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The U.S. Labor Market Experience in a Global Context

The recent recession was felt around the globe. Most advanced economies and some developing countries experienced a significant contraction in real output sometime after 2007, and this widespread slowdown translated into exceptionally bad performance in world output. According to the IMF, after growing at a rate of 4.2 percent every year between 2000 and 2007, world output grew only 2.8 percent in 2008 and contracted by 0.5 percent in 2009. This might be the first time since World War II that the world economy actually shrank.

While the major industrialized countries led this decline with sizeable contractions in their GDP, the effects of the downturn on labor markets differed across countries. When we looked at a set of developed countries that experienced similarly sized shocks to GDP-about 5 percent on average from peak to trough-along with Ireland and Japan, which saw much larger declines, we found a wide range of unemployment responses across countries. For example, GDP fell about as much in the United States as it did in Spain, but the unemployment rate increase in Spain was double that of the U.S.

Figure 1. Changes in GDP and Unemployment

Germany is unusual in that its 7 percent decline in GDP was accompanied by a decrease in its unemployment rate! It's impossible to tell from the unemployment rate alone, however, what else might be happening in the labor market to explain such data. It could be that in Germany the unemployment rate declined but those who are employed worked less. That response would not be captured explicitly in the unemployment rate and unfortunately, we lack data robust enough to allow us to compare hours worked across countries.

While the extent of the increase in unemployment varied across countries, the underlying pattern of unemployment over the course of the recession was remarkably uniform. Looking at the unemployment rate increases starting from the beginning of the contraction in real output, we see that the response was gradual and persistent almost everywhere. Unemployment started to show significant signs of an upward trend a couple of months after the start of the recession in each country, and it stayed elevated long after GDP began to pick up. In the case of Ireland and Spain, peak unemployment rate levels were observed only recently. Again, Germany is the exception.

Figure 2. Increase in Unemployment Rate

So far, we have assumed that labor markets respond to aggregate economic activity, with higher unemployment rates following contractions in real output. But all economies might not respond to aggregate conditions in the same way. One potential reason is that labor market institutions differ across countries. For instance, continental European countries have very strict laws against firing employees and hiring temporary workers. It is conceivable that employers in those countries might not have as much flexibility as they would like to adjust their workforces in the face of a recession. Anticipating the restriction, firms might be hesitant to hire in the first place, even when times are good. Such conditions would imply muted change in the unemployment rate as it responds to business cycles fluctuations.

We can explore this issue with an index computed by the OECD. The Overall Strictness of Employment Protection index provides a measure of the overall strictness of the labor market in a country with respect to the processes and costs involved when firing workers or hiring temporary employees. The measure can help us determine whether rigid labor markets (economies with strict employment protection) responded differently than more flexible labor markets during the Great Recession. In a sense, employment protection handicaps the ability of the labor market to adjust at the extensive margin as output falls. Plotting the unemployment rate change over the recession and the overall strictness indicator in the figure below shows us how the relationship plays out.

Figure 3. Employment Protection and Unemployment

Even though all of the countries in this extended sample are among the major advanced economies, they range widely in the strictness of their employment protections, with values between 0.2 and 3.4 (the OECD average is 1.9). The United States has the lowest employment protection score of the countries in the sample. Correspondingly, the unemployment rate response in the U.S. labor market was one of the strongest we see on the chart. Spain and Ireland stand out as major outliers in terms of their unemployment rate response, and they blur the relationship between employment protection and rising unemployment. Indeed if one ignores these two outliers, the trend line suggests a somewhat significant negative relationship: as employment protection increases, the unemployment rate response becomes increasingly muted. However, this relationship ignores the variance in the severity of the recession across countries.

To understand how the severity of the recession interacted with the degree of employment protection, we split countries into a “less strict” group and a “strict” group. The strict group includes Spain, France, Portugal, Sweden, Italy, Germany, and Finland, while the less strict group consists of the United States, the United Kingdom, Canada, Ireland, and Japan. The less strict countries exhibit a labor market whose response varies with the depth of the GDP decline. Deeper recessions are associated with larger increases in the observed unemployment rate. In the strict countries, even as the declines in GDP increase in severity, the labor market does not calibrate accordingly. Spain's outsized increase in unemployment influences this relationship for the group of strict countries and makes the relationship relatively insignificant.

One needs to exercise caution when interpreting these results, as our very small sample for one particular episode may not necessarily generalize. Nevertheless, this casual correlation suggests that increasingly large declines in GDP fail to yield additional changes in the labor market on the extensive margin in countries with relatively strict employment protection.

Another pattern shared across countries concerned the unemployment experiences of men and women. In all of the countries in our sample, women fared better than men throughout the recession.

Figure 6. Importance of Housing Downturns

The different experiences of men and women make sense considering male-dominated industries like construction and finance were hit hard by the recent recession. Housing downturns were an important factor in the recessions of about half of the countries in our sample. Construction was an especially large contributor to employment declines in Ireland and Spain, as in the United States. Correspondingly, males experienced dramatic increases in unemployment in those countries.

The U.S. experience in the Great Recession has been characterized by persistently high unemployment despite a modest recovery in GDP. Looking at that experience in a global context, we see that while the shock experienced by some of the major industrialized countries was relatively uniform in size, the labor market responses of the group exhibited a lot of variation as well as some similarities. Countries with less strict employment protection and those with significant housing market problems experienced larger increases in their unemployment rate when the recession hit. Among almost all of them, however, unemployment rate increases were gradual and persistent, and they disproportionately affected men.

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