Tuesday, December 10, 2013

Minimum Wage, Demographics, Emergency Unemployment Insurance, and Labor Force Participation from 2007-2011

In the previous post, I estimated the effects of these issues on unemployment.  Now, I'm going to look at Labor Force Participation (LFP).

Edit:  After looking some more at the relationship between the MW and the proportion of workers at or below MW, I noticed a non-linearity at the low end of the range, where MW levels were in 2007.  The first hike in 2007 hardly budged the proportion of workers at MW.  This was likely because the legislated MW had fallen below the typical voluntary MW.  I have updated the graphs and numbers below to reflect that deviation from the trend.

Minimum Wage

I discussed this in the previous post, and went into more details in the posts before that.  Even though there have been relatively few separate minimum wage episodes over the past 60 years, I was able to establish a strong relationship between the 6 month change in employment over the course of the typical episode and the scale of the MW increase in relation to the average wage.  The forecast specified by that relationship is what I use here to estimate the effect on labor force participation (LFP).  Much of the lost employment coming from MW hikes appears to lead to lower labor force participation instead of unemployment.


I have discussed this quite a bit.  Most recently here.  This shouldn't be complicated.  There are stable long-term trends among different age groups.  As the population bulge enters the older age groups, this causes the reported labor force participation rate to shrink.

Emergency Unemployment Insurance

EUI plays a small role here.  I referenced a GAO report here that found about 1/5 of EUI recipients who had aged out of EUI exited the labor force.  An analysis of these factors should include the effect that EUI should have on inflating LFP.  I presume that, on the margin, this is not controversial.  On this particular effect, I don't have any clever methods to get at a number, so I have simply estimated this effect to be equal to 10% of the cyclical long term unemployed.  This estimate leads to a fairly small number, in any event.  I don't believe I am double counting with the EUI unemployment effect, because that measure specifically did not attribute any additional unemployed workers to the effect.  It only accounted for longer durations of unemployment among the given number of unemployed.

Here is the estimated effect of these factors on LFP.
graph before update

The minimum wage effect is estimated to outweigh the demographic effect since 2009.  Adding these effects up and comparing them to the actual change in LFP over this period, we see this comparison:

Considering that these three forecasts come from three separate contexts, it's kind of surprising that they would add up to explain the entire recent this much of the character and the decline in the LFP.  But, maybe they do.

Here is the chart, extended to 2013.  As with the unemployment chart, I am less confident in the Minimum Wage effect once we get past 2011.  But, we can see here that as the EUI and MW factors dissipate, the actual LFP is now sloping below the estimate derived from these factors.

graph before update

Unemployment, Labor Force Participation, Market Frictions, and the Definition of Cyclical

Here is a long term chart of the cyclical deviation of LFP, compared to the inverted Unemployment Rate:

Here is that chart, with the adjustments from 2007-2013 that I have just estimated, removed.  If my estimates are correct, this would represent the truly cyclical behavior of the current labor market.

graph before update
With the adjustments, unemployment looks similar to previous downturns.  But, adjusted LFP seems just a little too high.

It could be that I have overestimated something.  It could be that my model doesn't capture enough unemployment among the MW job losers, so that adjusted unemployment and adjusted LFP are both too high.  The adjustment to reduce the estimated effect of the 2007 mimimum wage hike, as discussed above, does create a more realistic looking cyclical LFP path in the early part of the crisis.  In the 2nd version of the new graph, I changed the assumption about EUI and the labor force.  If we assume that, instead of 10% of the excess long term unemployed, that a full 25% of excess long term unemployment will transfer out of the labor force, then the cyclical trend looks very normal.

Obviously, tweaking other estimates here and there would move the demographically detrended LFP up or down, slightly.  The point here isn't to claim exact numbers, but simply to suggest that reasonable estimates of the effects of these policies and long term trends can explain all of the supposedly unusual labor market behavior.  At least, I think I've given some plausibility to the idea that there is no big mystery in recent LFP behavior.

One other comparison I will make with the adjusted data is to compare the standard Beveridge Curve (the relationship between unemployment and the number of job openings) and an adjusted Beveridge Curve that utilizes my policy-and-demographic-adjusted unemployment rate.  My adjusted unemployment rate pulls the Beveridge curve back into the recent conventional range.
graph before update

So, if my adjustments are accurate, does this shift in the Beveridge curve point to labor market frictions and rigidities.  Historically, the Beveridge curve has shifted slowly through decades:

Is this just a reflection of shifting levels of labor market frictions?  How much have policies such as the Minimum Wage been reflected in these changes?

The other question that comes to mind is, "What is the difference between structural and cyclical or demand-driven shocks?"

Disemployment from the minimum wage is clearly a structural shock, but it plays out like a cycle.  EUI also looks pro-cyclical to me.  It's countercyclical for the unemployed person who is provided with a safety net.  But, it's pro-cyclical to the analyst looking at the unemployment rate.

So, the discussion seems a little confusing to me if someone says, "Bad news.  It looks like the LFP drop is cyclical.  Unemployment should be even higher than it looks."  Once you correct for the demographic issue, do you answer, "No, it's not.  Much of this might be a minimum wage or EUI effect."?  Or, do you answer, "Yes.  You're right.  Much of it might be a minimum wage or EUI effect."?

I believe I have two more posts coming on the topic, if anyone is still reading at this point...

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