This paper discusses how financial innovation turned U.S. mortgages into an asset class with worldwide investor appeal. It suggests that U.S. financial markets have been skilful in developing tools that have helped households exploit favorable global financing conditions to boost home ownership and acquire housing wealth. It reviews trends in labor supply and demand, electricity sector challenges, oil price developments, and the performance of the U.S. economy. It analyzes U.S. banking developments, with focus on large complex banking groups (LCBGs), and describes the structural change and competition among auto manufacturers and airlines.

Abstract

This paper discusses how financial innovation turned U.S. mortgages into an asset class with worldwide investor appeal. It suggests that U.S. financial markets have been skilful in developing tools that have helped households exploit favorable global financing conditions to boost home ownership and acquire housing wealth. It reviews trends in labor supply and demand, electricity sector challenges, oil price developments, and the performance of the U.S. economy. It analyzes U.S. banking developments, with focus on large complex banking groups (LCBGs), and describes the structural change and competition among auto manufacturers and airlines.

II. Recent Trends in Labor Supply and Demand7

A. Introduction

1. Cyclical developments in the U.S. labor market have been atypical in recent years. Aggregate employment and participation have tended to fall during a recession but quickly bounce back during recoveries (Figure 1). Despite a strong economic recovery since 2001, however, the bounce-back of labor markets failed to materialize, labor force participation has remained below its pre-recession level, and employment growth has been relatively sluggish.

Figure 1.
Figure 1.

United States: Labor Market Indicators

Citation: IMF Staff Country Reports 2006, 278; 10.5089/9781451839654.002.A002

Sources: Haver Analytics; and Fund staff calculations.

2. The unusually low level of unemployment and participation rates raise questions on how much slack remains in the labor market. With the unemployment rate just a notch above 4½ percent but wide-spread wage pressures not in evidence, an accurate gauge of the extent of labor market “reserves” is crucial for policymakers.

3. This chapter reviews relevant findings of the recent academic literature. Particular attention is paid to the question whether the unusual behavior of the labor participation rate and employment growth reflects cyclical fluctuations or structural shifts with potential longterm implications.

B. What Explains Low Labor Market Participation?

4. Current research suggests that both cyclical and structural influences are behind low participation rates since the 2000–01 recession. Aaronson and others (2006b) found that tight labor markets in the late 1990s contributed to a strong increase in labor market participation, and sharply deteriorating labor market conditions played a part in the decline through 2003. In addition, there is a substantial body of work suggesting the presence of a number of structural factors.

Demographic factors

5. Ongoing shifts in the age composition of the workforce tend to depress the aggregate participation rate. As labor market participation tends to be the highest for prime-age workers, and tapers off as workers get closer to retirement (Figure 2), a shift towards a larger share of mature workers may act as a drag on the aggregate participation rate.8 With the leading edge of the baby boomers just two years away from retirement, the ranks of mature workers have been swelling rapidly in recent years, and demographic change may have become a significant driver of changes in aggregate labor supply behavior.

Figure 2.
Figure 2.

Average participation rates by age cohorts, 1995-2005

Citation: IMF Staff Country Reports 2006, 278; 10.5089/9781451839654.002.A002

Sources: Haver Analytics.

6. However, demographic factors account for only about a quarter of the drop in the participation rate between 2000 and 2005. Under the assumption that age and gender-specific participation rates had remained at their 2000 levels, the rise of the share of mature workers at the expense of prime age workers would have implied a decline in the aggregate participation rate (Figure 3)9. However, this demographic shift only accounts for ¼ percentage point of the 1.1 percentage point decline in the overall participation rate.

Figure 3.
Figure 3.

Contribution of demographics to the change in aggregate participation rate, 2000-2005

Citation: IMF Staff Country Reports 2006, 278; 10.5089/9781451839654.002.A002

Sources: Bureau of Labor Statistics; and Fund staff calculations.

7. The bulk of the decline in the aggregate participation rate appears to be related to weaker labor market participation of younger cohorts. The youngest age groups experienced the sharpest drop, although participation has also fallen for prime-age workers, particularly women (Figure 4). Elderly women have remained significantly more active in the labor market compared to 2000, however, helping to raise the participation rate of older workers by 4 percentage points over the past 5 years.

Figure 4.
Figure 4.

Change in labor force participation rate by age group, 2000–2005

Citation: IMF Staff Country Reports 2006, 278; 10.5089/9781451839654.002.A002

Source: Haver Analytics.

Specific participation rates

8. The almost double-digit drop in the teen participation rate explains close to half of the drop in the participation rate in recent years (OECD, 2005). Unlike after previous recessions, the youth participation rate has continued to decline during the recent recovery. Studies suggest that increasing school enrollment, as well as stronger competition in labor market segments where youth participate, may have played a role.

  • Higher school enrollment is estimated to account for about ¼ of the decline in teen participation (Aaronson and others, 2006b; Coffin, 2004).10 Increases in family wealth, as well as higher returns to schooling—both longer-term trends—were both identified as significant factors. In addition, Aaronson and others (2006a) note that a fall in tuition (net of grants and education tax benefits) and an increase in the number of community colleges lowered the cost of education and made college attendance more widely accessible over the last decade.

  • Stronger competition from other population groups may have increased the share of discouraged youth. For example, low-skilled women who entered the labor market following the implementation of the Temporary Assistance for Needy Families welfare reform may have competed for jobs available for young adults. Immigration of unskilled workers may also have worsened employment opportunities, particularly for less-educated young males (CBO, 2004a, b).11 In addition, higher participation by older workers could have had an impact to the extent that employers have substituted inexperienced young with experienced mature workers.

9. Moreover, the long-term increase in female participation appears to have come to an end. Prior to the last recession, a slight trend decline in prime-age male participation—continued since 2001—had been offset by a trend increase in female labor participation. Indications are that the latter trend has now halted:

  • Weaker labor market conditions only explain about a third of the fall in female participation between 2000 and 2004 (Hotchkiss, 2005). Shifts in the demographic composition of the female labor force, including a greater share of Hispanic women, as well as the somewhat weaker labor market pull from education are found to have contributed. However, the bulk of the decline in the participation rate remains unexplained, suggesting a role for structural factors.

  • The decline in female labor market participation has been concentrated among younger, highly educated, married women with young children (Bradbury and Katz, 2005). This suggests that changes in labor market preferences or other factors specific to that demographic group, may have been partly responsible. Rising incomes may also have allowed secondary earners in families with higher incomes to withdraw from the labor market.

10. The rise in labor participation rates of older workers is largely seen as a response to structural factors. Long-term trends such as rising longevity, better health, higher educational achievement, and higher female participation among the baby boomers have facilitated labor market participation by older workers.12 In addition, ongoing health care cost increases, the weakening of company-based defined benefit pension plans, recent pensions scandals, and uncertainty regarding the Social Security system may have motivated workers to delay retirement.13 By contrast, the effects of the unwinding IT bubble—which impacted retirement assets—are seen as moderate, given that the share of significantly affected individuals appears to have been relatively small (Coile and Levin, 2006) and the subsequent housing boom has mitigated any negative wealth effects.

C. What Influenced Employment Growth?

11. Employment growth has been unusually weak during the current recovery. Nonfarm payroll employment has grown by less than 2 percent since the cyclical trough in 2001, compared to 6 percent over a corresponding period in the early 1990s and around 12 percent on average in previous cycles. The weakness of employment has been most pronounced in manufacturing, but the service sector has also underperformed relative to previous upturns.

12. The lack of job growth is often attributed to the increased pace of structural change in the economy, but the empirical evidence is inconclusive. Structural change is characterized by permanent destruction of jobs in declining industries and creation of new jobs in emerging industries. Given the need for labor markets to adjust, structural change could have imposed a temporary drag on employment growth in recent years. However, the evidence for this hypothesis is mixed:

  • On the one hand, temporary layoffs have played a relatively small role in the latest cycle, consistent with the view that structural factors have grown in importance (Schweitzer, 2004). In addition, the share of industries experiencing either net job gains or job losses during both phases of the last economic cycle has increased from previous cycles (Groshen and Potter, 2003). This could indicate that the share of declining or emerging industries in the economy is growing, consistent with intensifying structural change.

  • On the other hand, data for job creation and job losses across industries do not support the hypothesis of growing inter-industry job reallocation in recent years (Faberman, 2004).

13. While outsourcing has grown considerably in recent years, the evidence supporting a significant impact on employment growth also remains limited:

  • There are indications that industries and occupations commonly associated with offshoring have experienced above-average job declines since 2001 (GAO, 2004). However, negative employment effects associatedwith outsourcing vanish at less disaggregated industry levels as higher employment growth in other industries provides an offset (Amiti and Wei, 2005).

  • Consequently, job growth at the sectoral level appears to be only weakly affected (Amiti and Wei, 2004).14 This is confirmed by statistics suggesting that the scale of outsourcing remains small (Schultze, 2004). For example, layoffs due to overseas relocation represented only about 1.5 percent of layoffs in 2004.15

  • Looking at the broader impact of globalization, Faberman (2004) finds that trends in job destruction and creation across industries are independent of their exposure to international trade.

  • An earlier analysis found that increased foreign trade contribute to changes in relative wages, butits effect on aggregate employment remains ambiguous (Swagel and Slaughter, 1997).

14. The close correlation between employment and investment growth suggests that the sluggish recovery of the labor market may be related to unusually subdued investment (Figure 5). In the aftermath of the investment boom in the late 1990s, and in the face of larger economic and geopolitical uncertainties, firms appear to have become cautious both in their capital spending and hiring decisions. Therefore, the finding that many industries reduced employment levels both during and after the recession may less reflect structural factors than large adjustment needs in industries where capital spending and employment growth had been previously overambitious (Faberman, 2004; Cooper, 2006).

Figure 5.
Figure 5.

Growth in non-residential investment and private employment

Citation: IMF Staff Country Reports 2006, 278; 10.5089/9781451839654.002.A002

Source: Haver Analytics.

D. Conclusions

15. A number of structural factors are likely to restrain labor supply growth in the United States. Notwithstanding higher participation rates among the elderly, population ageing is likely to have slightly negative impact over the medium term, with the Bureau of Labor Statistics projecting to a fall in the overall participation rate of ½-1 percentage point. Youth participation could continue on its declining trend if school enrollment were to rise, reflecting likely increases in returns to schooling. Similarly, the trend rise in female labor participation may have come to an end, particularly as higher wealth and family incomes facilitate withdrawals from the labor force.

16. There is little evidence for structural factors behind the slow rate of employment growth in recent years, however. By contrast, there is some support for the hypothesis that low labor demand may be related to the unwinding of an investment and employment boom in the late 1990s. With the labor market expected to tighten once this adjustment has run its course, wage pressures could be expected to increase.

References

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7

Prepared by Evridiki Tsounta.

8

Of course, ongoing demographic change may also trigger longer working lives.

9

The estimates are based on a simple accounting procedure suggested by MacGregor and Mang (1996). The approach is based on the idea that “changes in the aggregate participation reflect changes in the participation rate of individual age-sex cohorts as well as changes in the importance of each of these cohorts in the distribution of the population” (Dugan and Robidoux, 1999).

10

Aaronson and others (2006a) find that about 1.6 percentage points of the 8 percentage point drop in teen participation between 2000–04 could be explained by a rise in school enrollment. The remaining was explained by lower participation rates among existing students (5.1 percentage points), and non-enrollees (1.4 percentage points). For 20–24 year-olds, the contributions were more evenly spread. Coffin (2004) finds that 40 percent of the decline in teen participation since the end of the recession is explained by increases in school enrollment, particularly in summer schools, and teen unemployment.

11

Immigrant labor has been the largest source of growth in the total labor force, accounting for about half of its increase since the beginning of the 1990s (Camarota, 2004). Between 2000 and 2005, the number of less-educated adult immigrants in the labor force increased by 1.6 million. By comparison, unemployment among less educated adult natives increased by nearly 1 million, with an additional 1.5 million choosing to leave the labor force (Camarota, 2006). In addition, while the number of discouraged workers has declined over the past year, this decline has been limited to those aged above 25 years old (OECD, 2005), suggesting that most of the discouraged workers had been among the younger, less educated cohorts.

12

For an overview of the factors affecting elderly participation, see Burtless (1999) and Burtless and Quinn (2001).

13

Gruber and Madrian (1995) suggest that the introduction of a universal health care system in the United States would increase the rate of early retirement.

14

Amiti and Wei (2004, 2005) only consider data for an earlier period (up to 2000).

15

Based on the Department of Labor’s Mass Layoff Survey that covers establishments with at least 50 employees.

United States: Selected Issues
Author: International Monetary Fund