Global EconomyChris EdmondLabor Market DynamicsRevised: January 9, 2008An adult can be classified as either in the labor force or not and that if in the labor force shemay be employed or unemployed. These three concepts are labor market states. Many countriesalso collect data on changes in labor market states from one month to the next, generally termedlabor market flows. For example, an employed worker can either stay at the same job, take adifferent job, become unemployed, or leave the labor force. Similarly, an unemployed worker canstay unemployed, become employed, or leave the labor force. These changes in the labor marketstates of workers are known as worker flows. Related information on job flows is collected fromfirms. A firm is said to create jobs if it lists more positions (filled or not) than in the previousperiod and destroys jobs if there are fewer. Total job creation for the economy as a whole is thetotal number of positions added by firms that create jobs. Similarly, total job destruction is thetotal number of positions lost by firms that destroy jobs. The astonishing feature of flow data ishow much churning goes on: millions of people gain and lose jobs every month, and millions ofjobs are created and destroyed, whether the economy is growing or shrinking.Job creation and destructionModern economies create and destroy jobs (positions) at very high rates. New positions arecreated either because existing firms expand their operations or because new firms hire workers.We refer to this phenomenon as job creation. At the same time, existing firms sometimes eliminatepositions. We refer to this process as job destruction. An establishment (a production unit, likea factory, or a store) is said to create jobs if it increases the number of positions between oneperiod and the next. The economy’s overall job creation is the sum of the increases in positionsacross all the establishments that created jobs. Similarly, an establishment is said to destroy jobswhen it decreases its number of positions from one period to the next. The economy’s overalljob destruction is the sum of the decreases in jobs across all establishments that destroyed jobs.The sum of job creation and job destruction is referred to as job reallocation or job turnover. Jobcreation, destruction, and reallocation rates are simply ratios of job creation, destruction, andreallocation, respectively, to the total number of jobs in the economy. These rates vary greatlyacross countries, but their magnitudes are impressive everywhere. In the US over the last 10 years,the quarterly gross job creation rate in the private sector was about 7.8% while the gross jobdestruction rate was about 7.4%. So job reallocation amounts to a staggering 15.2% per quarter.Labor Market Dynamics 2Another interesting feature of modern economies is that individual workers change labor marketstatus regularly. An employed individual can either stay in her job, move to another job, becomeunemployed (leave one job but look for another), or leave the labor force (leave one job withoutwanting another). Similarly, an unemployed person can become employed (get a job), stay un-employed (look for a job without taking one), or leave the labor force (stop looking for a job).Someone out of the labor force can become employed (take a job), become unemployed (look fora job without taking one), or remain out of the labor force. We have information from surveys oneach of these possible changes.Some summary measures will give you a sense of how this looks for a typical individual. Jobfinding or accession occurs when individuals take new jobs, regardless of their current status. Jobseparations occur when individuals leave jobs, regardless of reason. The finding and separationrates are ratios of total accessions and separations, respectively, to total jobs. The sum of the tworates is referred to as the worker reallocation rate. In the late 1980s, the annual job finding ratein the US was 45.2% and the annual separation rate was 46.0%. The worker reallocation rate wasa staggering 91.2%! These numbers do not say why workers change jobs, merely that they do.The numbers for the US are unusually high. Worker reallocation rates are generally lower in othercountries, including France (59.6%) and Italy (68.1%). Apparently in the US it is more commonboth to leave a job and to take a new job.Fine points (feel free to skip). Part of worker reallocation is induced by job reallocation. Theopposite, however is not true. A worker can find a new job without a firm creating a new job(the position may have been unfilled). Similarly, a worker can separate from a job without thejob being destroyed. The excess of worker reallocation over job reallocation is called excess workerreallocation.A model of unemployment dynamicsLet’s now turn to a model of labor market flows. For simplicity, we will ignore transitions into andout of the labor force and so focus only on transitions between employment and unemployment.This has the virtue of making the model very easy to work with. (Unfortunately, it also has thevice that the numbers generated by the model are not quite realistic).Individuals may be either unemployed, Ut, or employed, Etwith labor force Ut+ Et= L constant.The unemployment and employment rates are then ut= Ut/L and et= Et/L so:ut+ et= 1.The number of unemployed people in the next period Ut+1will be the number unemployed now,Utplus a constant fraction 0 < s < 1 of employed people who are separated from their job, sEtLabor Market Dynamics 3minus a constant fraction 0 < f < 1 of unemployed people who find a new job, fUt. That is,Ut+1= Ut+ sEt− fUt,or,∆Ut+1= sEt− fUt.Unemployment rises over time if more employed people lose their job than unemployed people findnew jobs and falls over time if the reverse is true. (This should remind you of the dynamics ofcapital accumulation in the Solow growth model).Since the labor force is constant, the unemployment rate follows the same process:∆ut+1= set− fut,and since ut+ et= 1,∆ut+1= s(1 − ut) − fut. (1)This is useful because we have summarized the dynamics of unemployment in a single equation.If you were told what the unemployment rate was now, say u0, then repeated application of thisequation would enable you to calculate the unemployment rate in future periods. It would be avery simple matter to do these calculations in Excel.Steady state unemployment, u, is found by setting ∆ut+1= 0 so that:0 = s(1 − u) −