Sundheim 1
Long Has Become Too Long:
A Close Look at Unemployment Transition Rates in the 2007-2009 Recession
Elizabeth Sundheim
December 2012
Advisor: Professor Bryan Engelhardt
Abstract
Since the trough of our most recent recession, the unemployment rate has began to decline slowly.However, unlike any other recession, the average number of weeks the unemployed remain without a job continues to increase. Thelack of correlation hasleft many perplexed as to how the 2007-2009 recession differs from previous recessions. This paper investigateshow unemployment transition rates during the 2007-2009 recession changed in the presence of observable and unobservable heterogeneity compared to previous recessions.Using data from the Current Population Survey and a separated markets approach, the hazard rate for various typesof people is estimated using maximum likelihood estimation. Furthermore, I estimate theaverage lengths of unemployment for various groups of peopleand the proportion of people falling into these groups to see if the lengths and proportions have changed. Results show that for some types of people the hazard rate has considerably changed compared to previous recessions. Additionally, the findings suggest that while lengths of unemployment for various groups of people have remained unchanged, the proportions of people falling into these groups have changed during our most recent recession.
Introduction
During the 2007-2009 recession, leading news outlets published and broadcasted frightening headlines, portraying the 2007-2009 recession as the worst recession the United States has ever experienced. While many individuals may find this to be true, the 2007-2009 recession is both comparable and contrastable to previous recessions. Similar to previous recessions, the unemployment rate rose drastically during the 2007-2009 recession.[1]However, unlike previous recessions, the duration of unemployment for the average unemployed individual during the 2007-2009 recession increased substantially. Ben Bernanke, Federal Reserve Chairman, has referred to this rise as a “national crisis” (Crutsinger 2011).While the duration of unemployment for the average unemployed person did increase during previous recessions, it never increased as high as it did during the 2007-2009 recession. These similarities and differences between recessions are most clearly depicted in Figure 1 and Figure 2. For example, looking at the trends in Figure 1, the averageindividual in the labor force during theearly 1980s and 2007-2009 recessions experienced similar unemployment rates. Looking at the trends in Figure 2, the average individual in the labor force during the early 1980s and 2007-2009 recessions experienced very different unemployment durations.
After closely comparing a previous recession with our most recent one, it is evident that the unemployment rate does not always play a direct role in determining the spike in average duration of unemployment during a particular time period. The rapid increase in unemployment duration during the 2007-2009 recession left many distressed and confused. Understanding labor market cycles and fluctuations, many government officials and economists thought that even though this duration rose significantly, it would slowly decrease during the economic recovery. Now three and a half years after the trough of the recession, what was expected to happen has hardly begun to occur. Throughout the economic recovery of this most recent recession, the average duration of unemployment continued to rise, leaving many still concerned and perplexed. Figure 2 clearly depicts this. From June 2009, the trough of the recession, until October 2012, the average length of unemployment for an individual increased by 16.3 weeks.
Figure 1: Unemployment Rate
Source: Bureau of Labor Statistics
Figure 2: Average Weeks Unemployed
Source: Bureau of Labor Statistics
In order to better understand the substantial rise in the duration of unemployment, this paper examines how unemployment transition rates have changed throughout the past 4 recessions in the presence of observable and unobservable heterogeneity.To determine whether previous recessions were different, Iestimate the hazard rate using maximum likelihood estimation for a variety of types of people. Furthermore, I estimate the average lengths of unemployment for various groups of people and the proportion of people falling into these groups to see if the lengths and proportions have changed. All estimations use data from the Current Population Survey.
To prevent long unemployment spells from occurring in the future, understanding long term unemployment during the 2007-2009 recession is extremely important for both our economy and the labor market. People who are unemployed for extended periods of time are likely to experience financial hardship (Kaiser Family Foundation 2011).Additionally, as duration of unemployment increases, the unemployed are found to devote less time to job search (Krueger and Mueller 2011). Furthermore, it is probable that the longer a person is unemployed, the less employable they become. It has been found that long unemployment spells lead to a depreciation of a worker’s human capital (Pollak 2012). While not in the labor market, unemployed persons are not always able to keep up with the advancements in their industry and subsequently their skill sets deteriorate.Many policy implications and structural changes to job search programs could possibly result from a better understanding of the hazard rates in the 2007-2009 recession.
Background Literature
Economists have speculated potential economic and societal factors that have lead to the sharp increase in the duration of unemployment. While testing these factors has certainly helped us begin tocomprehend why the 2007-2009 recession experienced unemployment spells unlike any other recession, it has not helped us understand how unemployment duration during the 2007-2009 recession structurally differed from previous recessions.For both the 2007-2009 recession and previous recessions, examiningchanges inpopulation parameters and transition rates in the presence ofobservable and unobservable heterogeneitycan potentially aid in the understanding of the increase in the duration of unemployment during our most recent recession.A common misconception is that the unemployed all face a similar situation during a recession, that is being unemployed for a long period of time.Calculating population parameters in the presence of unobservable and observable heterogeneity assists in distinguishing between the varying lengths of unemployment during a recession and the proportion of unemployed persons experiencing these lengths.Calculating transition rates helps explain how the probability of finding a job varies over the duration of unemployment for various unemployed persons.
While this paper will explain how transition rates and population parameters in the presence of observable and unobservable heterogeneity have changed throughout several recessions, it will not pinpoint a reason why they have changed. Nevertheless labor economic theory provides potential explanations for these changes. Two theoretical models that very likely may explain these changes are job search intensity and directed search. Economists such as Eckstein,Wolpin, and Moen have greatly explored these theories empirically and theoretically.
Search intensity can be defined as the time and effort put into searching for a job or the number of “units of search” supplied by a given individual. Search units are increasing in cost and are chosen optimally to maximize the net returns from job search. Various types of people choose a different number of search units, depending on their search costs, the cost of unemployment, and their expected returns from employment (Petrongolo and Pissarides 2001). During economic downturns, it has been found that the marginal product of searchintensity falls both because of a decline in the probability of obtaining a job conditional on a given search intensity and because of a decline in the expected present value ofincome from a job (Shimer 2004).As a result of much discouragement, it is possible that there was a greater decline in search intensity during the 2007-2009 recession compared to previous recessions, causing the unemployed to spend an extended period of time searching for a job.
Directed search can best be understood in terms of the decision process that occurs when deciding which job openings to apply to. Assuming a distribution of wage offers, the unemployed can decide between jobs that offer high wages and those that offer low wages. The varying wage offers may be a result of identical firms offering different wages (Burdett and Mortensen 1998) or match heterogeneity (Jovanovic 1979). When appplying to jobs, individuals choose a reservation wage and reject all wage offers below the reservation wage (Petrongolo and Pissarides 2001).An increase in the percentage of the unemployed having a high reservation wage could have greatly increased the duration of unemploymentduring the 2007-2009 recession.The unemployed may have been more likely to apply to the jobs with higher wages, neglecting the jobs with lower wages. This phenomenon may have created a more competitive labor market for high paying jobs and as a result extending unemployment duration and the job search process for many.
Even though economists have not thoroughly examined structural changes in the duration of unemployment during our most recent recession, economists, using a wide variety of methods, have empirically tested possible factors that have lead to the sharp increase in unemployment duration. Such factors include changing characteristics of the labor force, extension of Unemployment Insurance benefits, and weak labor demand. Aaronson, Mazumder, Schechter (2009) investigate the effect of changes in age and other workforce characteristics on the rise in the duration of unemployment.In order to complete their study, they utilize individual-level data from the U.S. Bureau of Labor Statistics’ Current Population Survey and an approach called a Blinder/Oaxaca decomposition. Their analysis begins by showing that the significant rise in the average duration of unemployment between the mid-1980s and the mid-2000s can best be attributed to demographic changes in the labor force. In comparison to the early 1980s, Aaronson et al. (2009) find that at the end of 2009 only half of the increase in the average duration of unemployment can be explained by demographic factors that were present much before the recession began, leading them to believe there are new recent factors contributing to the rise. Thus, to further this empirical study, they examine how much of the remaining increase can be attributed to weak labor demand and extensions of unemployment insurance benefits. Their results show that the remaining unexplained increase is due mainly to weak labor demand, which is reflected by low levels of hiring. Only about 10-25% of the increase in the duration of unemployment from mid 2008 to the end of 2009 is associated with extensions of unemployment insurance benefits. One drawback of this study is that Aaronson et al. (2009) do not provide sufficient statistics on how demand is getting distributed.
Another economist has also assessed whether the recent surge in unemployment duration can be explained by the extension of Unemployment Insurance (UI) benefits from the normal 26 weeks to a maximum of 99 weeks for most eligible workers. Using the haphazard roll-out of the Emergency Unemployment Compensation and Extended Benefits programs during the 2007-2009 recession, Rothstein (2011) explores the impact of the recent UI extensions on job search and reemployment. Employing the longitudinal structure of the Current Population Survey (CPS), Rothstein (2011) develops hazards rates for unemployment exit, reemployment, and labor force exit that differ between states, over time, and among individuals with different unemployment durations. Calculating these hazard rates helps Rothstein (2011) distinguish the effects of UI extensions from other factors on employment and unemployment outcomes. The results of his study show that extensions of UI benefits had significant but small negative effects on the likelihood that the unemployed, most of which were long-term unemployed, would reenter employment.
Because workforce characteristics and extended UI benefits have been found to impact only slightly the substantial rise in the duration of unemployment, Valletta and Kuang (2012) proposed thatother factors must hold primary responsibility for the recent rise in unemployment duration and empirically tested these proposed factors. Of these, they believe that the most apparent is the severity and persistence of job losses in comparison to previous recessions.In order to empirically test this, Valletta and Kuang (2012) both follow and add to the approach used by Aaronson et al. (2010) by including measures of cumulative employment losses. The data used in their study comes from the CPS; it includes the most recent recession and its aftermath and the early 1980s recession and its aftermath. Using monthly CPS data on individual unemployment duration for these time periods, they calculate the percentage change in payroll employment relative to the pre-recession peak. They then use this percentage as an explanatory variable in a statistical exercise. Completing this exercise, Valletta and Kuang (2012) find that changes in workforce characteristics and cumulative employment losses explicate much of the increase in the unemployment duration of the recent recession compared to the early 1980s recession. For example, unemployment duration was 15.7 weeks longer for the 12 months leading up to August 2011 than for the 12 months leading up to January 1985. Of those weeks, 4.1 can be explained by changes in workforce characteristics and 7.5 can be explained by the longer length and persistence of employment losses during the most recent recession. Therefore, there are still 4.1 weeks that remain unexplained. They find that this number of weeks is only slightly larger than the estimated 3.5-week effect of extended UI benefits discussed in Daly et al. (2011). In conclusion, they find that weak labor demand is the primary explanation for the increase in the duration of unemployment. Nonetheless, Valletta and Kuang (2012) do not provide us with enough insight as to how this weak labor demand is getting distributed. While each of these factors that the economists have researched has affected the rise in unemployment duration in some way, they all cannot fully explain the increase. The question as to why there has been an increase in the duration of unemployment still remains unanswered.
Data
Individual level CPS data from the Integrated Public Use Microdata Series (IPUMS-USA) was used to examine maximum likelihood estimators and hazard rates in the presence of observable and unobservable heterogeneity. The individual level CPS data set captures duration of unemployment, for the CPS has been asking participating respondents their duration of unemployment since 1948.The question about unemployment duration is asked to a specific group of respondents, including unemployed people who were not interviewed in the prior month and newly unemployed people. The length of unemployment duration for an unemployed person is automatically updated for those who continue to be unemployed in the following month (Bureau of Labor Statistics 2011a). Duration of unemployment represents the length of time (through the current survey week) during which unemployed persons are continuously looking for work. For persons on layoff, the duration of unemployment differs. It represents the number of full weeks since the end of the person’s most recent layoff (Bureau of Labor Statistics 2011b).[2]
To account for observable heterogeneity, a few individual level CPS descriptive variables were chosen to divide the numerous observations into four specific groups. A separated markets approach is preferred due to its flexibility over a proportional hazards model.This approach is similar to that used in Flinn (1986) and Eckstein and Wolpin (1995).The individual level CPS data was broken down into the following groups: 16-34 year olds who have less than a high school diploma and those who have a high school diploma (or the equivalent) but no further education, 16-34 year olds who have completed some college but no degree andthose who have received an Associate’s Degree, Bachelor’s Degree, Master’s Degree, Professional Degree, or Doctorate Degree, 35-54 year olds who have less than a high school diploma and those who have received a high school diploma (or the equivalent) but no further education, 35-54 year olds who have completed some college but no degree and those who received an Associate’s Degree, Bachelor’s Degree, Master’s Degree, Professional Degree, or Doctorate Degree.A further breakdown than that mentioned above would have resulted in too few observations to be in each group. For instance, an additional breakdown by occupation would cause group totals to fall far below 300 observations.
Understanding the structure of the duration of unemploymentduring the 2007-2009 recession required comparing the 2007-2009 recession topreviousrecessions. To remain consistent when comparing recessions, the data used to compare recessions came from the March data set following the trough of each recession. Specifically, the March CPS data set was chosendue to the fact that it is known to have a key supplement and is the standard month to use. The trough of each recession was determined by the National Bureau of Economic Research, the official attributor of US business cycle expansions and contractions. For the early 1980s recession, the trough occurred in November 1982and therefore March 1983 data was used. For the early 1990s recession, the trough occurred in March 1991 and therefore March 1992 data was used. For the early 2000s recession, the trough occurred in November 2001 and therefore March 2002 data was used. For the 2007-2009 recession, the trough occurred in November 1982 and therefore March 1983 data was used.