a downward shift in desired investment.

The reasons behind the increased interest rate spread are not completely understood, but a recent paper by Ricardo Caballero of MIT, Emmanuel Farhi of Harvard University, and Pierre-Olivier Gourinchas of the University of California-Berkeley tries to sort of the causes. The three economists find an increase in risk premiums, meaning that investors want to be compensated more for investing in riskier projects. They also point out that other factors, such as increasing economic “rents” (excessive profits) and technological change that favors capital, may also be contributing to the increased spread and declining interest rates.

Of course, slowing economic growth also could be responsible for declining investment as accelerator models of investment would indicate. But it’s not clear what the relative importance of these factors are for the United States. Better understanding how much desired investment is declining in the United States and what’s behind that trend can help policymakers not only boost short-term growth and boost productivity, but also give them greater insight into what might reverse the decline in interest rates.