Why Do Monthly Job Loss Estimates Exclude the Farming Sector?

In April, nonfarm payroll employment declined by more than 500,000 jobs for the sixth month in a row. While the pace of nonfarm job losses slowed, the Bureau of Labor Statistics (BLS) report on the employment situation continues to paint a fairly grim picture. Employment in the farming sector was actually a bit higher in January 2009 (the most recent month for which data is available) than it was in January 2008. Why doesn't the BLS cover farms and ranches in its payroll survey? Might the omission of the farming sector from the BLS payroll survey cause the jobs report to be too gloomy?

According to the BLS, farms simply fall outside the scope of the payroll survey. When the BLS began studying payrolls and employment in 1915, it focused exclusively on the manufacturing sector. The need for more accurate employment estimates during the Great Depression led the BLS to develop more comprehensive estimates of wages and employment in nonfarm industries during the '30s. Historically, at least, one can imagine the relative difficulty of gathering timely employment information in the rural farming sector.

The lack of agriculture in the payroll survey, however, is almost certainly inconsequential. The absence of farms in the Bureau's payroll survey matters less to today's employment picture than it did during the early and mid 20th century. In 1930, 21.5 percent of the workforce worked in farming, and agricultural output represented nearly 8 percent of U.S. economic output. At the turn of the 21st century, less than 2 percent of the labor force worked in agriculture, a sector that now represents less than 1 percent of national economic output.

The small share of the population employed in agriculture makes it unlikely that the Bureau's payroll survey--with a sample covering about one-third of total nonfarm payroll employment--will distort the overall jobs picture by failing to account for farm sector employment. Even an agricultural boom in the midst of the current recession would do little to reverse the dismal national employment trends.

Although the BLS excludes agriculture from its payroll survey, it does capture farm employment indirectly through a survey of 60,000 households. The most widely reported unemployment rate comes from this household survey, which includes respondents from all economic sectors: manufacturing, services, agriculture, or the ranks of the self-employed.

The household survey categorizes a person as employed if they worked for pay at some point during the past week, whether she worked in a factory, on a ranch, in an office, or for herself. A person who does not have a job, but actively searched for one at some point in the preceding four weeks, is considered unemployed. Anyone who does not have a job and has not been looking in the past month is classified as "not in the labor force."

The unemployment rate is simply the ratio of unemployed workers to the labor force (the sum of employed and unemployed workers). As the ranks of the unemployed continued to swell during April, the unemployment rate rose from 8.5 percent to 8.9 percent, reflecting an increase in joblessness among all workers, including farm hands and the self-employed.

Discussion Questions

1. There are a number of jobless people who would like to work but have given up on their job search because they believe it to be futile. The BLS classifies these discouraged workers as 'not in the labor force' rather than unemployed because they did not search for a job in the preceding four weeks. Consulting this table, how does the number of discouraged workers in April 2009 compare to the number in April 2008? If the BLS were to count discouraged workers as unemployed (and, by extension, part of the labor force), what would happen to the unemployment rate?

2. How has the recession affected the ranks of discouraged workers? For more information, consult this recent BLS report.

3. The BLS tracks the number of people who work part time for economic reasons, also known as involuntary part-time workers. By counting anyone who worked for pay during the preceding week as employed, the household survey classifies a number of involuntary part-time workers as employed. In what way does the official unemployment rate miss the underemployment associated with involuntary part-time work? This table contains information on involuntary part-time workers. How has the recession impacted the number of people employed part-time for economic reasons? What happened to the number of involuntary part-time workers between March 2009 and April 2009?

4. Even as Americans eat a larger variety and quantity of foods than ever before, the share of economic output attributable to agriculture declines. How can you explain this development?

Gainfully Unemployed

A 35-year-old Wisconsin man was recently fired from his job at Qdoba after he trashed the place, throwing pots, pans, desserts, and boxes of hot sauce on the floor. His motive? He claimed he was trying to get fired so he could collect unemployment insurance. Apparently, nobody told him that Wisconsin only pays unemployment benefits for certain types of separations. Not surprisingly, getting fired for intentional wrongdoing isn't covered.

Nearly everyone has had a job they despised. At some point the earnings from the job no longer outweigh the costs of sticking with it. The typical reaction is to simply quit and begin look for a better job. True, the newly unemployed worker will no longer collect any wages. But the added leisure time and the prospect of better work are presumably more than enough compensation for the lost earnings.

During the current economic downturn, fears about prolonged unemployment may make another option more viable: getting fired or laid off. While those who quit are not eligible for government unemployment insurance benefits, those who get fired or laid off might be.

Although the Wisconsin man was unaware that trashing his place of employment would disqualify him for unemployment benefits, other workers may devise less obvious ways of getting themselves removed from their unpleasant job. If they land themselves in the ranks of the unemployed without compromising their unemployment insurance eligibility, they'll be out of an unwanted job and into a welcome series of government checks.

In normal times, the Wisconsin man may have simply quit, but it's not hard to believe that concerns over prolonged unemployment, combined with a dicey understanding of unemployment insurance eligibility, made this decision unacceptable.

It turns out that unemployment benefits influence worker decisions about whether to take a job as well. Search theory economists showed that the last time the British government reduced the number of weeks fired employees could collect unemployment insurance, the average duration of unemployment shrunk by the number of weeks that unemployment benefits were no longer paid.

Discussion Questions

1) Part of the federal economic stimulus package gives state governments the option of using funds to extend the amount of time that an unemployed person can collect benefits. What trade-off do governments face when they choose to extend the duration of unemployment benefit eligibility during tough economic times?

2) At the root of this entire disturbance was the worker's goal to qualify for unemployment. If he had been better informed about the rules regarding dismissal for cause, how would this change his decision?

3) How might a worker hoping to shake lose of a lousy job and collect unemployment insurance benefits game the system?

4) Ignoring cases where those fired are not elligible, would you expect to observe behavior where people seek to get fired to collect unemployment more among high-skill or low-skill workers? Which group typically faces more competition in the job market and has a harder time finding a new job? How are these two ideas related?

Should the Government Bail Out the Auto Industry?

America's Big Three—General Motors, Chrysler, and Ford—are in big trouble. Sales from the not-so-fuel-efficient fleet of American-made vehicles had already suffered considerably because of high gas prices even before the financial crisis began to get serious in September of 2008. Faced with undesirable terms in private credit markets, the Big Three are now turning to the government for financial assistance. The House passed a bill to rescue the Big Three car companies with $15 billion in emergency loans on Wednesday, December 10, but the Senate abandoned the plan the day after. Should the government bail out the auto industry?

Those in favor of the bill argued that the rescue plan can prevent the loss of 500,000 jobs in the auto industry. Job losses in the auto sector would most likely have spillover effects in other sectors. As auto workers lose their jobs, they would consume fewer goods and services, negatively affecting industries in retail, health care, and financial services. With unemployment already rising, supporters of the bailout argued that keeping auto workers in their jobs is much easier than creating new jobs for them.

Opponents of the bill compared the bailout to the inefficiencies generated by government subsidies and tariffs. Many companies face financial problems—why should the government save the Big Three and not the others? Poor performance is typically a good signal that a company should change how and what it produces. A partial government takeover of American auto companies will not ensure that the firms will start producing vehicles that people want to buy. A bailout, according to critics, will simply prolong the inevitable: the consolidation of the American auto industry, the large number of layoffs that come with it, and the migration of workers from autos to more profitable industries.

Discussion Questions

1. What is the role of labor unions in contributing to the financial problems facing the Big Three? In particular, how well do the wages reflect the productivity of the workers in the Big Three? Click here to read more.

2. Do you think the problems faced by the Big Three stem primarily from the recent financial crisis or from longer-term decisions about what types of vehicles to produce and how to produce them?

3. Some suggest that another reason leading to the failure of the Big Three is that American consumers prefer cars made by foreign companies, such as Toyota and Honda, to cars made by American-owned companies. How does the market of foreign-made cars affect the demand for American cars?

4. Foreign-owned automakers, like Toyota and Honda, operate production facilities in the United States and employ American workers. How would these firms be affected by a bailout of the American-owned Big Three? How will foreign auto firms with operations in and outside of the United States be affected if one or more members of the Big Three were allowed to fail?

5. How do the loans compare with tariffs in foreign trade? What advantages and disadvantages do they share in common?

6. What would happen to the broader economy if the plants closed and workers became laid off? What might these workers do to find new employment? Which sectors would employ them?

America's Looming Liquidity Trap

In October 2008, the US unemployment rate hit 6.5%, a 14-and-a-half year high, as announced by the Labor Department. This lofty rate is likely to increase in the coming months in the wake of the ongoing financial crisis and adjustments in the real estate market. It also comes despite two 50 basis point cuts in the target federal funds rate made by the Federal Reserve during that month. These interest rate reductions brought the target fed funds rate down to 1%, a very low target rate by historical standards and close to the nominal rate floor of 0%. The Federal Reserve therefore finds itself in the thorny situation of having only 100 basis points left to work with for possible target rate cuts. (Note that a basis point represents 1/100th of a percentage point, so 1% is 100 basis points.)

The fed funds rate cannot go below 0% because a transaction at a negative nominal rate implies a negative nominal cost of borrowing funds. Furthermore, that implies a positive nominal payoff to the borrower and a positive nominal loss to the lender. Under typical, positive rates of inflation, the real costs and payoffs are amplified. This is shown in the following Fisher equation where i is the nominal interest rate, r is the real interest rate, and is the inflation rate:


This floor for the nominal fed funds rate brings up the very real possibility that the US will soon be mired in a liquidity trap—a situation in which "the monetary authority is unable to stimulate the economy with traditional monetary policy tools." One explanation for this weakness of monetary policy comes from the analysis on the real interest rate given above. In difficult economic times, why would financial institutions take on the risk of lending out money to a borrower who may default on the loan when the real return on even a fully repaid loan is negative!

An excellent source on how our nation might remedy its liquidity trap is given by the 2008 Nobel Laureate in Economic Sciences, Paul Krugman. His 1999 article "Thinking About the Liquidity Trap" offered policy solutions for springing the Japanese economy from the type of liquidity trap that now threatens the United States. Krugman's figure 1 from that paper shows a nice IS-LM example of the ineffectiveness of monetary policy. Wikipedia provides a good introduction to the IS-LM model. Below I present a modified version of Krugman's figure 1, in the context of current US interest rates, to represent traditional monetary expansion with a looming liquidity trap.



An economy may also happen to face declining consumption expenditures, as the US currently does, due to concerns about a rising unemployment rate, which can result in lower exogenous consumption and a falling marginal propensity to consume. In that case, the resulting leftward movements of the IS curve make monetary policy even less effective. Krugman's solution to the scenario is to have the monetary authorities credibly commit to sustained higher future inflation. The expectation that such higher inflation will eat away at the purchasing power of cash holdings should convince consumers to ramp up their spending and move the IS curve rightward.

President-elect Obama and the new Congress will undoubtedly undertake expansionary fiscal policy to attempt to move the IS curve rightward. However, our already massive national debt and the likelihood of waste involved in government spending, support Krugman's solution. Our newly elected officials and the Federal Reserve Board are facing unenviable policy choices.

Discussion Questions

1. Suppose that you were in control of US fiscal and monetary policy. What policies, if any, would you implement to improve US economic conditions?

2. Do you believe that America will soon face a liquidity trap? Why or why not?

3. The International Monetary Fund forecasts that the world's rich economies will collectively experience economic contraction for the first time since World War II. When was the last time America faced a liquidity trap? What circumstances led to that liquidity trap environment?

Conflicting Employment Figures

The government's monthly survey of businesses indicates that payrolls experienced a net drop of 63,000 jobs during February. At the same time, numbers from the government's monthly survey of households indicated that the unemployment rate declined from 4.9% in January to 4.8% in February. How can the unemployment rate fall even as the economy sheds jobs? Understanding this paradox requires a closer look at the household survey numbers for the past two months.

* Numbers in thousands

The household survey indicates that the number of employed persons saw a net decline between January and February. The ranks of the employed thinned by about 255,000 people. Normally, the net drop in the number of employed people would cause the ranks of the unemployed to swell by a similar amount. The government considers a person unemployed if she lacks a job but has actively searched for one in the past four weeks. Yet, the pool of unemployed workers actually shrank by about 195,000 people between January and February. The change in the size of the labor force over the same period provides some clues as to why.

The number of people dropping out of the labor force in February exceeded the number of new entrants—on net about 450,000 people left the labor force. These people either left jobs with no intent of finding another or gave up on their employment searches altogether. If you want a job but you're so frustrated with past failures to find one that you stop looking, the government classifies you as a discouraged worker and no longer considers you to be part of the labor force.

All things being equal, February's employment drop of 255,000 should have increased the pool of unemployed workers from 7.58 million to 7.83 million. Things weren't equal though, as a number of people considered unemployed in January gave up on their job searches in February, contributing to the 450,000 person drop in the size of the labor force and causing the number of unemployed workers to come in at 7.38 million in February rather than 7.58 million. If we assume that all 450,000 people became discouraged workers in February, the drop in the ranks of the unemployed and, consequently, the labor force, reflects the inability of those out of work to find compatible job vacancies.

The unemployment rate is simply the ratio of unemployed people to the size of the labor force (unemployed / labor force). Since the ranks of the unemployed declined by 2.6% and the size of the labor force declined by only 0.3%, the fraction of the labor force considered unemployed declined from 4.9% in January (7,576 / 153,824) to 4.8% in February (7,381 / 153,374). In this peculiar case, the small drop in the unemployment rate reflects economic weakness rather than economic strength.

Discussion Questions

1. Here's what the employment numbers for February would have looked liked if the 450,000 people who left the labor force had remained in the labor force as jobless workers actively searching for employment (unemployed people):


* Numbers in thousands

Under these conditions, what would the unemployment rate have been for the month of February 2008?

2. You can find the Bureau of Labor Statistic's (BLS) news release for February 2008 here. The national unemployment rate is at best a rough gauge of joblessness in the United States. The February numbers illustrate how the unemployment rate can paint a misleading picture of labor market strength. A fuller understanding of labor market issues requires a closer look at employment figures. How do the unemployment rates for specific age and racial groups differ from the national rate?

3. According to the BLS, who are the people who “work part time for economic reasons”? What has happened to their numbers over the past year? Does the unemployment rate capture changes in the number of folks who work part time for economic reasons?

4. Our assumption that all 450,000 people who left the labor force in February became discouraged workers is unrealistic. (Indeed, the BLS only counted a total of 396,000 discouraged workers in February.) Who, according to the BLS news release, is considered a “marginally attached worker”? Are all marginally attached workers also discouraged workers?

5. An unemployment rate of just below 5% is still relatively low by historical standards. Nonetheless, tepid employment reports in January and February darken the U.S. economic outlook when considered along side reports of weak output growth and continuing turmoil in housing and financial markets. Keeping in mind that the Fed's recent rate cuts and the government's tax rebates will begin to impact the economy in May and June, what type of economic performance do you expect in the United States for 2008?

The Phillips Curve and the Federal Reserve

The Phillips Curve is a concept often covered in introductory macroeconomics. However, in some economic and political circles, the concept is considered outdated and useless. Some economists and commentators, such as Lawrence Kudlow, might go as far as to say that the Phillips Curve is dead. Why does the Phillips Curve command such controversy? Is it as irrelevant as some economists claim?

The traditional Phillips Curve is the trade-off between the inflation rate and the unemployment rate. Many economists in the 1960s thought that the Federal Reserve or Congress could permanently lower the unemployment rate by increasing the inflation rate. The trouble is, the traditional Phillips Curve violates one of the central tenets of economics: the classical dichotomy. According to the classical dichotomy, nominal variables do not affect real variables. Consider a simple example:

I hold a bag of apples that weighs 5 pounds. The weight (i.e., the force exerted on my arm) is a real variable and the unit of measurement (i.e., pounds) is a nominal variable. Suppose the U.S. government passes a new law that says all measurements must conform to the metric system. Now the same bag of apples weighs 2.27 kilograms. Notice that the nominal variable (how the weight is measured) has absolutely no effect on the real variable (the force exerted on my arm).

The traditional Phillips Curve is in direct contradiction of the classical dichotomy. The Phillips Curve implied that the government could effectively reduce the unemployment rate (a real variable) by changing how fast overall prices are growing in the economy (a nominal variable). Though the traditional Phillips Curve held up well in the 1960s, the 1970s would usher in the downfall of the traditional Phillips Curve.

In the 1970s, the trade-off between the unemployment rate and the inflation rate seemed to fall apart. The United States experienced soaring overall prices and rising unemployment. In other words, there appeared to be an upward-sloping relationship between the inflation rate and unemployment rate. Due to this fact, many economists declared the Phillips Curve to be dead.

Due to the abrupt change in the correlation between inflation and unemployment, several theories were proposed as alternatives to the Phillips Curve. These theories include the Real Business Cycle (RBC), Rational Expectations, and Monetarism. Often times these theories are called “New Classical” economics because they promote the classical dichotomy.

Under heavy pressure from competing theories and empirical evidence, a new school of thought known as “New Keynesian” economics sought microeconomic foundations for the Phillips Curve. Edmund Phelps, the Nobel Laureate in 2006, augmented the traditional Phillips Curve by adding the critical role of expectations. Under the expectations-augmented Phillips Curve model, a trade-off between inflation and unemployment does exist but only in the short run. According to the model, inflation expectations adjust to return the economy to its natural rate of unemployment (i.e., an unemployment rate consistent with non-accelerating inflation). George Akerlof, the Nobel Laureate in 2001, provided behavioral explanations for the trade-off. Subsequent works by economists, such as David Romer and Greg Mankiw, provided additional microeconomic foundations for a short-run trade-off.

Through all the intellectual turmoil, most economists agree on the following:

1. There is a short-run trade-off between the inflation rate and the unemployment rate.
2. In the long run, the inflation rate adjusts to restore the natural rate of unemployment. Hence, policy makers cannot permanently push unemployment below its natural rate by permanently increasing the inflation rate.

How well does the modern Phillips Curve describe the real world, and do practitioners actually use the modern Phillips Curve? James Stock and Mark Watson, authors of a famous introductory econometrics textbook and well-respected econometricians, empirically showed that the modern Phillips Curve bested all other alternatives in terms of forecasting inflation. Ben Bernanke, chairperson of the Federal Reserve, professed publicly here and here on the importance of the modern Phillips Curve in the Fed's inflation forecasts, which ultimately influence monetary policy.

The Phillips Curve has changed over the past 40 years, but it is very much alive as a reference for monetary policymakers.

Discussion Questions:

1. Go to the Bureau of Labor Statistics web site and pull data on the national unemployment rate and the CPI inflation rate. For your convenience, I have included the spreadsheet here. Does there appear to be a trade-off between inflation and unemployment between January 2001 and December 2001?

2. Does there appear to be a trade-off between January 1997 and October 2007?

3. Why do you think an increase in the inflation rate decreases the unemployment rate in the short run? Why do you think a decrease in the unemployment rate increases the inflation rate in the short run?

Loss Aversion and the Housing Market

For many people, the pain of losing $500 outweighs the pleasure of gaining $500. As Austan Goolsbee points out in a recent New York Times column, this aversion to loss is especially acute when it comes to selling real estate. People are stubborn about selling a house for less than they paid for it. If selling at prevailing market prices means accepting a significant loss, some people refuse to sell at all, or else base pricing decisions not on what they would willingly pay to buy a similar house today, but rather on what they paid for the house when they bought it. As a result, sellers who bought houses during the peak of the housing boom will list their properties for a higher price than nearly identical homes purchased earlier on at lower prices. At worst, the strong reluctance to sell at a loss leads to a prolonged freeze in the housing market, with many homes listed for sale at prices that buyers will not pay. Since people who sell a house often go on to purchase another, loss aversion can contribute to weaker housing demand and prolong the housing slump.

The housing correction in the U.S. continues to reduce house prices in many regional markets. The correction raises the risk of a downturn in the U.S. economy. As house prices decline (other things being equal), household wealth declines, and consumption expenditures decrease. The shock to consumption spending may contribute to slower growth or even a recession. As Goolsbee points out, loss aversion in the housing market adds to the gloomy outlook for the broader economy. The reduction in housing-market transactions affects the consumption of durable goods and increases the costs associated with switching jobs. Read Goolsbee's column to find out more.

Discussion Questions

1. According to the article, what fraction of home buyers are moving within a metropolitan area? How will seller reluctance to lower prices during a housing slump affect the number of future buyers in a local housing market?

2. Suppose a beet farmer arrives at the farmers' market only to discover that other beet farmers are selling identical beets for less than he had intended to sell his own beets. He is likely to succumb to competitive forces and sell his beets at the prevailing price. Why are house sellers, unlike beet farmers, unwilling to lower their prices? Does it have to do with characteristics of the sellers or characteristics of the markets?

3. What are durable goods? Why would this type of housing-market freeze impact sales of durable goods? Why do you think the ups and downs of durable-goods sales are closely aligned with the ups and downs of the business cycle?

4. Frictional unemployment refers to the relatively short spells of unemployment associated with finding and transitioning to a new job. For example, a recent college graduate searching for her first job or a banker transitioning between jobs in different areas will be frictionally unemployed until they start at their new positions. How might a prolonged housing freeze increase frictional unemployment? To what extent might a housing freeze cause people to stay in jobs they would otherwise leave?

Oil Shock, Part II: The Macroeconomic View

Microeconomists examine how the BP oil field shutdown affects oil prices, the behavior of automobile drivers, and profitability of particular industries. Oil Shock, Part I showed that the oil field shutdown raises the price of oil which reduces the profitability of many firms.

Macroeconomists, on the other hand, examine the economy-wide effects such as how a sharp rise in oil prices affects inflation, output, and unemployment. Suppose that the BP oil field shutdown causes the inflation rate to increase from Inflation Rate 1 to Inflation Rate 2 because firms try to pass on some of the higher input prices to higher output prices. In order to simplify the analysis, assume that full-employment output is constant at FE Output. Full-employment output, or potential output, is the amount of output that the economy produces when all the resources in the economy are efficiently utilized.

If the BP oil field shutdown increases the inflation rate, then the Fed will pursue a tight (anti-inflation) monetary policy which raises interest rates. Higher interest rates would reduce consumption and investment, causing output to fall. An output gap opens up as actual output falls below full-employment output in the short run. In the long run, the output gap will cause the inflation rate to fall back to its initial state. As the inflation rate falls in the long run, the Fed will pursue loose monetary policy and return the economy back to full employment.

A fall in output usually leads to an increase in the unemployment rate as firms cut back on production of goods and services and lay-off workers.

If the BP oil field shutdown leads to an inflation shock, then interest rates will rise, output will fall, and unemployment will increase in the short run.

However, inflation's tyranny does not end there. A higher inflation rate also destroys wealth in terms of stocks and bonds. An increase in the interest rate also reduces the price of stocks and bonds (archived entry: Why Does Bernanke's Small Talk Move Markets?)

1. Financial markets are very sensitive to inflation data. Suppose the Bureau of Labor Statistics reports that the inflation rate increased from 2% to 4%. Why would stock and bond prices fall as soon as the report is released, but before the Fed actually changes any interest rates?

2. The Fed, in its last FOMC meeting on August 8, 2006, kept the federal funds rate unchanged at 5.25%. Could this mean that the Fed does not consider the BP oil field shutdown an inflation shock?

3. Inflation expectations matter. The Fed's inflation-fighting credibility has been strong since Paul Volcker (the Federal Reserve Chairman from 1979 to 1987). Suppose consumers and producers always expect the Fed to return the economy to a target inflation rate--would higher oil prices require the Fed to raise interest rates (or raise them by as much)?

Bringing the French Unemployment Picture Into Focus

News reports consistently cite the high unemployment rate for young people in France. According to the OECD, in 2002 the unemployment rate for French 20- to- 24-year-olds was 15.5%. This is higher than many other industrialized countries--for example, the same figure for Canada was just 7.2%, less than half of the French statistic.

However, while the difference in the unemployment rate between two adjacent years in the same country can tell you a lot about the state of the economy, the difference in unemployment rates between two countries is harder to interpret because so many factors can differ. To make a meaningful comparison of the labor market in two countries, it helps to look at other variables besides the unemployment rate. For example, the same OECD report also shows that the fraction of all 20- to- 24-year-olds who were unemployed was 8.4% in France, compared to 5.7% in Canada--higher to be sure, but by much less.

How can these two measures of joblessness paint such different pictures? Might it be that labor market conditions in France are not as bad as the unemployment rate suggests? Recall that the unemployment rate is the fraction of the labor force that is unemployed, not the fraction of the population. The unemployment rate is higher in France because a smaller fraction of 20- to- 24-year-olds are in the labor force there. The labor force participation rate for this age group is 54% in France and 79% in Canada.

These rates mean that for every 1000 20 -to- 24-year-olds in France, 540 say they want to work and 84 of them are unemployed, which leads to an unemployment rate of 84/540 or about 15%. For every 1000 20- to- 24-year-olds in Canada, 790 are in the labor force and 57 of them are unemployed, which leads to an unemployment rate of 57/790 or about 7%.

Yet other statistics show more clearly that the labor market opportunities for some young people in France are in fact much worse than in Canada. One useful measure is the duration of unemployment. For each 1000 young people in France, take the 84 who are in the labor force and unemployed. Of these, 34 have been unemployed for more than 6 months. Of the corresponding 57 people who are unemployed in Canada, only 5 have been unemployed for this long. (See Table 2, below.) This tells you that on average, spells of unemployment last much longer in France.

So the two major differences between France and Canada are (1) France has a lower labor force participation rate, and (2) long-term unemployment is much more prevalent in France. There are several explanations for these differences. A recent article in the Financial Times suggested that the main reason for the lower labor force participation rate may be that more twenty-somethings in France attend university. In fact, this can account for only a small part of the difference. The fraction of 20- to- 24-year-olds in education is only five percentage points higher in France--44% compared with 39% in Canada. Most of the 25 percentage point difference in labor force participation rates must therefore arise for some other reason.

A more troubling explanation for both differences is that many young people in France stay out of the labor force because they are discouraged--that is, they have been unemployed for so long that they do not feel that they can find a job, so they stop looking. Or they never bother to look. How many students would try to find a summer job knowing that it could take more than a summer’s worth of searching to find one? If many of the people who are out of the labor force would actually like to work but are so discouraged that they don’t even try, the human cost of France’s labor market rigidities may be even higher than its unemployment rate suggests.

1. Students across France have been protesting a new law that would make it easier for French employers to fire young workers. How might the passage of such a law affect the unemployment rate and the labor force participation rate? Why?

2. France has an unusually high minimum wage. Consider two groups: young people who have completed high school and drop outs who haven’t. Which group would you expect to have more unemployment because of the minimum wage? Would you expect this unemployment to be short-term or long-term?

3. Suppose the poor labor market for French youth encourages French students to stay in school longer than they would otherwise choose to, earning postgraduate degrees. What long-term effect would this have on the French economy?

Paul Romer is currently the STANCO 25 Professor of Economics in the Graduate School of Business at Stanford University and the founder of Aplia.

Youth Unemployment in France

Dominique de Villepin, France's prime minister, wants to loosen job protection rights for young workers. A recent Financial Times article (de Villepin labour reforms) highlights de Villepin's labor proposal. Existing French labor laws make it difficult and expensive for French firms to fire workers. The laws intend to prevent companies from dismissing employees on a whim. But job protection rights have some unintended consequences as well.

To analyze the effects of the laws, imagine yourself as a French business owner. Suppose a young, inexperienced worker applies for a position with your firm. There's a 50 percent chance she will work hard and a 50 percent chance she will slack off. You might be less willing to take a chance on this inexperienced worker if you face high dismissal costs in the event that she's a slacker. In short, French laws designed to protect workers actually create a disincentive for businesses to hire young, inexperienced workers in the first place. Some argue that this accounts for the sky-high youth unemployment rate in France, which currently stands at 23%--and even higher among immigrant populations.

De Villepin's reform would allow companies to hire workers ages 26 and under on a two-year trial basis. If a young worker excels during the two-year trial, she gets a full-time contract and all of the job protection rights that come with it. But if she doesn't, the employer could let her go at no cost. De Villepin argues that these looser firing restrictions would encourage firms to hire more young workers, driving down the youth unemployment rate.

De Villepin is not the first to propose such reforms. Each time officials proposed youth labor reforms in the past, massive labor union and student protests derailed the legislation--de Villepin can expect more of the same.

1. In addition to job protection measures, France offers comparatively generous unemployment insurance payments and high minimum wages. How do these policies affect the demand for inexperienced youth labor?

2. Would you classify the unemployment created by government legislation such as the minimum wage or firing restrictions as structural, frictional, or cyclical?

3. French officials defend job protection measures, arguing that job security makes workers happier, and therefore more productive. How might job protection measures affect worker productivity?

4. If you were a student in France, would you join the protests or endorse de Villepin?

Topics: Labor market, Unemployment, Structural reforms