FOCUS
The Current Population Survey (CPS) is the main source of statistics on the labor force, employment, participation, and earnings in the United States.
When the CPS began in 1940, it was based on in- terviews of 8,000 households. The sample has grown considerably, and now about 60,000 households are interviewed every month. (The CPS was redesigned in 1994, which is why, for consistency, Figures 6-2, 6-4, and 6-5 start only in 1994.) The households are chosen so that the sample is representative of the U.S. population.
Each household stays in the sample for four months, leaves the sample for the following eight months, then comes back for another four months before leaving the sample permanently.
The survey is now based on computer-assisted inter- views. Interviews are either done in person, in which case interviewers use laptop computers, or by phone. Some questions are asked in every survey. Other questions are specific to a particular survey and are used to find out about particular aspects of the labor market.
The Labor Department uses the data to compute and publish numbers on employment, unemployment, and participation by age, sex, education, and industry. Econo- mists use these data, which are available in large compu- ter files, in two ways:
The first is to get snapshots of how things are at various points in time, to answer such questions as: What is the distribution of wages for Hispanic–American workers with only primary education, and how does it compare with the same distribution 10 or 20 years ago?
The second way, of which Figure 6-2 is an example, is answered by the fact that the survey follows people through time. By looking at the same people in two con- secutive months, economists can find out, for example, how many of those who were unemployed last month are employed this month. This number gives them an esti- mate of the probability of somebody who was unemployed last month found a job this month.
For more on the CPS, you can go to the CPS homepage.
(www.bls.gov/cps/home.htm)
Some of the people classified as “out of the labor force” are very much like the un- employed. They are in effect discouraged workers. And while they are not actively looking for a job, they will take it if they find one.
This is why economists sometimes focus on the employment rate, the ratio of employment to the population available for work, rather than on the unemploy- ment rate. The higher unemployment, or the higher the number of people out of the labor force, the lower the employment rate.
We shall follow tradition in this book and focus on the unemployment rate as an indicator of the state of the labor market, but you should keep in mind that the unemployment rate is not the best estimate of the number of people available for work.
6-2 Movements in Unemployment
Let’s now look at movements in unemployment. Figure 6-3 shows the average value of the U.S. unemployment rate over the year, for each year, all the way back to 1948. The shaded areas represent years during which there was a recession.
Figure 6-3 has two important features:
■ Until the mid-1980s, it looked as if the U.S. unemployment rate was on an upward trend, from an average of 4.5% in the 1950s to 4.7% in the 1960s, 6.2% in the 1970s, and 7.3% in the 1980s. From the 1980s on however, the unemployment rate stead- ily declined for more than two decades. By 2006, the unemployment rate was 4.6%.
These decreases led a number of economists to conclude that the trend from 1950 to the 1980s had been reversed, and that the normal rate of unemployment in the United States had fallen. How much of the large increase in the unemployment rate since 2007 is temporary, and whether we can return to the low rates of the mid-2000s, remains to be seen.
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Working in the opposite direc- tion: Some of the unemployed may be unwilling to accept any job offered to them and should probably not be counted as unemployed since they are not really looking for a job.
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In 2010, employment was 139 million and the population available for work was 237.8 million. The employment rate was 58.5%. The employment rate is sometimes called the employment to population ratio.
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Unemployment rate (percent)
2 2010 3 4 5 6 7 8 9 10
1950
Figure 6-3
Movements in the U.S.
Unemployment Rate, 1948–2010
Since 1948, the average yearly U.S. unemployment rate has fluctuated between 3% and 10%.
Source: Series UNRATE: Federal Reserve Economic Data (FRED) http://research.stlouisfed.org/fred2/
■ Leaving aside these trend changes, year-to-year movements in the unemployment rate are closely associated with recessions and expansions. Look, for example, at the last four peaks in unemployment in Figure 6-3. The most recent peak, at 9.6%
is in 2010, is the result of the crisis. The previous two peaks, associated with the recessions of 2001 and 1990–1991 recessions, had much lower unemployment rate peaks, around 7%. Only the recession of 1982, where the unemployment rate reached 9.7%, is comparable to the current crisis. (Annual averages can mask larger values within the year. In the 1982 recession, while the average unemploy- ment rate over the year was 9.7%, the unemployment rate actually reached 10.8%
in November 1982. Similarly, the monthly unemployment rate in the crisis peaked at 10.0% in October 2009.)
How do these fluctuations in the aggregate unemployment rate affect individual workers? This is an important question because the answer determines both:
■ The effect of movements in the aggregate unemployment rate on the welfare of individual workers, and
■ The effect of the aggregate unemployment rate on wages.
Let’s start by asking how firms can decrease their employment in response to a decrease in demand. They can hire fewer new workers, or they can lay off the workers they currently employ. Typically, firms prefer to slow or stop the hiring of new work- ers first, relying on quits and retirements to achieve a decrease in employment. But doing only this may not be enough if the decrease in demand is large, so firms may then have to lay off workers.
Now think about the implications for both employed and unemployed workers.
■ If the adjustment takes place through fewer hires, the chance that an unemployed worker will find a job diminishes. Fewer hires means fewer job openings; higher unemployment means more job applicants. Fewer openings and more applicants combine to make it harder for the unemployed to find jobs.
■ If the adjustment takes place instead through higher layoffs, then employed work- ers are at a higher risk of losing their job.
In general, as firms do both, higher unemployment is associated with both a lower chance of finding a job if one is unemployed and a higher chance of losing it if one is employed. Figures 6-4 and 6-5 show these two effects at work over the period 1994 to 2010.
Figure 6-4 plots two variables against time: the unemployment rate (measured on the left vertical axis); and the proportion of unemployed workers finding a job each
䉳 Note also that the unemploy- ment rate sometimes peaks in the year after the recession, not in the actual recession year. This occurred, for exam- ple, in the 2001 recession. The reason is that, while output is higher and growth is positive, so the economy is technically no longer in recession, the additional output does not re- quire enough new hires to re- duce the unemployment rate.
4.0 5.0 6.0 7.0 8.0 9.0 10.0
1994-1 1997-1 2000-1 2003-1 2006-1 2009-1
16.0 18.0 20.0 22.0 24.0 26.0 28.0 30.0 32.0 Unemployment rate 34.0
Percent of unemployed workers finding a job each month
(inverse scale)
Percent of unemployed finding a job (inverse scale)
Unemployment rate (percent)
Figure 6-4
The Unemployment Rate and the Proportion of Unemployed Finding Jobs, 1994–2010
When unemployment is high, the proportion of unemployed finding jobs within one month is low. Note that the scale on the right is an inverse scale.
Source: See Figure 6-2.
month (measured on the right vertical axis). This proportion is constructed by dividing the flow from unemployment to employment during each month by the number of un- employed. To show the relation between the two variables more clearly, the proportion of unemployed finding jobs is plotted on an inverted scale: Be sure you see that on the right vertical scale, the proportion is lowest at the top and highest at the bottom.
The relation between movements in the proportion of unemployed workers find- ing jobs and the unemployment rate is striking: Periods of higher unemployment are associated with much lower proportions of unemployed workers finding jobs. In 2010, for example, with unemployment close to 10%, only about 18% of the unemployed found a job within a month, as opposed to 28% in 2007, when unemployment was much lower.
Similarly, Figure 6-5 plots two variables against time: the unemployment rate (measured on the left vertical axis); and the monthly separation rate from employment (measured on the right vertical axis). The monthly separation rate is constructed by dividing the flow from employment (to unemployment and to “out of the labor force”) during each month by the number of employed in the month. The relation between the separation rate and the unemployment rate plotted is quite strong: Higher unemploy- ment implies a higher separation rate—that is, a higher chance of employed workers losing their jobs. The probability nearly doubles between times of low unemployment and times of high unemployment.
Let’s summarize:
When unemployment is high, workers are worse off in two ways:
■ Employed workers face a higher probability of losing their job.
■ Unemployed workers face a lower probability of finding a job; equivalently, they can expect to remain unemployed for a longer time.
6-3 Wage Determination
Having looked at unemployment, let’s turn to wage determination, and to the relation between wages and unemployment.
Wages are set in many ways. Sometimes they are set by collective bargaining;
that is, bargaining between firms and unions. In the United States, however, collec- tive bargaining plays a limited role, especially outside the manufacturing sector. To- day, barely more than 10% of U.S. workers have their wages set by collective bargaining agreements. For the rest, wages are either set by employers or by bargaining between
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To be slightly more precise, we only learn from Figure 6-5 that, when unemployment is higher, separations into un- employment and out of the labor force are higher. Separa- tions equal quits plus layoffs.
We know from other sources that quits are lower when unemployment is high: It is more attractive to quit when there are plenty of jobs. So, if separations go up and quits go down, this implies that lay- offs (which equal separations minus quits) go up even more than separations.
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Collective bargaining: bar- gaining between a union (or a group of unions) and a firm (or a group of firms).
1994-1 1997-1 2000-1 2003-1 2006-1 2009-1
4.0 5.0 6.0 7.0 8.0 9.0 10.0
Unemployment rate Monthly separation rate
Monthly separation rate (percent)
Unemployment rate (percent)
1.00 1.10 1.20 1.30 1.40 1.50 1.60 1.70 1.80
1.90 Figure 6-5
The Unemployment Rate and the Monthly Separation Rate from Employment, 1994–2010 When unemployment is high, a higher proportion of workers lose their jobs.
Source: See Figure 6-2.
the employer and individual employees. The higher the skills needed to do the job, the more likely there is to be bargaining. Wages offered for entry-level jobs at McDonald’s are on a take-it-or-leave-it basis. New college graduates, on the other hand, can typi- cally negotiate a few aspects of their contracts. CEOs and baseball stars can negotiate a lot more.
There are also large differences across countries. Collective bargaining plays an important role in Japan and in most European countries. Negotiations may take place at the firm level, at the industry level, or at the national level. Sometimes con- tract agreements apply only to firms that have signed the agreement. Sometimes they are automatically extended to all firms and all workers in the sector or the economy.
Given these differences across workers and across countries, can we hope to for- mulate anything like a general theory of wage determination? Yes. Although institu- tional differences influence wage determination, there are common forces at work in all countries. Two sets of facts stand out:
■ Workers are typically paid a wage that exceeds their reservation wage, the wage that would make them indifferent between working or being unemployed. In other words, most workers are paid a high enough wage that they prefer being employed to being unemployed.
■ Wages typically depend on labor-market conditions. The lower the unemployment rate, the higher the wages. (We shall state this more precisely in the next section.) To think about these facts, economists have focused on two broad lines of explana- tion. The first is that even in the absence of collective bargaining, workers have some