The Shadow Labour Supply And Zero Marginal Product Workers

The Shadow Labour Supply consists of people who are not in the labour force i.e. not actively searching for a job, but still want a job.

This paper by Davig and Mustre-del-Rio explores the flows between the shadow labour supply and the labour market. It is very interesting because a significant rise in discouraged workers is not a good thing by any measure.

From 2008 to 2013, the estimated size of the shadow labour supply has risen from 4.5 million to almost 6.8 million people in the United States.

The shadow labor supply, consisting of individuals who are not actively searching for a job but would like to work, has grown considerably in recent years. Although this group has characteristics similar to those who are officially counted as unemployed, individuals in this group flow into employment at a lower rate. Still, they become employed at a much higher rate than those who indicate they do not want a job. Compared with that group, individuals in the shadow labor force are also more likely to start looking for a job.

Nevertheless, despite the swelling size of the shadow labor supply, a return of these individuals to the labor force in numbers that would considerably affect the unemployment rate appears unlikely. Variation in their job search behavior may influence the future path of the unemployment rate modestly, but not greatly. Although individuals in the shadow labor force do flow back into unemployment, the peak in their return to the labor force typically occurs in the first few post-recession years. The recent, post-recession peak of their flow back into unemployment has already occurred, in mid-2010. While another surge back into the labor force by individuals in the shadow labor supply is possible, historical evidence suggests it is unlikely. Broader variation in flows between the different non-employment categories, however, can have a more substantial impact on the unemployment rate over the next few years.

Arnold Kling speculates that these people realise that they are currently zero marginal product workers, so they might as well stop actively searching for work to preserve their sanity. He adds that people who are still looking for work unsuccessfully “didn’t get the memo”.

It isn’t a particularly nice conclusion, but this is economics not sociology. When you add in the reality that when nominal wages can’t be cut payrolls will, perhaps a lot of people are completely unwilling to re-enter the labour force at a lower wage and would rather go fishing than take a job at a lower wage rate.

I’m looking forward to whatever he writes about the topic when he gets back to it. His upcoming macroeconomics book should be really interesting.

Mainzeal In Receivership

New Zealand’s 3rd largest construction firm has been placed into receivership. Mainzeal is interesting because it is part of Richard Yan’s Richina Group.

Over at the NBR, the comments state the obvious : sub-contractors and employees will bear the brunt of the collapse. The secured creditors are likely to recover most of their loans and the executives at Mainzeal are unlikely to face any civil or criminal sanctions.

Putting aside the role poor management and leaky buildings played in the Mainzeal collapse, we should be concerned when large construction firms go under.

That’s because the construction sector is one of the best industries for creating flow-on work for low marginal product workers. The ~20% contraction of the construction sector since 2008 has been responsible for a whole world of hurt. It has driven a lot of skilled workers to Australia and others into insecure contract work on a project-by-project basis.

Another reason why we should be concerned with the way the construction sector operates is because it best represents the “contractor-sub contractor” model of doing business. Risk is transferred downwards while profits are concentrated amongst firms at the top of the pyramid with the most leverage.

Although Mainzeal didn’t have a major share of the market in Christchurch rebuild work, a lower number of firms operating in that market is clearly not good for homeowners.

I look forward to reading the receiver’s reports. How long until the construction sector gets the regulation it needs when it comes to payment of sub-contractors? The Construction Credit Contracts Act doesn’t help you when a company is placed into receivership.

Who Do Employers Compete With For Labour?

The common assumption is that employers compete with each other for labour. This is true for the currently employed or recent graduates. They have to deliver a salary that reflects the level of work expected and what the workers themselves want from an employer. It’s a two way street despite what some lobbyists would have you believe.

This ignores the alternatives to the labour market that are available. These include working in the cash economy, payment in kind, living off benefits or from family support.

I’m not casting value judgments here – I’m simply saying that in order for an employment offer to be competitive it has to substantially exceed that available from WINZ or StudyLink.

No potential employee will care about you if you are offering a rubbish wage. They’ll clock in and clock out just as they should – you’re on a different planet if you think employers arbitrarily lowering wages and moving towards casualisation doesn’t have blowback in labour productivity trends.

One of the reasons employers are struggling to plug the mythical “skills gap” is they’re not offering wages that are competitive with alternatives on offer, primarily from the welfare budget.

If the labour market was functioning healthily, and entrepreneurs were creating lots of new jobs to replace those lost in the recession, going back to university for another degree would be a financially irresponsible decision.

Foregoing a $40,000 salary for another 2 years of StudyLink would be blatantly stupid. But in the current environment, part-time and casual employment is significantly more likely than full-time graduate employment in the field that you studied.

There is a funny idea that students go onto post-graduate study because they want to. That might be true for many.

But the reality is that without Studylink many students would starve. They can’t even get low-skill part-time jobs to help them through university because the low skill labour market has become a numbers game.

So returning to study is actually a way of earning an income and putting food on the table. Not all students receive parental support or have the connections to get decent summer jobs.

The great tragedy of this whole debacle is that my generation has a lot of resentment towards the baby boomers at the top.

We don’t want much – contrary to popular belief – but it really irritates me how myths like “word harder” or “just get a valuable skill” persist.

The mathematics mean that not only can most graduates not look forward to full-time graduate employment, they can’t look forward to any employment that justifies the direct costs and opportunity costs they’ve spent on their wonderful university education.

There are 175,000 people unemployed, over 300,000 on benefits of some sort and over 100,000 students receiving student allowance.

These numbers aren’t going down anytime soon. The time for action is now. Aggressive job creation policy is a must by making it far less risky to experiment and find patterns of sustainable specialisation and trade.

And no, training wages and eliminating employment rights are not what I mean by “making it far less risky”.

The Vanishing Labour Market

…in New Zealand we have one political party talking about subsidising manufacturing and the other political party talking about how lazy the unemployed are.   It makes me a sad panda. – Matt Nolan

One reason that young Kiwis aren’t saving is because they aren’t earning enough. Income less expenses equals savings.

The cost of living has gone through the roof over the past decade, with hardly any increase in wages, salaries or opportunities to create your own wages through freelancing or self-employment.

In 2012, young Kiwis need to lower their expectations because of the destruction wrought by the baby boomers and assorted grey hair elite.

Yes, some young Kiwis buy fancy gadgets. But not all of them do.

Yes, some young Kiwis earn high incomes. But most of them don’t.

Yes, some young Kiwis waste heaps of money partying. But a lot of them can’t afford even that.

I am sick of reading comments by people born into an entirely different economic paradigm.

Yes, your job cleaning toilets with a toothbrush paid your way through university.

But if you’ve taken a look at low skill jobs these days, you’ll find that part-time is the new full-time and casual is the new part-time.

There is also an inability to perform basic math on the part of many who criticise young people who don’t work or can’t find a job.

Even if they did get a job, their employers can treat them like crap without a care in the world. Why? Because there are literally hundreds of other people who could do the same job.

We no longer have a functioning labour market in the sense that every generation before us experienced.

We have a skills market. If you don’t have a specific skill then you don’t get anything.

Our current education system is designed to produce people who slot perfectly into production lines and paper pushing jobs.

Creative ability is crimethink, innovation is insolence and self-directed learning is subordination.

There is an enormous gap between reality – skills market replacing the labour market – and what our entire education apparatus actually does.

There is no hope for changing the education and benefit system to focus on the sort of upskilling needed in the 21st century because it can’t be centrally planned.

If you have no skills employers want, the motivation to teach yourself them and put yourself in a position to earn income from those skills comes from within.

I’m a sad panda too, but not because of what political parties are saying, but because so many young people are ignoring the economic reality that they have to have a bunch of valuable skills to even get a look in to the skills market.

The bonus of many other young people’s lack of foresight is higher wages in the long-term for people who realise the way the economy is going and constantly add to their skill set through self-directed learning and real world freelancing projects.

Just look at the reality behind income inequality – we are moving towards a cognitive elite capturing almost all of the gains in productivity because not everyone can get their heads around the new economy.

Charting Our Unemployment Crisis

Key Points:

  • Unemployment is at a 13 year high of 7.3%
  • Our recovery from the global financial crisis is pathetic. Our annual GDP growth rate is a national disgrace.
  • Labour costs have increased almost 40% during this period
  • While labour productivity has stagnated
  • There isn’t much of a relationship between business confidence and the unemployment rate
  • Exports have been growing and less labour intensive production methods favoured
  • Increased M3 since 2008 hasn’t reduced unemployment

The news that unemployment is at a 13 year high of 7.3% is absolutely shocking. It’s even worse when you realise the number of measurement problems that Statistics New Zealand can’t overcome because of the nature of macroeconomic data measurement. Statistics NZ does a reasonable job with the HLFS so we have to work with what we’ve got and not get sidetracked by “what counts as unemployment” sideshows.

John Key needs to urgently review his government’s policies. Saying that he won’t “change tack” when there is no hope on the horizon for the extra 78,000 unemployed people in New Zealand is not good enough. Blaming the global financial crisis is not an option when there is an underlying productivity sickness in the New Zealand economy.

Reserve Bank governor Graeme Wheeler should definitely consider a cut in the OCR before 1 January so my iPredict contracts pay out. It could also boost aggregate demand. There is still some room for New Zealand’s monetary policy to move before it hits the zero lower bound / liquidity trap situation. But that is neither here nor there. And US unemployment has barely changed despite the Federal Reserve cutting the discount rate to 0%.

A picture is worth a thousand words. I think charts can help us think about our unemployment crisis. The fact that they prompt more questions than provide answers is a sign that we are on the wrong track. A failure to implement different labour market policies could accelerate our decline into middle income nation ignominy. What those policies should be is a matter for a later post.

This chart clearly shows that the recovery from the global financial crisis is not nearly as fast as the recovery from the Asian financial crisis in 1998 and its impact on our exports and GDP. This does not bode well because GDP growth compounds over time – even 1% less growth now is an enormous reduction in living standards extrapolated out to the 2020’s and 2030’s when the retiree to worker ratio will be at its lowest and we need a lot of excess wealth stored to pay for superannuation and health care.

This chart clearly shows the rise of labour costs as shown by the Statistics NZ index. You can read more about how its calculated at Statistics NZ.  There has been almost a 40% rise in the cost of labour in 13 years. But what has happened to productivity during that time?

This graph shows that labour productivity has grown roughly 7.5% (8/106) during this 13 year period. That is substantially less than the increase in labour costs. Employers have to finance higher labour costs with something. They’re not getting it all from higher productivity and more output. This means that workers at the margin will find themselves laid off.

Tyler Cowen’s “zero marginal product of labour” theory he’s blogged about could conceivably apply to swathes of currently unemployed Kiwis. They were the last to be hired and the first to be fired. With structural changes in the labour market due to technology, an argument could be made that cyclical unemployment doesn’t explain all of the increase in unemployment since 2008.

Increases in GDP growth certainly reduced the unemployment rate in the early 2000’s. But with unemployment now at 7.3% that’s almost double what it was at the beginning of 2008. I won’t share the graphs from Trading Economics / Statistics NZ but the number of employed persons has grown from ~1.8 million to ~2.2 million. During the same time our population has increased from ~3.8 million to almost 4.5 million. It would be interesting to study the role that immigration has played on the domestic labour market and exploring if there is any impact from work visa or working holiday visas on the sort of jobs at the marginal end of the labour force.

M3 is defined by the Reserve Bank as the broadest monetary aggregate.

M3 is the broadest monetary aggregate. It represents all New Zealand dollar funding of M3 institutions and any Reserve Bank repos with non-M3 institutions. M3 consists of notes & coin held by the public plus NZ dollar funding minus inter-M3 institutional claims and minus central government deposits.

Since the beginning of 2008, M3 has grown around 25%. This has not had any significant impact on reducing unemployment, in fact it has accompanied the rising unemployment rate. Why aren’t banks lending more to businesses to spur a recovery? Why are all the anecdotal stories I hear about stingy bankers failing to fund another promising business proposition?

Monthly mortgage loan approvals are up 40% on two years ago and running at $1.3 billion a month. Imagine $1.3 billion a month being funnelled into net new business lending and the long-term implications for productivity growth. Banks are fuelling the fire with the likes of 95% mortgages while bending any businessperson wanting to buy machinery or get a letter of credit over a barrel.

An increase in credit of this magnitude should be going hand in hand with a major rise in business investment. But that’s being thwarted by bankers who’d sooner give you $500,000 for a villa in Newtown than $50,000 for a piece of machinery. They have no vision or ability to comprehend reasonable business plans and their “fairweather friend” attitude means they have no credibility as financing partners.

But if we grow our exports we can create jobs and catch up with Australia! This chart is for the kooks who think that higher unemployment is because our export sector is struggling. If that was true the unemployment rate would have plummeted over the past four years.

Despite the high dollar, exports have increased almost a third since the onset of the global financial crisis. This could be because of the commodities boom and demand from China. It could also be because exporting industries have switched to less labour intensive forms of production. This would lead to less need to hire more workers if you’ve automated your factory.

There are some people who take business confidence seriously. But how can you look at the following and not detect a certain partisan bias? I think business confidence cannot explain why businesses aren’t hiring. They’re supposedly more confident than they were in the middle of a massive housing boom yet don’t want to add more workers.

Note that business confidence was slightly negative when unemployment was low in 2006, 2007 and early 2008. Perhaps business owners really don’t like paying wages and are invested aggressively in cost reduction and automation so they don’t need to go anywhere near the labour market. With some of the rules surrounding employment law, I would not be surprised but will refrain from comment until I’ve looked into the data more closely.

This was my first post full of charts and my brief analysis. If you’d like to add something please comment. I’ll be performing this sort of analysis more regularly.

It’s not as rigorous as building an Excel model for your consumption but it does involve a bit of reality based thinking.

I’d like to know what you think of my analysis and would be grateful for any pointers to interesting working papers, commentary or journal articles.

It would be really appreciated.