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Climbing out of the Job Pool

It's not unusual for some unemployed workers to stop looking for jobs during a recession. But in this downturn, the retreat from the work force has turned into a mass exodus. The latest report from the Bureau of Labor Statistics showed that the labor force participation rate--the percentage of people either employed or actively job-hunting--fell by 0.8 percentage points over the past year, to 66.4%. That's the biggest year-over-year drop since the early 1960s.

The sharp decline suggests the published unemployment rate understates the damage to the labor market, since people not looking for work are not counted as unemployed. The understatement is particularly bad for the young, among whom the withdrawal from the labor force has been concentrated so far (chart).

Consider the unemployment rate for males ages 20 to 24, which rose to 10.6% in January, 2002, from 7.7% in the same month in 2001. That's bad enough, but over the same period the percentage of this group working or looking for work plummeted from 82.9% to 80.3%. With the exception of one anomalous month in 1999, that's the lowest participation rate on record for this group. If the withdrawn workers are added back into the numbers, the unemployment rate for this age group would be much higher. The situation for young women is similar, but not as extreme.

What's happening is that young workers, facing a bad labor market, are going back to school. BLS figures show that the percentage of young people enrolled in school rose substantially over the last year. By contrast, older workers seem to be in greater demand, rather than less, and more eager to work. The unemployment rate for workers 55 and older has gone up less than a percentage point, even while the pool of older workers in the labor force has expanded (chart). For example, the number of people ages 55 to 64 in the workforce rose 6.8% over the past year. That's a switch from the last recession, when older workers were more likely to be laid off. This time, older workers seem to be a resource rather than a burden, while it's the young who are taking the hit. Urban economists have long theorized that there is an optimal size for a city to maximize the productivity of its workers. Up to a certain size, the economies of scale afforded by urban infrastructure improve productivity. But once a city gets too large, congestion can actually cause productivity to drop.

The problem was that finding city-by-city data on productivity to test the theory was very hard. However, it turns out China keeps track of detailed output data for almost 700 of its largest cities. Using the data, a new study by Chun-Chung Au and Vernon Henderson of Brown University estimates the optimal size for city productivity, taking into account the relative proportion of manufacturing vs. services.

They found that the best size for a Chinese city with an equal balance of services and manufacturing would be between 1.4 million and 2.6 million workers. Cities that were more dependent on manufacturing would be most productive at a smaller scale, while services-based cities would benefit from being larger, perhaps between 2 million and 4 million workers. (These estimates for China are unlikely to apply to the U.S. Nevertheless, for a point of comparison, New York, one of the most heavily services-dependent U.S. cities, has a workforce of roughly 3.5 million.)

Surprisingly, Au and Henderson found that rather than suffering overcongestion, most cities in China were actually too small compared with their optimal scale. They attribute this to Chinese governmental policy restricting internal migration. These days, economic studies have become essential to any good lobbying effort. But their advocacy role has rarely been so blatant as in the ongoing fight over steel imports. When the U.S. International Trade Commission in December recommended tariffs on imported steel, it triggered a flurry of competing economic reports, with directly contradictory results.

On the one side were economists hired by the Consuming Industries Trade Action Coalition (CITAC), a group of steel-using companies and industry groups, including Caterpillar Inc. and Toyota Motor Manufacturing North America Inc. The study, by Joseph F. Francois and Laura M. Baughman of Trade Partnership Worldwide LLC, concluded that tariffs on imported steel would boost prices and cost between 36,000 and 75,000 jobs across the economy, eight times the number of steel industry jobs saved. Moreover, the CITAC study claimed the tariffs would cost consumers between $2 billion and $4 billion.

The steel industry fired back with a counterstudy by Massachusetts Institute of Technology economist Jerry A. Hausman, renowned for his work on telecom deregulation and antitrust. Hausman argued that CITAC's study badly underestimated the amount of American steel that could be substituted for imports. With U.S. steelmakers operating at two-thirds capacity, it wouldn't be hard for domestic producers to fill the supply gap caused by restrictive tariffs (chart). As a result, "the cost of a domestic automobile would increase by less than $2," writes Hausman.

With CITAC responding with its critique of Hausman's critique, the actual truth is hard to figure. The U.S. steelmakers are clearly under serious stress. But it's likely that they would be far better helped by a revival of the U.S. economy than they would be by tariffs on foreign steel--and that's not captured in either study.

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