Abstract
The Great Recession of 2007–09 led to a worldwide increase of 30 million in the number of people unemployed, with about half of that increase among advanced countries. This article discusses the factors behind this rise in unemployment, the reasons why countries such as Germany experienced little increase in unemployment while others were hit hard, whether policies were able to stave off an even worse outcome, and what the prospects are for labor markets in advanced countries.
Prakash Loungani
Question 1: What was the unemployment experience during the Great Recession?
The global unemployment rate rose from 6 percent in 2008 to 6.8 percent in 2009, based on statistics for countries monitored by the IMF’s World Economic Outlook, but there was considerable variation among countries.
Variation across country groups: The impact was more pronounced in advanced economies than in others. These economies accounted for half of the increase in the number of unemployed people between 2008 and 2009. The unemployment rate went up by 2 percentage points in the advanced economies, by about 0.5 percentage point in emerging markets and barely budged among low-income countries as a whole (Figure 1).
Variation among the advanced economies: Spain, Iceland, Ireland, and the United States experienced the largest increases in the unemployment rate in 2008–09. But countries like Germany, Korea, and Norway went through the Great Recession with hardly any increase in unemployment (Figure 2).
Unemployment by Country Groups 2008–09
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Source: World Economic Outlook Database.Advanced Countries: Change in Unemployment Rate 2008–2009
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Source: World Economic Outlook Database.Question 2: What accounts for cross-country differences in unemployment during the Great Recession?
Three factors are likely at play in accounting for the crosscountry variation (IMF-ILO 2010; IMF 2010a, 2010b; OECD 2010; Elsby, Hobijn, and Sahin 2010; Vitek 2010; Dao and Loungani, 2010):
(i) the extent of the drop in output;
(ii) structural bottlenecks in certain sectors or other mismatches;
(iii) the impact of macro and labor market policies.
The role of each of these factors is discussed in the questions that follow but, to preview the results, the drop in output is the predominant explanation. Most observers interpret the drop in output as aggregate demand-driven and reflecting people’s desire to reduce debt-to-income ratios (“develerage”); some also assign a role to uncertainty about the policy environment (Baker, Bloom, and Davis, 2011).
Structural factors may have played a supporting role in some countries, particularly where the collapse of the housing sector was a major reason for the drop in output. And the role of policies, particularly labor market policies, could be important in some specific cases, such as in explaining why Germany had such a small increase in unemployment.
Question 3: Did Okun’s Law survive the Great Recession?
Yes. The relationship between declines in output and increases in unemployment—generally referred to as “Okun’s Law”—held up well during the Great Recession. At a broad level, regions of the globe where growth held up better in 2009 had smaller increases in unemployment between 2008 and 2009 (Figure 3).
Regional Okun’s Law
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Source: International Labour Organisation and World Economic Outlook Database.For advanced economies, where there is a longer time-series of reliable data, the relationship is much tighter. Figure 4, from Ball, Leigh, and Loungani (forthcoming), shows the relationship for a few countries. Departures from Okun’s Law during the Great Recession were small in magnitude relative to the movement in unemployment. Exceptions include Finland, Germany, the Netherlands, and Sweden, where the unemployment rate in 2009 was a percentage point or more below the level predicted by Okun’s Law. In Spain, unemployment was 1.4 percentage points above the predicted level.
Cross-Country Okun’s law 1980-2011
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Micro evidence from within the United States also points to the drop in output (or aggregate demand) as a key factor driving the rise in unemployment. Mian and Sufi (2011) test this at a micro level using industry-by-county data on employment in non-tradable and tradable industries. Their hypothesis is that negative consumer demand shock in a given location should reduce employment in industries producing non-tradable goods in that specific location, but should reduce employment in industries producing tradable goods throughout the country. Consistent with this hypothesis, job losses in the non-tradable sector from 2007 to 2009 were significantly higher in high leverage counties that experienced sharp demand declines, whereas employment declines in the tradable sector were uncorrelated with leverage. Mian and Sufi estimate that the drop in output can account for 4 million of the 6.2 million jobs lost in the United States between March 2007 and March 2009.
Question 4: What role did structural factors play in the rise in unemployment?
Structural factors may have played a role in countries such as the United States and Spain where the collapse of a housing boom was the major reason for the drop in output. Chen, Kannan, Loungani, and Trehan (2011) measure the extent of industrial mismatch using data on industry stock returns. Increased dispersion in stock market returns across industries is also signaling an increase in structural unemployment. When underlying shocks to the economy have disparate impacts on the fortunes of industries, dispersion in stock market returns rises. During the Great Recession, dispersion in stock returns reached historic highs, partly reflecting the hits to the financial and construction sectors. This indicator explains about a quarter of increases in the unemployment rate, with bigger impacts on long-term unemployment (Figure 5, upper panel). In contrast to this structural indicator, the impacts of uncertainty, emphasized by Bloom (2009) and Baker, Bloom, and Davis (2011), are largely on short-duration unemployment (Figure 5, bottom panel).
United States Unemployment
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Source: Chen, Kannan, Loungani, and Trehan (2011).There is also some evidence of skill mismatches playing a role in the United States. Estevão and Tsounta (2011) measure the mismatch in each U.S. state between the demand for workers of various skills and the supply of those skills. They show that several U.S. states saw large increases in skill mismatches over the course of the Great Recession.
Question 5: How was Germany able to survive the Great Recession without much increase in unemployment?
To ease the pain in labor markets, governments complemented monetary and fiscal policy actions with active labor market policies. One of the key policies was to provide government financial assistance for programs to encourage companies to retain workers but reduce their working hours and wages. Such short-time work programs can spread the burden of the downturn more evenly across workers and employers, reduce future hiring costs, and protect workers’ human capital until the labor market recovers. The usage of short-time work programs as well as their contribution to the dampening of unemployment varied considerably across countries (IMF 2010b), implying that the design of the program as well as the underlying economic condition was vital for its success.
During the Great Recession, short-time work programs were most extensively used in Germany and are often credited for having played a crucial role in dampening the increase in unemployment there. However, Möller (2010) challenges this view. Instead, he suggests that the nature of the shock (which hit mostly export-oriented manufacturing firms) as well as the initial condition prior to the crisis, particularly a shortage of trained workforce, high costs of layoffs and rehiring, led to strong incentives for labor hoarding on the part of German firms. However, even if it was not the main driving force behind the behavior of firms, the short-time work scheme does appear to have supported this employment-friendly incentive in a beneficial way.
Question 6: Did macroeconomic and financial policies stave off another Great Depression?
At the onset of the Great Recession, monetary and fiscal policies turned stimulative in most countries. The case for a “critical role of an early, strong, and carefully thought out, fiscal response” was made by Spilimbergo, Symanksy, Blanchard, and Cottarelli (2008). Estimates suggest that the impact on 2009 global growth from the fiscal stimulus ranges from 1.2 to 4.5 percentage points.
For the United States, a number of papers find that monetary policies, particularly quantitative easing, are likely to have stimulated output and employment, by lowering long-term interest rates and depreciating the dollar (for example, Gagnon, Raskin, Remache, and Sack, 2010). The impact of financial policies, such as the Troubled Asset Relief Program (TARP) and several fiscal stimulus measures, such as the American Recovery and Reinvestment Act (ARRA), are more controversial. Blinder and Zandi use counterfactual simulations from a large-scale macro model to argue that without the financial and fiscal policy responses, the U.S. downturn would have continued into 2011, with a 12 percent decline in GDP—compared with an actual decline of about 4 percent—and a peak unemployment rate of 16.5 percent. They conclude that “this dark scenario would constitute a 1930s-like depression.”
Micro evidence from U.S. states supports the view that fiscal policies had an effect on employment. About $120 billion of Federal money was given to state and local governments to help them maintain employment and services. A substantial fraction of this spending was determined not by current economic conditions in a state, but to historical formulas that imparted a somewhat random element to the amount of aid that various states received. Chodorow-Reich, Feiveson, Liscow, and Woolston (2010) exploited this feature of the data to show that states that received more state fiscal relief because of these historical factors had significantly stronger employment growth, relative to predicted, than states that received less.
Question 7: What are the prospects for labor markets in advanced economies?
It is likely that labor markets will be slow to recover. In the near-term, the fiscal consolidation that many countries have turned to could act as a drag on the recovery in output and unemployment, particularly long-term unemployment. Ball, Leigh, and Loungani (2011) find that fiscal consolidations raise both short-term and long-term unemployment, but the impact is much greater on the latter. Moreover, while the impact on short-term unemployment comes to an end within three years, long-term unemployment remains higher even after five years (Figure 6).
Fiscal Consolidation and Unemployment
Citation: IMF Research Bulletin 2012, 001; 10.5089/9781475502183.026.A003
Source: Ball, Leigh, and Loungani (2011).Moreover, even after a cyclical recovery, structural trends that predate the Great Recession could dim labor market prospects. Loungani, Wang, Feiveson, and Jalles (2011) summarize the evidence on how skill-biased technological change and the increased prevalence of global supply chains have led to a striking loss of middle-income and manufacturing jobs in advanced economies, and the odds for a recovery in these jobs remain low.
The longer-term solutions to the hollowing out of middle-income jobs lie in retraining, better education, and increased productivity in nonmanufacturing sectors. But more immediate action is also needed to cushion some of the human costs of structural change, just as policymakers acted to reduce the human costs of the Great Recession (Dao and Loungani, 2011). Spence (2011) argues that redistribution must be part of the policy response: the potential benefits include increased social cohesion and continued support for globalization. Spence cautions that if the employment challenges confronting the advanced economies are not tackled, countries may resort to “protectionist measures on a broad front [and] the global economy will be undermined.”
References
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