Recycling Labor; C. W. Baird

Yet in any market-based economy there will always be layoffs and there will always be hires. Moreover, this is to be celebrated. It is a sign of economic health. Given the pace of change in what we know, in what is discov ered to be possible, in consumer tastes and preferences, and in the extent of competition, labor, like all productive resources, must con stantly be recycled. The popular press always stresses the downside of the recycling of labor. Bad news Charles Baird is a professor of economics and the director of the Smith Center for Private Enterprise Studies at California State University at Hayward. 8 sells better than good news and each plant closure or massive layoff is easy to capture on videotape. The upside of recycling-the hir ing-is more diffuse and less visible. Never theless, most of the time the upside outweighs the downside. From December 1997 to November 1998, in spite of all the layoffs and downsizing that occurred, entrepreneurs in the American economy created over a million and a half net new jobs. That's an average of 131,916 more jobs created than lost each month. And 1998 was not unusual. Table 1, column 2, shows this net job creation (December to November, seasonally adjusted) in each year starting in December 1992. Column 3 shows the 12 month diffusion index of employment change for the same periods. A diffusion index of 50 percent indicates an equal number of Ameri can industries adding and decreasing jobs.

TABLE 1 YEAR NET NEW JOBS DIFFUSION INDEX 1992 1,106,000 62.9 1993 2,293,000 69.2 1994 3,362,000 66.6 1995 672,000 63.5 1996 2,543,000 69.1 1997 2,825,000 72.9 1998 1,583,000 n.a. Source: http://www.bls.gov/news.release/empsit. toc.htm (Bureau of Labor Statistics Employment Situation Report) In every year net new jobs were created, and more industries added than eliminated jobs. Clearly, layoffs and downsizing do not mean the American economy is falling apart. Moreover, the personal fortunes of most people who receive layoff notices are not ruined. Most find new jobs at better pay after a job search and relocation. Table 2, column 2, shows the American unemployment rate, and column 3 shows the median duration of unemployment in November for each year from 1992 to 1998. Column 4 shows the private-sector employee total compensation index for the third quarter of each year. For example, in the third quarter of 1998 total compensation paid. to private-sector employ ees was 38.7 percent higher than in the second quarter of 1989. Total compensation includes wages and salaries plus all benefits such as health insurance and paid vacations. .

Median Duration (in weeks) 9.0 8.3 9.1 8.1 7.8 7.8 6.7 Year 1992 1993 1994 1995 1996 1997 1998 TABLE 2 Unemploy ment Rate (percent) 7.4 6.6 5.6 5.6 5.4 4.6 4.4 Compen sation Index (1989/2=100) 114.7 118.9 122.8 126.1 129.7 133.7 138.7 9 unemployment is temporary and a bridge to a better job. The unemployed fall into four categories: job losers, job leavers, re-entrants, and new entrants to the labor market. The job losers are those who are fired, those who receive layoff notices, and those who have completed a tem porary job. Job leavers are those who choose to quit a job either to take or to seek another job. Re-entrants are people who were employed in the past but who dropped out of the active labor force for some time to pursue other activities, such as school or homemak ing, and who then take up an active job search. New entrants are those who are engaging in active job search for the first time.

Table 3 shows the percentage distribution of the unemployed in each of the four cate gories in November in the years 1992 to 1998. Job losers are the largest group, followed by re-entrants. TABLE 3 Job Job New Year Losers Leavers Re-Entrants Entrants 1992 55.2% 10.5% 24.0% 10.3% 1993 52.5 11.9 25.2 10.4 1994 48.0 9.5 34.5 8.0 1995 47.6 11.1 33.4 7.8 1996 45.9 11.4 34.6 8.1 1997 45.6 10.3 35.2 8.8 1998 45.0 10.7 35.4 8.9 Source: http://www.bls.gov/news.release/empsit. toc.htm Using Bureau of Labor Statistics (BLS) data, the Employment Policy Foundation concluded that in the last five years, average annual employment growth in the highest paid one-third of new jobs was 3.2 percent. In the same period, employment growth aver aged just over 1 percent in the lowest-and middle-paying thirds. This means that over 60 percent of all employment growth occurred in jobs in the top third.! Since 1983, job growth in the top third has been 50 per cent, which is one-and-a-half times more than in the lower third.2 It seems clear that for most people who receive layoff notices, Source: http://www.bls.gov/news.release/empsit.

toc.htm Job leavers and new entrants together make up roughly 20 percent of the unemployed. In November 1998 the seasonally adjusted num ber of unemployed people was just over six million. So there were about 2.7 million job losers, three-quarters of a million job leavers, over 2 million re-entrants, and over half a mil lion new entrants. They were all actively involved in the labor recycling process. Another way to think of employment and unemployment is as percentages of the total civilian noninstitutionalized population aged 16 or over (hereinafter, the population). The unemployment rate reported above is the 10 THE FREEMAN/IDEAS ON LIBERTY. APRIL 1999 number of unemployed divided by the active labor force. The active labor force is the sum of the employed and the unemployed. Only people who are out of work and who are actively seeking work are counted as unem ployed. Many people in the population are not in the active labor force. The laborforce par ticipation rate is the active labor force divided by the population. Table 4, column 2, shows the labor force participation rate in November of the years 1992-1998. Column 3 shows the ratio of the employed to the population. The difference between columns 2 and 3 in any year is the ratio of the unemployed to the pop ulation. Those ratios are shown in column 4.

In November 1998, for example, only 3 per cent of the entire population was unemployed. The other 97 percent were either employed or were not seeking employment. Since 1994, when the BLS began to collect the data, only 0.5 percent of those out of the labor force were discouraged about finding work. The rest were out of the labor force by choice.3 Typi cally the discouraged job seekers are those whose skills have become obsolete and who need retraining. TABLE 4 Participation Employed! Unemployed! Year Rate Population Population 1992 66.3% 61.4% 4.9% 1993 66.3 61.9 4.4 1994 66.8 63.0 3.8 1995 66.5 62.8 3.7 1996 67.0 63.4 3.6 1997 67.1 64.0 3.1 1998 67.1 64.1 3.0 Source: http://www.bls.gov/news.release/empsit. toc.htm The Market Process The labor market, like any other market, is a process of interaction between forces of demand and supply. The buyers of labor are employers, and the sellers of labor are job seekers and job holders. When employers "buy" labor, they hire the productive services of workers. Labor is employed, along with materials, supplies, and the services of capital goods, to produce output that employers in tum sell to customers. Workers supply labor services to employers in exchange for wages, salaries, and benefits.

The maximum amount that an employer is willing to pay for a worker's services is called his demand price for the labor. It depends on the increment to output that the services make possible and on the prices for which the employer can sell the additional output to cus tomers. Suppose that employer expects that an additional worker makes possible the creation of ten additional units of output per day, and that when those units are sold, the employer will receive $120 of extra revenue net of all other incremental costs. The hiring cost is the sum of compensation paid to the worker and employment taxes paid to government. The employer would not be willing to pay $120 per day or more for the worker's services, but at any hiring cost less than $120 per day, the employer would increase profits by hiring the worker. From the employer's point of view, the lower the hiring cost the better so long as he can hire the quantity and quality of labor he wants. The lower the hiring cost, the more eager the employer will be to hire additional workers if he can get them.

If workers' productivity declines because of, for example, a change of technology that makes their services less important, or ifthe prices that the employer receives from customers decline because, for example, the customers decide they want to buy different products, the employer would have to cut labor costs by lay offs or by reducing rates of compensation (or both). The latter is likely to cause many workers to quit because they have no reason to think that the reduced compensation is the best they can do. Both those laid off and those who quit will begin a process ofjob search. The minimum compensation that an employee will accept from an employer is called his supply price for the job. It depends on his perception of his alternative employ ment (and unemployment) opportunities. Other things equal, the better his alternatives the higher his supply price. If you know you can get $15 per hour from Employer X for doing a job, you will not accept anything less from Employer Y for doing the same job. If your alternative to working for Employer X is to be unemployed (a very unlikely situation), you will have a higher supply price if your family will support you during unemployment than you will if your best alternative is to become homeless.

So there is an upper limit on what' an employer will pay and a lower limit on what a worker will accept. The actual rates of com pensation depend on the relative strengths of two types of competition in the relevant labor market-competition among employers to hire and competition among employees to be hired. For a given level of competition among employees, the more intense the competition among employers to hire, the greater the pay. Conversely, for a given level of competition among employers to hire, the greater the com petition among employees, the lower the pay. Every hiring of every worker is an employ ment contract based on voluntary exchange. Every employer and every employee enter into such contracts because they expect to be better off than they would be if they did not do so. From an individual worker's point of view, the best of all possible situations is to be the only one who can do a particular kind of work and to have hundreds of employers competing to hire someone who can do the job. Such a worker would have tremendous bargaining power, and anyone employer would have almost no bargaining power. Similarly, from an individual employer's point of view, the best of all possible situations is to be the only buyer of a particular kind of labor service and to have a plethora of workers competing to do the job. Such an employer would have tremen dous bargaining power, and anyone worker would have almost no bargaining power. Bar gaining power in any market depends on the alternatives available to the actors therein.

Enterpreneurship Entrepreneurs are the key actors in all mar kets. The role of an entrepreneur is to discov er and grasp profit opportunities. Every prob lem that emerges in a market is a profit oppor tunity for an entrepreneur who first notices how to solve it and undertakes the solution. Successful innovations by entrepreneurs elicit RECYCLING LABOR 11 imitation, and imitation by more and more people means that, in freemarket settings, problems inevitably give way to solutions. Entrepreneurs do what they do in pursuit of profit; but when they are successful, and therefore make profit, the rest of us benefit from their innovations. Entrepreneurship involves creating new products, creating new technologies, creating new productive resources, assembling new combinations of productive resources to pro duce old and new products, adopting new forms of organization, and entering new mar kets and exiting old ones. Buyers and sellers in all markets must keep abreast of more inno vation now than ever before. In today's mar kets, successful innovation at one place rapid ly affects most other place's. Entrepreneur ship, and responses to entrepreneurship, lie behind the recycling of labor (and of other productive resources).

Suppose that the proposed merger of Exxon and Mobil takes place. In the face of falling prices for petroleum and its products (which itself is due to successful innovations in the discovery, production, and refining of crude oil as well as the discovery and implementa tion of alternativeenergy sources),the decision makers in the new firm will have to cut out duplicative operations. This means that many employees of the merged firm will receive layoff notices. Perhaps some will be able to stay on by agreeing to accept cuts in compen sation, but most will quite reasonably think that it is possible to find other satisfactory jobs that pay as much or more as the ones they have lost. While searching for alternatives, they will be counted by the BLS as unem ployed. Some will find new employment quickly; others will not. As noted, the median duration of unemployment in November 1998 was 6.7 weeks. If after some initially planned search period, some job seekers find no satis factory new jobs, they will reevaluate their prospects and lower their supply prices. Or perhaps they will become convinced that their best strategy is to undertake retraining so they can find different sorts of jobs.

Employers in markets for new products and products for which customer demand is rising also engage in search. They search for new 12 THE FREEMAN/IDEAS ON LIBERTY • APRIL 1999 employees who can do what needs to be done. They could attract a lot of applicants right away by offering very high pay and benefits, but most will reasonably think it would be cost-effective, at least for awhile, to offer nor mal compensation and spend some time sam pling the workers that apply. Recycling labor is not a simple matter of throwing all appli cants into a common bin. They must be sort ed according to abilities, interests, and costs. If after some initially planned period of search the employers do not find enough sat isfactory employees, they will then offer bet ter compensation to attract more applicants. The key insight is that every unemployed worker who wants to work is a potential prof it opportunity for an entrepreneur who dis covers ways of employing him. Even workers who have a hard time finding new work are potential profit opportunities. They are likely to be available at modest levels of compensa tion, making it cost-effective to hire and train them. And when they are trained they acquire additional bargaining power with their employers and with potential new employers.

This is why, in a market-based economy, lay offs do not usually result in a growing number of unemployed people and falling average rates of compensation. Unemployment is like a pipeline. There are always people entering the pipeline, but there are always people exit ing too. Even if the number of people in the pipeline at any moment were always the same, the faces on those people would be constantly changing. Entrepreneurs, like all people, make mis takes. Some entrepreneurs think they perceive profit opportunities and hire additional labor to try to grasp those opportunities. When loss es instead of profits emerge, they have to pass out layoff notices. However, the historical record suggests that under normal circum stances, entrepreneurial successes more than make up for entrepreneurial failures. After all, entrepreneurs are self-interested and therefore keenly motivated to avoid mistakes and the losses that result.

Of course, there are occasional periods dur ing which unemployment increases relative to employment, but these are the result of faulty government policies that cripple the labor recycling process. If, for example, the govern ment inflates the money supply and thus dis torts the price signals to which entrepreneurs respond, lots of' entrepreneurs will hire labor that later, after the market corrects the distort ed prices, they will have to layoff. Excessive taxation and regulation are other ways in which government can cripple the labor recy cling process. Government Doesn't Create Jobs It is entrepreneurship in the context of free dom, not government, that creates increasing employment opportunities. Try to imagine what would happen to the labor-recycling process if entrepreneurs had to get permission from some government authority before they could enter or exit markets, expand or con tract employment, create new products, change technologies, or alter their organiza tional structures. The pattern of production would become less and less consistent with the pattern people want. Innovation would shrivel. Lots of people would continue to be employed doing what they always did, but they would increasingly produce things for which there would be no demand. There would be few job opportunities for new peo ple in the labor force. Production would be aimed at keeping government authorities, not customers, happy.

American presidents like to assert that they are elected to "run the economy." We should be grateful that that is merely their conceit. No one runs a successful economy. Its success depends on no one's being in charge of it all. At the same time, its success depends on everyone's being in charge of his own produc tion and exchange activities, dealing with oth ers on the basis of voluntary exchange. D 1. The American Workplace 1998 (Washington)D.C.: Employ ment Policy Foundation [www.epf.org]) 1998»)p. 24. 2. Economic Bytes, EmploymentPolicy Foundation)November 2) 1998. 3. http://www.bls.gov/news.release/empsit.toc.htm)Table A-lO.