The Flow Analysis of Labour Markets

Ronald Schettkat

• Publisher: Routledge
• Year: 1996
• eBook ISBN: 9781134779413
• Topic: Business
• Subtopic: Business General
• Index: Business

Well-functioning labour markets are a precondition for economic development. In order to function smoothly the market needs to be able to adjust effectively and quickly to new developments. An understanding and analysis of adjustment processes within labour markets is therefore essential for economic theory and policy proposals. This study discusse

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THE FLOW APPROACH TO LABOR MARKET ANALYSIS

Introduction

Ronald Schettkat

DYNAMIC ECONOMY

The strength of capitalist market economies is their ability to improve existing products and to create new products (Schumpeter’s ‘creative destruction’); this is the source of economic progress that brought about tremendous income growth. Creative destruction produces heterogeneity among firms and is a source of continuous frictions in the economy in general and in the labor market in particular. Labor markets need to adjust to changing skill requirements, shifting locations, etc. Well-functioning labor markets are a precondition for such a dynamic economic development and an understanding of adjustment processes in labor markets and their proper analysis is essential for economic theory and policy proposals.

Adjustment processes in the labor market were not part of the perfect Walrasian world, in which information was costless and complete. As long as economic theory dealt with an artificial framework in which frictions were assumed away, there was no need to analyse adjustment processes. The economy simply shifted quickly from one equilibrium to another if external shocks occurred. However, as early as the 1930s George Stigler emphasized the costs of information, and in the 1970s frictions in labor markets became the key explanation for the coexistence of unemployment and vacancies (Phelps et al. 1970). Allowing for frictions in labor market models paved the way for the analysis of adjustment processes in mainstream economics; at the same time the distinction between the two components of stocks—flows and durations— became important.

The developments in labor market analysis away from the perfect Walrasian world are closely linked to developments in economic theory in general. Frictions, transaction costs, imperfect competition, asymmetric information, strategic behavior of agents (game theory), etc. are no longer regarded as deviations from an otherwise perfect world but lie at the heart of economic theory. ‘Imperfections’ are universal and Robert Gordon (1990:1163) suggests itshould be recognized ‘that these features are part of the way markets function. Imperfect markets and especially imperfect labor markets have been recognized for a long time, but it is only recently that models which analyze adjustment processes and frictions in labor markets more carefully have been developed (for notable exceptions see below). The analysis of mobility and adjustment processes in labor markets has become known as the ‘Flow Approach’ (Blanchard and Diamond 1992) and this is what this volume is all about.

One advantage of the flow approach is that it improved analysis of the adjustment processes which are not revealed by net changes of employment and unemployment. Even in steady state, when levels do not change, large flows in and out of employment and unemployment can be taking place. Microdata analysis has discovered this tremendous mobility within the labor market hidden in stock data. Flows in the labor markets are much larger than net changes suggest. For example, in Germany during 1991 the number of employees increased by about 200,000 persons, which was the net effect of 7.4 million new employment contracts and 7.2 million terminated contracts. But it is not only workers who are mobile; jobs show an enormous dynamism as well. Between 1976 and 1985 in the USA, for example, an average of about 12.5 per cent of all jobs disappeared, while 13.5 per cent of all jobs were newly created each year (OECD 1987). The labor market processes concealed behind the 1 per cent net increase in jobs are highly dynamic.

The flow approach takes account of the micro foundation of economic behavior while at the same time allowing for more general macroeconomic explanations. It is a framework which, potentially, recognizes the microeconomic foundation of macroeconomic theory while at the same time providing a means of understanding the impacts of the macroeconomic situation on microbehavior. The flow approach gives new insights and opens up new opportunities to discriminate in empirical tests between rival labor market theories.

Flows are the aggregate measure of mobility at the micro level, and analysis of flow data has produced several new insights into the functioning of labor markets:

• flows are much larger than changes in stocks suggest;
• at any given time some firms are expanding while others are shrinking;
• this happens in recessions and in booms, in growing as well as in shrinking industries;
• job turnover is substantial but labor turnover is much higher;
• flow rates differ substantially between countries but they also show common patterns;
• in a recession the flow from employment into unemployment increases, as does the flow in the reverse direction;
• labor market efficiency improves in recessions;
• levels of voluntary mobility among workers (quits) are highly procyclical;
• the unemployment outflow is only weakly or not at all correlated with the number of vacancies and hires.

Although not all of these findings are yet clearly understood, many more questions can potentially be answered using flow analysis. These include:

• To what extent is worker mobility endogenous to labor market conditions?
• To what extent do vacancies represent net additional labor demand or to what extent do they simply represent labor demand substituting for quits?
• How does this pattern vary over the business cycle?
• How does labor turnover relate to job turnover?
• How do labor market flows vary over the business cycle?
• How does job turnover vary over the business cycle and what are the causes of this variation?
• What is the impact of national institutions on job and labor turnover?
• Is the distinction between quits and dismissals just a statistical, administrative artifact or is there a substantive difference between voluntary and involuntary mobility (quits and dismissals)?
• How is turnover related to wage differentials?
• Are workers attracted to new jobs by wage signals or by quantity signals such as job availability?
• Is there evidence that wage differentials compensate for differences in job stability?
• What is the relation between flexibility and mobility in the labor market?
• Are there secular trends in flows which may be related to institutional changes, as claimed in the debate over ‘Eurosclerosis’?
• Do higher job turnover and job creation correlate positively?
• How do labor market situations affect interregional mobility (migration)?

These are issues investigated in this volume. The book gives an overview of the ‘state of the art’ in flow analysis and provides many new theoretical and empirical insights. The contributions are written by internationally known researchers and cover a large number of countries (USA, Canada, Japan, the Netherlands, UK, France, Italy, Germany). The contributions were discussed extensively at the conference on ‘The Flow Approach to Labor Market Analysis’ in the Wissenschaftszentrum Berlin, which was made possible by financial support from the Fritz Thyssen foundation and the Wissenschaftszentrum.

OVERVIEW AND SUMMARY

The second chapter by Ronald Schettkat (Wissenschaftszentrum Berlin) provides an overview of key concepts in flow analysis like job turnover, labor turnover, etc. It discusses the causes of flows and frictions in the labor market and presents comparative empirical findings for several highly industrialized countries.

In Chapter 3 Jonathan S.Leonard (University of California at Berkeley) analyzes institutional influences on job turnover. He answers two major questions:

1. What causes job instability?
2. What are the consequences for microeconomic analysis?

Leonard (1987) was the first to study job turnover on a broad statistical basis showing that the popular study by Birch, which identified small firms as job creators and larger firms as job destroyers, simply revealed a statistical artifact. Many new jobs are created in small firms but many jobs are also lost in small firms. Moreover, he found that, on average, firms which expanded employment in one year would often reduce employment in the following year. In the long run, however, there is almost no autocorrelation of employment growth by establishment size.

Leonard found in his pioneering study on job turnover that a tremendous number of jobs are created and destroyed every year. At that time this was regarded as a measurement error, but it is now a well-established stylized fact in economics. It is implausible to blame wage rigidity for the high job turnover because unionized establishments in the USA, where wage rigidity would be expected to be relatively high, show job turnover patterns that are no different than those of nonunionized establishments.

Leonard argues that economists stress demand and supply in their theories but that most studies actually concentrate on the supply side of the labor market and on workers’ characteristics, while the demand side is largely neglected. Hamermesh (1993) argued similarly and supported his argument with the fact that 70 per cent of labor economic articles in major journals dealt with labor supply issues and only 30 per cent with the demand side of the labor market. The consequences of product market volatility for job instability have largely been neglected although job turnover can account for a substantial amount of unemployment. Establishment closures contribute little (about 20 per cent) to job destruction, but are nevertheless spectacular and politically influential. Most job turnover, however, is ‘everyday’ job turnover and takes place as a result of restructuring within industries (competition, see Chapter 2) rather than between industries (structural change). Restructuring gives rise to costs, of which unemployment may be the most important, but it also produces gains in the form of new jobs. Jobs and establishments are heterogeneous and this should have consequences for the concept of the representative firm often used in economic analysis.

Charles Holt (University of Texas at Austin) discusses the origins and policy relevance of flow analysis of labor markets in Chapter 4. The origins of the flow approach are closely connected to Holt’s career. In the 1960s he had already developed a matching function and his well-known article with Martin David on vacancies and labor market dynamics paved the way for recent efforts in labor market analysis. In his contribution to the ‘New Microeconomics’ (Phelps et al. 1970), Holt made theoretical arguments in favor of the procyclical behavior of quits rather than the anticyclical behavior favored by most authors in the volume. Holt also criticized the fact that labor demand was almost totally neglected in labor economics (see also Leonard in this volume). When Holt started his research group at the Urban Institute in Washington, the vacancy-unemployment relation was used as one of the main variables influencing wage change.

This relation in turn depends on turnover, employment growth, and matching efficiency in the labor market, concepts which have become increasingly important in recent labor market models which try to explain the behavior of imperfect labor markets (see the contributions in this volume; Card and Krueger 1995; Manning 1995). With their model the researchers in Holt’s group could explain clockwise loops around the Phillips curve. In a flow model of labor market dynamics Holt integrated monthly flow data from the Current Population Survey (CPS) and modeled and measured transition probabilities for various groups. Again, this approach became standard in modern labor economics.

The international comparative study in Chapter 5 by Tito Boeri (OECD, Paris) investigates cyclical patterns of gross job flows and the macroeconomic relevance of job turnover. This is important for the interpretation of the business cycle either as a variation in aggregate demand or as a period of restructuring. Boeri analyzes the turnover patterns in eight countries (Canada, Denmark, France, Germany, Italy, Norway, Sweden, and the USA) and shows that during recessions in the USA net employment decline shows sharp spikes together with an increase in job turnover. This pattern is clearly consistent with the interpretation of recessions as restructuring periods. However, in other countries net job decline is less sharp than in the USA and there is no apparent relationship between increases in job turnover and a decline in net employment, with the exception of Norway. Although there are serious problems concerning the international comparability of job turnover data (in some countries the series are based on manufacturing only, while in others only turnover in establishments over a certain size is counted, in some countries job turnover figures come from administrative data, in others from survey data), these do not affect the longitudinal behavior of the data within one country. The costs of job destruction may differ between countries and this may explain the different patterns. Furthermore, in some countries subsidies are used to smooth the process of job destruction (see also Leonard’s contribution in this volume).

In Chapter 6 Simon Burgess (University of Bristol and Centre for Economic Performance, London School of Economics), Julia Lane (American University) and David Stevens (University of Baltimore) analyze job flows and workers flows with a panel of US firms. It is clear that job-tojob mobility (see also Schettkat in this volume) is a substantial part of overall hiringactivity. Burgess, Lane and Stevens use a unique database which allows for a combination of establishment and worker characteristics and covers virtually all employees in Maryland. This database allows for analysis of worker turnover over the life-cycle of a firm. Turnover rates are computed on the basis of the firm’s employment levels.

Burgess, Lane and Stevens found that ‘churning’ worker flows, that is hires and separations which do not affect the level of employment in a firm (substitutional turnover, see Chapter 2 for definitions) account for two-thirds of all worker flows, a value consistent with findings in other studies (Schettkat 1992; OECD 1994). The analysis also shows that the firm component explains a large amount (60 per cent) of total variation in ‘churning’ worker flows, compared with only 5 per cent for the interfirm variation in job flows.

Job reallocation in firms which survive for less than two years is particularly high: 12 per cent of all job reallocation occurs in these firms although they account for only 6 per cent of employment. This again shows that newborn—and small—firms contribute substantially to job creation but also to job destruction. Worker turnover is very high in short-lived firms, young continuing firms and dying firms but considerably lower—although not low—in mature firms. Surprisingly, even in firms which die young, hiring is similar to that in mature firms (see also Hamermesh et al. 1994).

As firms age, worker flow rates decline mainly as a result of a decline in the ‘churning’ worker flow rate. This may be taken as an indication that after a certain time firms succeed in assembling their desired team. This is confirmed by dynamic analysis: job creation is followed by high churning flows. On the other hand, high churning flows have a damaging effect on jobs, which shows that a stable work force is one of the important factors in determining whether firms survive.

A comparison of the US and Canadian unemployment processes is given by Pierre-Yves Crémieux (University of Quebec at Montreal) and Marc Van Audenrode(Laval University, Quebec) in Chapter 7. It is well known that the Canadian and US economies are similar in many respects but that Canada has developed welfare state institutions similar to those in Europe. The gap between the US and Canadian unemployment rate widened during the 1980s. This had two main causes: (1) unemployment duration increased in Canada; and (2) the incidence of unemployment remained constant in Canada but decreased in the USA. Unemployment duration increased in Canada because transitions from unemployment into employment declined, as did transitions into and out of the labor force. The generosity of unemployment insurance in Canada has been suspected as a cause of higher unemployment in Canada, but empirical studies have failed to deliver support for this hypothesis (Ashenfelter and Card 1986; Card and Riddel 1993). Actually, contrary to expectations created by the greater generosity of unemployment insurance, wage losses after unemployment are actually higher in Canada than in the USA. Different classifications of unemployment account for about half of the observed unemployment differential. Decline in unemployment incidence and stable durations in the USA account for the entire difference in unemployment rates for women and for about 60 per cent of it for men.

Crémieux and Van Audenrode investigate whether job turnover differentials can explain the US/Canadian difference in unemployment rates. Job turnover may also influence differences in unemployment incidence and duration in the two countries. However, employment is not the only form of exit from unemployment—another is inactivity. Crémieux and Van Audenrode’s unemployment flow analysis shows that unemployment duration is the main cause of the difference between the US and the Canadian unemployment rate (for Germany see Schettkat, this volume).

It is well known that Japan is distinct from other industrialized countries in many respects and that unemployment is not a serious problem for Japan. Consequently the focus of many ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• FIGURES
• TABLES
• CONTRIBUTORS
• 1: THE FLOW APPROACH TO LABOR MARKET ANALYSIS
• 2: FLOWS IN LABOR MARKETS
• 3: INSTITUTIONAL INFLUENCES ON JOB AND LABOR TURNOVER
• 4: FLOW ANALYSIS OF LABOR MARKETS
• 5: CYCLICAL PATTERNS OF GROSS JOB FLOWS AND THE MACROECONOMIC RELEVANCE OF JOB TURNOVER
• 6: JOB FLOWS AND WORKER FLOWS
• 7: IS THE USA/CANADA UNEMPLOYMENT GAP TRULY LARGE?
• 8: THE EFFECT OF INDIVIDUAL CHARACTERISTICS AND OF PARAMETRIC AND NON-PARAMETRIC APPROACHES ON JOB DURATION IN JAPAN
• 9: ASPECTS OF LABOUR FORCE DYNAMICS IN FRANCE
• 10: LABOUR TURNOVER FLOWS BY TYPE IN FRANCE
• 11: JOB CREATION AND DESTRUCTION IN ITALY
• 12: THE FLOW APPROACH IN THE NETHERLANDS
• 13: ON-THE-JOB SEARCH, MOBILITY AND WAGES IN THE NETHERLANDS
• 14: LABOR MARKET DYNAMICS IN GERMANY
• 15: REGIONAL MIGRATION AND THE HIRING FUNCTION