Are the Problems in the Employment Sector Structural?
With payroll growth stalling and the labor sector softening noticeably, cries have gotten louder that the reason firms are not hiring has to do with a structural disconnect between employers and potential hires. Essentially, the thought is that the unemployed do not have the necessary skills needed in the current economy and that they will need to be retrained before they will be able to find a job.
If structural unemployment is indeed the cause of the disconnect between employers and potential hires, that means that unemployment will remain elevated for a longer period of time and that there will also be higher potential rates of inflation. As a result, monetary policy would likely need to be tightened before the employment sector recovers to its pre-recession levels.
Proponents of the structural unemployment problem often point to the upward shift in the Beveridge Curve, or the drop in the labor participation rate, as conclusive evidence that there is a structural dislocation in the employment sector.
In our report from March 8, 2012, "Retirement vs. Discouragement: The Decline in Unemployment," we showed that a large portion of the decline in labor force participation is the result of natural demographic shifts. Thus, the drop in labor force participation does not offer conclusive evidence that there are structural problems in the labor market.
Incidentally, new research now shows that the Beveridge Curve may have also been skewed into making the labor sector look more structurally flawed than it really is.
The Beveridge Curve
What the Beveridge Curve shows is the relationship between job vacancies and unemployment. The theory states that job vacancies would be lower during times of high unemployment because firms would have an easy time finding suitable candidates to hire from a large supply of potential employees.
click to enlarge
Since the end of the Great Recession, the unemployment rate has declined, but at a slower rate than the increase in job openings. As a result, the Beveridge Curve has shifted higher for the first time since the end of the 1973/74 recession.
Businesses seem to be having a hard time filling job openings even though the current unemployment pool is as large as it has ever been. The mismatch between the qualifications of the unemployed and the skills needed by firms is a textbook definition of structural unemployment.
However, the textbook may just be wrong when it comes to understanding the labor market today.
Motivations for Hiring
The Beveridge Curve assumes that businesses are doing everything they can to fill job openings. But what if firms have deliberately slowed down the intensity of their hiring search?
New research from University of Chicago Professor Steven J. Davis, Chicago Fed Economist R. Jason Faberman, and University of Maryland Professor John C. Haltiwanger (2012) suggests that firms are not pursuing workers with the same motivation that they did prior to the Great Recession. Therefore, their contention is that the Beveridge Curve has shifted not because of structural unemployment, but because firms are not in a hurry to fill their job openings.
According to the researchers' proprietary measure for evaluating recruiting intensity, businesses are currently putting in considerably less effort than they did before the Great Recession.
Under normal circumstances, hiring managers would not need to make much effort to find new workers since the abundance of unemployed makes it easy to fill a job opening. That is exactly what happened in the immediate aftermath of the Great Recession.
Since then, hiring rates have declined substantially yet businesses have not stepped up their recruiting intensity to find qualified workers. If businesses were having difficulties finding qualified hires, recruiting intensity levels should have picked up sharply over the last several quarters as hiring managers searched harder for qualified candidates.
Even though there are plenty of job openings, businesses are not exerting a lot of effort to find workers. Evidently, the job openings are either not critical for business operations or businesses are simply making due until the ideal candidate falls into their lap.
Either way, the data suggest the lack of hiring is a business strategy and not the result of structural deficiencies in the labor market.
More Evidence from the BLS
Another sign of structural unemployment would be if certain employment sectors were recovering at a much slower pace than the rest of the economy. This would suggest that there was a shift in demand that made an area of the economy obsolete.
For example, the prevailing wisdom is that the construction industry is hampering the overall economy with structural unemployment because the housing boom trained too many construction workers.
If this was the case, then certain sectors - i.e., construction - would experience severe unemployment while other sectors would show a solid recovery. The data from the BLS do not support this.
All industry unemployment rates have increased by relatively similar amounts since May 2007.
Furthermore, the industries that had the lowest (highest) unemployment rates in May 2007 also had the lowest (highest) unemployment rates in May 2012.
There are no employment sectors that are lagging the general economy.
This is not only a clear strike against structural unemployment, but more evidence that the slow recovery is being driven by businesses deliberately holding back on hiring workers since they are unsure about future demand.
The Hysteresis Conundrum
The problem with businesses not actively pursuing new employees is that, over time, this will lead to structural unemployment, otherwise known as "hysteresis."
The average worker in the U.S. has been unemployed for 39.7 weeks as of May 2012. That is down from an all-time high of 40.9 weeks in November 2011, but still nearly 20 weeks longer than after the recessions in the early 1980s when the unemployment rate also reached 10%.
The longer workers stay unemployed, the more their skills deteriorate and their qualifications recede. Thus, the pool of qualified candidates shrinks as unemployment lengthens.
When firms do not actively pursue ways to fill their job openings, they are ironically making it more difficult to fill the job at a later date.
The Pitfalls of Current Business Strategy
As hysteresis develops, the labor pool will essentially be split into two groups - those potential employees with current skills that meet business demand and those whose skills have deteriorated to such an extent that they are nearly unemployable.
As long as the growth rate of skilled workers is more robust than that of unskilled workers - which is likely given the strong preference for young adults to go to college during the Great Recession - the economy will press ahead.
Therein lays the problem.
As businesses compete for skilled workers, income growth will accelerate. This will lead to stronger inflation levels. At the same time, the unskilled workers will find it consistently more difficult to find jobs, which leads to persistently high unemployment.
This dichotomy will eventually raise the likelihood that monetary policy will have to tighten from higher inflation even though the unemployment rate remains above pre-recession levels.
Therefore, the ongoing disconnect between inflation and unemployment - caused specifically by structural unemployment - would prevent the economy from growing at its full potential.
The employment sector is dealing with a case of cyclical unemployment that is deep, but not so deep that the sector is embroiled in structural problems. An overall pickup in aggregate demand is enough by itself to lower the unemployment rate back to its pre-recession levels.
Yet, current business strategy is setting up for structural unemployment in the foreseeable future if businesses do not structure their recruiting efforts around filling their job openings.
Davis, Steven J.; Faberman, R. Jason; and John C. Haltiwanger. 2012. "Recruiting Intensity During and After the Great Recession: National and Industry Evidence." American Economic Review: Papers and Proceedings. Vol. 102, No. 3.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.