Tuesday, July 19, 2011

Job Friction - Why Economists Employed at the Federal Reserve Think You're Unemployed

I regularly take a look through the websites of the twelve Federal Reserve Districts looking for speeches or publications made by Governors or other staff members.  Sometimes, going beyond what Mr. Bernanke has to say about various topics can be quite enlightening.

By way of introduction, for those of you that aren't aware, the Federal Reserve is composed of twelve Districts as shown on this map:

Each of the twelve Federal Reserve Banks is subdivided into twenty-four branches with each of the twelve Banks being responsible for the commercial banks within its geographic boundaries.  As shown on this link, each Federal Reserve Bank has its own directorship.  This list of directors also outlines the principal business affiliation of the director; if you take the time to run through the list, you'll see that it is a who's who of American business, banking and economics.  Who says that it doesn't pay to rise to the top of the heap?

Back to the subject of this posting.  In July 2011's "The Regional Economist" published by the St. Louis Federal Reserve, there is an article entitled "The Mismatch between Job Openings and Job Seekers".  In light of last month's dismal unemployment statistics, this article is of particular interest because it may explain part of the reason why American unemployment has remained stubbornly high during the so-called "recovery".  Apparently, this stubbornness even surprises Mr. Bernanke who was quite certain that his QE2 program would solve all of America's economic woes.

The authors of the article, Maria E. Canon and Mingyu Chen, open by noting that during the 2007 - 2009 recession, more than 89 million employees lost their jobs with the unemployment rate spiking to a high of 10.1 percent in October of 2009.  While the unemployment picture has improved slightly, the BLS data release last week shows that unemployment rose by 0.1 percent to 9.2 percent, a relatively insignificant improvement over its 27 year high back in October 2009.  Now, let's leave the "Mismatch" article for one moment and look at another St. Louis Fed article. 

According to an essay entitled "Many Moving Parts" in the 2010 Annual Report for the St. Louis Fed, the loss of 8 million jobs during the Great Recession has been a persistent phenomenon that just will not go away no matter how many times Mr. Bernanke tells us that it will.  The authors of the study, David Andolfatto and Marcella Williams, even go so far as to explain to the Great Unwashed Masses that unemployment is not really a measure of joblessness.  Here's their explanation verbatim:

"Contrary to common belief, unemployment is not technically a measure of joblessness. It is, instead, a measure of job search activity among the jobless. Millions of unemployed people find jobs every month, even in a deep recession. Millions of workers either lose or leave their jobs every month, too, even in a robust expansion. The large and simultaneous flow of workers into and out of employment suggests that the labor market plays an important role in reallocating human resources to their most productive uses through good times and bad.

The job search activity of unemployed workers is mirrored on the other side of the labor market with the recruiting efforts of firms that have unfilled job openings. It is a property of the labor market that job vacancies coexist with unemployed workers, a fact that suggests the presence of "frictions" in the process of matching workers to jobs."

Isn't this a fine example of "economist-speak"?  Try telling this to some poor schlub who has been out of work for nearly a year, "Hey buddy, you're not really jobless, you're just experiencing job friction!".  You say tomato, I say tomahto.  The Fed speaks nonsense.

The authors of the Mismatch essay go on to state that job vacancy and unemployment rates (remember, it's NOT joblessness!) tend to move in opposite directions over a given business cycle.  When times are good, companies create jobs and that makes it easy for unemployed workers to find a job.  In this particular cycle, the authors observe that, while job openings in the United States have increased recently (the article was written in April 2011), unemployment remains persistently high.  Realistically, they do note that given the severity of the Great Recession that "...it is likely to take years before the unemployment rate falls back to its pre-recession levels."  No sh!t Sherlock.

In section 5 of the report, the authors look at the concept of job vacancies and unemployment.  They note that it seems a bit off that job vacancies coexist with unemployment and wonder why it is that firms with job openings simply don't hire from the more than ample pool of the unemployed.  Well, duh!  Perhaps the fact that the manufacturing and construction sectors have been particularly hard hit makes it nearly impossible for those millions of unemployed auto workers and construction workers (among others) to find replacement work since both sectors are circling the white, porcelain bowl.  But, of course, economists have to coin a phrase for this concept; they term it "search frictions".  Since I am not a qualified economist, perhaps I'd be safest if I quoted the definition of "search friction" directly from their report:

"...First, jobs and workers each possess idiosyncratic characteristics that make some job-worker pairings more productive than others. Second, jobs and workers do not necessarily know beforehand where the best pairing is located. If this is true, then it follows that jobs and workers should expend time and resources to search out the best matches. A firm will generally not want to hire the first worker who comes through the door. Likewise, an unemployed worker may not want to accept the first available job offer. The same principles are at work in most matching markets, including, for example, the marriage market."

Even more amazingly, the authors note that job and unemployment both vary over a business cycle and in a predictable way.  Unemployment tends to be high when the job vacancy rate is low and vice versa.  Sounds like common sense to me but economists have devised a curve called the Beveridge Curve that defines this relationship between job openings and the unemployment rate.  Here's the Beveridge Curve for the United States over the past decade:

You will notice right away that something goes amiss at the right end of the curve.  The little red dots seem to fall off the nice, predictable curvy line!  It seems that the so-called science of employment economics isn't quite as predictable as economists would like to think!  The off-curve data points show that there is an increase in the number of job openings but that there has been no accompanying decline in the unemployment rate.  This seems to puzzle the Fed because they state that "...it is not immediately clear how monetary or fiscal policies might alleviate the problem.".  Finally, someone at the Federal Reserve admits that their policies have not and likely will not fix the employment part of the economy.  Perhaps predicting economic trends is rather like herding cats, it sounds plausible but, in reality, it simply doesn't work. 

Now, let's go back to the "Mismatch" article.  The authors of this article postulate that it is possible that the prolonged joblessness of this "recovery" may be due to one of two reasons:

1.) Skills mismatch: this is defined as a mismatch between the skills of those unemployed and the job vacancies that employers are looking to fill.

2.) Geographic mismatch: this is defined as differences in geographic preferences between where the jobs are and where the employees prefer to work.

Those reasons for the prolonged period of high unemployment sound plausible to me but, keep reading, the Fed disputes the contribution of both factors to the increased rate of unemployment and comes up with a third alternative.  

Let's look at skills mismatch first.  This graph shows the average monthly share of vacant jobs and share of employment lost by industry for the three year period between December 2007 and February 2011:

Note that 50 percent of all of the jobs lost over this time period were in the construction and manufacturing sectors of the economy whereas 90 percent of the job openings were in other industries.  If you happen to be in the health and education sectors of the economy, you are one of the lucky ones because 20 percent of all job openings over the three year period have occurred in this sector and there was an employment gain of 18 percent.  While that’s all milk and honey if you happen to be trained for either sector, it’s not so wonderful if you are not.  For the unemployed person who worked in the manufacturing sector, it makes sense that they are unlikely to get work in the health or education sectors since they simply are not qualified to do the work and this will result in an extended period of unemployment.  While this may sound like a reasonable hypothesis to most of us, the authors of the "Mismatch" article summarize the findings of another study that looked in detail at the skills mismatch as noted above and found that there was only a 10 percentage point increase in misallocated workers during the Great Recession.  The authors point out that only 0.4 to 0.7 percentage points of the total 5 percentage point increase in unemployment during the Great Recession can be attributed to the mismatch between the skill set of the unemployed and the skills required by the employer who has the job openings and therefore, the concept of skills mismatch is not to blame for the stubbornly high rate of unemployment.

Now let's look at geographic mismatch.  In the case of the geographic mismatch, from one study, it appears that negative equity in homes has reduced the ability of homeowners to move to a new location because they may have to sell their homes at a loss.  But, of course, other economists in yet another study state that the aforementioned research was flawed and that, in fact, negative equity does not reduce the mobility of homeowners and that geographic mismatch had little impact on the unemployment rate during the Great Recession.

So, apparently it's back to the old drawing board.  The fine folks employed by the Fed have come up with yet another alternative explanation so they can justify their paycheques.  Perhaps because the number of job openings have increased by less than the increase in the number of unemployed workers, companies are spending more time being picky about who they hire because they think that there might just be a better candidate just dying to work for them.  According to this article in the Wall Street Journal, jobs that took two months to fill before the Great Recession are now taking up to 8 months to fill.  Apparently, companies simply aren't in a hurry to fill their vacancies perhaps because they are cautiously pessimistic about the strength of the “recovery”.  It sounds like a reasonable theory but I have a hard time imagining that this factor is responsible for the remainder of the 5 percentage point increase in unemployment that skills mismatch is not responsible for.  I'm sure that there is an economist somewhere out there who will put the boots to this theory but we’ll have to wait and see.

It's interesting to see how many theories there are regarding the stubbornly high American unemployment rate and how even the Federal Reserve, the guardian of the United States economy hasn't really got a clue about what is causing the problem or how to fix it.  Funny how the Fed really doesn’t even seem to understand the impact of its own policies, isn’t it?

But, on the upside of America's employment picture, apparently economists employed by the Federal Reserve, including the "Big Guy", can be wrong and still keep their jobs.  Way to go people!  Apparently, there's no job friction for economists.


  1. Very interesting. It is interesting to note that the way unemployment is calculated differs greatly from that of the great depression. It is true that the unemployment rate is not the "unemployed" rate. Many people just give up looking for work and there are no longer considered to be a part of the unemployment calculation as they are no longer looking for work. CNN puts the "unemployed" rate (the number of people without jobs that either were working or looking for work) at about 17 - 18%. This includes underemployed (another frightening stat)

    I would say that your criticism of the economists at the fed is a little unfounded. They are simply trying to find out what happened. That is not an easy task; People still argue about what the causes of the great depression are. It is important to look at all possibilities, and research as much as possible to at least mitigate the shock from the next boom and bust cycle.

  2. Regarding the Beveridge curve, if it is based on data up until 7/09 the prediction in the 10% range is essentially an extrapolation from unemployment rates of 4-6%. It seems like the extrapolation was flawed and the real curve should predict a job opening rate of about 2.0 at 10%. Now the question becomes why does the curve look like that and not why is this time different

  3. The tactical issues are probably diverse but there is a strategic issue here. Routine jobs are being eliminated by technology, whilst human interaction, or caring jobs, are on the increase as society improves and social sensitivities develop. Meanwhile creativity is, as always, a premium asset.

    Status quo is a powerful security blanket that causes social patterns to stick until, as in an earthquake, the tensions become too great.

    So we see a seismic shift of equilibrium.

  4. :))))))))) yet another brilliant article! I love your research! Thank you for doing the work and digging into the corners to find out the really spicy good stuff the rest of us!

  5. The answer is simple, read the Bell Curve. It points to the fact that people with low IQ and low work ethic no matter how much eduction you give them will be replaced by automation.

  6. I have to agree that there is a skills mismatch. I graduated from high school in 1997 and missed the whole internet revolution. Even though I have a doctorate and a Master of Science, my lack of computer skills are hurting me. I can't even update a website-I didn't think I would ever need to.