Higher effort levels are the cause of America's strange labor market: the fall in the labor participation rate and a recessionary level of duration of unemployment. In turn, the reason why effort levels have risen since 2000 is that economic growth has slowed and aging demographics. This still leaves open perhaps the most important question of all: why do we see signs of higher effort only in the U.S?
After all, demographics and low productivity growth have affected all of the advanced economies since 2000, but we see no evidence of higher effort levels in the U.K, Canada, France, Germany, Italy, Spain, Japan...
I'm no statistical wizard but even I understand that if only one out of however many developed economies obeys the theory, then the R squared won't number too good.
So how am I going to get out of this jam then? By countering this puzzle with another.
In the 2001 and 2008 recessions, U.S productivity acted strangely. In most economies1, and in the U.S prior to 2000, productivity falls as output falls, but in the 2001 and 2008 recession, productivity surged higher. It's natural to assume this was because of higher effort levels. This suggests that some time leading up to 2000 the U.S economy underwent a structural transformation that led it to have both2 secular increases in effort and cyclical increases in effort.
I could at this point just leave it that, treat the structural differences between the U.S and others as a giant black box and not delve into them in any way. I won't because it's rather unsatisfactory not to, and if we want to reverse the increase in effort levels we will need a much more precise understanding of its causes.
What stops firms from countries outside the U.S3 from imposing higher effort demands on their workers?
If employees were to immediately scatter to other companies when a firm tries to impose higher effort demands, then the firm would implode and the prospect of such a development would deter firms from attempting it in the first place.
Therefore how costly it is for employees to find a new employer has obvious relevance. The cost of finding a new job is twofold. First, there is the financial cost of not having employment for however long it takes to find a job. Second is the necessity of sending resumes and attending interviews with the realistic prospect of being rejected multiple times before obtaining a job offer. The U.S is one of the few countries where job quitters don't receive unemployment benefits. Only those workers who were laid off receive a benefit. Other countries that have similar systems include Canada, France (after 2014), and Croatia.
What other forces could prevent firms from raising effort levels (either during recessions or secular increases)?
If workers were part of unions then workers could threaten to strike. Or if workers weren't part of a union, they could threaten to unionize.
Looking around the world, countries that have stricter unemployment benefit schemes, like Canada and France, have strong unions. America in contrast has one of the lowest rates of union membership and it is also one of the countries where it is hardest to organize workers into a union.
It's possible that these two factors - unions and UI systems - are sufficient to explain the divergence between the U.S and other countries. However, we haven't exhausted the differences between the U.S and the rest. The U.S stands out from other economies on a number of dimensions. It is genuinely exceptional. Here are the five most relevant differences in my view:
1. The U.S is at the technological frontier: it both creates and adopts technology more freely than the rest of advanced economies. And it has been like that for a long while.
2. The U.S is more productive than most economies, and produces more output (i.e. more hours) than those economies with similar productivity.
3. The U.S has far bigger firms than other economies and does so even when accounting for its bigger population. I.e. top firms account for a larger percentage of output than comparable economies.
4. The U.S has greater inequality in labor income than other economies.
5. The U.S has much more labor and business turnover than the rest of the world. The length of job tenure is lower. Worker layoffs are higher and workers quit more.
This last point, lower length of job tenure and a higher rate of workers quitting, is a crucial one for whether a firm should raise effort requirements or not.
Let's do tenure first. In firms outside the U.S, employees have longer tenure and in all likelihood the employer, employee match is more valuable. I.e. employees have more firm-specific skills. Higher effort leads to greater labor market churn, which is more costly for firms outside the U.S.
Next, job quitting.
We already noted that in the U.S the cost of quitting a job to find another is more costly as far as monetary compensation is concerned. This implies that the cost of job switching is in fact higher in the U.S than elsewhere. What then is making American workers quit their jobs so readily? The simplest answer to that is, for a higher wage.
Points 1 through 5 indicate a more dynamic economy in the U.S than elsewhere. There will be more firms that are either growing or shrinking, rather than stable. Workers in shrinking firms will face stagnant or falling real wages while those in growing firms can expect large raises. Thus the push-pull of wage differentials can explain the higher quit rate even if otherwise switching costs are the same or higher.
What about points 1 through 3? Is the American economy more productive because it has larger firms? The opposite conclusion seems to fit the facts better. Firms that innovate and come up with either more valuable products or more efficient methods of producing goods will be rewarded with greater market share, and thus scale. Workers within these firms will gain higher wages, or to be precise, even higher wages than similarly skilled workers in other smaller firms. Inequality of income between workers will be higher.
What bearing does any of this have on job switching costs?
When an employee looks to another firm to switch to, he wants to find a firm that can offer him a job with a similar wage to his existing firm - before the effort increase. He applies for jobs that on average offer a wage slightly less than his current one. One can think of an employee who looks out of his firm's porthole. His field of view is restricted to scanning for firms and wage offers within a small delta of his prior wage from his current firm. The number of firms that meet this requirement will depend on the density of such firms in wage space. It should be immediately apparent that the higher inequality between firms in the U.S implies a more stretched out distribution of firms and fewer firms to be found in any given wage delta.
Therefore it makes more sense for the employee to just stay put in their current job position rather than attempt to switch to another firm.
Now while all these differences between the U.S and the rest are noteworthy, they have existed for a long time, so they can't explain why cyclical productivity changed post-2000 nor the secular increase in effort. The only change besides the decline in union membership is the increase in labor income inequality.
The changes necessary to reverse the increase in effort levels and fix America’s labor market are thus pretty obvious. One could alter the fundamentals that make America more dynamic, but this would be both hard to do and would come with a potentially large downside. This then leaves stronger unions and financial assistance to job quitters as the only other options. Whether these changes are worthwhile doing only Americans can decide.
Economies that experience rising productivity during recessions tend to be ones that had the most bone-crushing recessions. A couple of examples; Spain and Ireland in 2008. They saw deep and sustained losses in economic output following the bursting of their housing bubbles.
Germany is an interesting and illuminating exception to the latter; it has mild, labor-shedding recessions.
During the great recession, it had procyclical productivity like the rest of the G7, ex the US. But the three prior recessions were all labor shedding, including a very mild recession in 2000.
So why is Germany being awkward? Germany has high trade union membership, national wage bargaining, and union participation in company boardrooms - its co-determination system. If any place was favored to have labor hoarding cycles, Germany should be it.
The key to unlocking this puzzle lies in the close but not necessarily a happy relationship between company management and trade union leadership. When negotiating labor agreements, firms guarantee a limited number of layoffs in exchange for their wage offer.
But during a recession higher effort can come from firms reducing hiring not just from increased layoffs. Workers will thus experience higher effort levels unless firms keep hiring. But what can workers or unions do? They cant threaten to unionize, nor can they really threaten to strike since management is after all sticking to the letter of the deal.
Cyclical and secular increases in effort are similar but not identical. During a recession, wealth falls and this means that people value their leisure less highly. Therefore workers should be willing to increase their effort levels; thus only part of the increase in effort is excess effort. Another difference between cyclical and secular increases in effort is in a recession firms are financially constrained and need to cut costs or risk bankruptcy, workers and unions are thus more amenable to headcount reduction during downturns.
I've been careful to say that there are no signs of higher effort levels outside the U.S. Does that mean a zero increase in effort? It's hard to believe that if firms were to increase effort levels by .1% say that employees would immediately quit and seek employment elsewhere. We can infer then that effort levels have risen outside the U.S but by only a small amount. Employment will be slightly lower on a counterfactual basis and likewise, the duration of unemployment will be a little higher.