Sectoral Reallocation and the Labor Market

The topic for discussion today is the state of the US labor market: how we got here and why. I'm going to take a longer-term view, examining data from 2000 on, and using Canada as a benchmark.

First, let's look at private sector employment by sector in the US economy, in the first chart.

The chart shows employment across four sectors: services, manufacturing, mining and logging, and construction. Clearly, over the period from 2000 to 2012, there was a significant sectoral shift in the composition of employment. Employment grew in services and mining and loggging, and shrank in construction and manufacturing. There was a huge drop in construction employment from the peak of the housing boom in 2006. From the trough in the recent recession, employment in services and manufacturing has grown sluggishly, employment in mining and logging has grown at a high rate, and construction employment has been essentially unchanged.

Of course, it is also important to take account of the employment shares for each of the four sectors in the chart. The majority of employment throughout the period in question was in services, with services employment increasing from 65% of total employment in January 2000 to 70% in April 2012. Over the same period, employment in manufacturing fell from 13.2% to 9.0%, employment in construction fell from 5.2% to 4.2%, and employment in mining and logging rose from 0.5% to 0.6%.

If we were to try to explain what is going on in the first chart, what would leap to mind? First, the secular shift from manufacturing to services employment is well-known. Part of this is due to changes in demand - preferences have shifted from tangibles to intangibles. Some of it is due to changes in technology - there seem to have been significant productivity gains in manufacturing relative to services, although productivity in the services sector (e.g. financial services) is notoriously hard to measure. Second, the behavior of construction employment sticks out like a sore thumb. The increase in construction employment from 2000 to 2006 and the subsequent crash were driven by well-known incentive problems in the market for asset-backed securities, followed by the collective realization that asset-backed securities were not so well-backed.

The second chart shows employment for the same four sectors, except for Canada instead of the United States.

In this chart, the pattern of growth in employment in services and manufacturing looks very similar to the US. The share of services employment increases from 70.8%% in 2000 to 74.1% in 2012, with the manufacturing share falling from 16.5% to 10.2%. Construction employment looks much different in Canada though, with very strong trend growth throughout the sample period, and a quick recovery from the trough of the recent recession. Employment in mining and logging may look different in Canada and the US, but if we separate mining from logging, Canada and the US look similar, though Canada has a larger share of total employment in mining and logging than does the US.

The North American economy is highly integrated. Aggregate economic behavior in Canada and the United States has followed a similar trend, and business cycles in the two countries have been highly synchronized. The Great Depression was similar in Canada and the United States with regard to the behavior of real GDP, as was the case in the recent recession. However, the above two charts tell us that it may be difficult to reconcile the behavior of sectoral employment in the two countries with some conventional aggregate-shock model of the recent recession. How could such a model explain the differences in the behavior of construction employment in Canada vs. the US?

The aggregate labor market data for Canada and the US is especially interesting. The third chart shows total employment (from the household surveys now) for Canada and the US.

Over the 12-year period in the chart, Canadian employment grew by about 19%, while US employment grew by about 3%. The drop in employment in Canada during the recent recession is quite modest relative to the drop in the US. The fourth chart depicts labor force participation rates in the two countries.

This one is quite remarkable. First, the decline in the participation rate in the US that began with the recent recession is just part of a trend decline since 2000, which was interrupted for the period from the end of 2004 to the beginning of 2008. While the US participation rate declined by about 3.5 percentage points from 2000 to 2012, the Canadian participation rate actually increased by a percentage point.

The fifth chart shows unemployment rates in Canada and the US.

Historically, the Canadian unemployment rate was typically higher than the US unemployment rate, due to more generous unemployment insurance system in Canada, and sectoral and geographical differences. During the recent recession, however, the unemployment rate in the US rose by about double the increase (in percentage points) in Canada. If we took account of measurement differences in Canada and the US, the current difference between unemployment rates would be even larger than it is in the chart.

In the sixth chart, we show real GDP in the US and Canada.

In this chart, a key observation is that the recent recession was of similar depth and duration in Canada and the US. However, the recovery in Canada has been somewhat stronger, and at the end of the sample period real GDP was 3.8% higher relative to US GDP than it was in 2000.

Putting together real GDP and employment paths, we get the final chart, which shows average labor productivity in Canada and the US.

Here, a large gap had already opened up between US and Canadian productivity, and that gap increased significantly during the recession.

What are we to make of all this? I don't know about you, but the Keynesian narrative does not help me to make sense of what I'm seeing. If employment and labor force participation are so low in the US because wages and prices have been stuck for the last four years, and aggregate demand is insufficient, then we should be seeing the same phenomena in Canada. Canadian wages and prices can't be any less screwed up than are US wages and prices and, if anything, fiscal and monetary policies have been more "stimulative" in the US than in Canada. Further, according to Keynesian logic, it's essentially the same aggregate demand north and south of the 49th parallel. So why are the Canadians working so much more than the Americans?

Before the financial crisis, some of us liked to pay attention to financial factors, credit, banking, monetary economics, etc. Now we all know that those things are important, right? If you think about them, you can indeed begin to make sense out of the data above. The Canadian financial system essentially sailed through the financial crisis unscathed, save for a few bruises perhaps. The problems in US mortgage markets, which acted to foul up financial exchange and credit in general, are reflected in the performance of the US construction sector, and in US labor market performance, in ways that we have not yet been able to successfully quantify. There may be inefficiencies associated with these phenomena that can be corrected through the better design of fiscal and monetary policies, but it is far from obvious what the inefficiencies are, or what the correct policies are. Anyone who tells you they are sure of the answers is fooling themselves, or fooling you.