The Long and Short of It

This guest post is written by Sandile Hlatshwayo, a graduate student in economics at UC Berkeley, on forthcoming research with her co-authors Michael Spence and Nicolo Cavalli. 

In the post-crisis environment, issues of sustainability in the trajectory of the U.S. economy have come to the fore. However, many of these issues—persistently high unemployment, a large current account deficit, deleveraging in the household and financial sectors, and fiscal pressure—are better understood when placed in the context of changes in the economy’s structure over a broader horizon. As a follow-up to a 2012 publication, my co-authors and I are examining U.S employment, real value-added, and real value-added per job over the past two decades, while also conducting parallel analyses on Germany and Italy; this note focuses solely on the preliminary U.S. results. We separated U.S. industries into internationally tradable and nontradable components using Jensen & Kletzer’s (2005) approach. The approach determines the tradability of an industry based on its geographic concentration—the more regionally concentrated the industry, the higher its tradability (and vice versa). For example, take retail trade: its ubiquitous geographic presence implies that it is highly nontradable. The same could be said for dry cleaners, construction, and most health care services. On the other hand, mining tends to be geographically concentrated, which points to its tradability.

In the long term, the structure of the American economy has changed dramatically. Nontradable employment increased by 22.5 million from 1991 to 2011, while tradable employment fell by 1.2 million. Job gains in tradable service industries were offset by larger losses in manufacturing and agriculture. On the nontradable side, almost 60 percent of the employment increase can be attributed to government, accommodation and food services, and the health care sector.

Both tradable and nontradable value-added increased, both on the order of 50 percent. Manufacturing sectors that suffered a loss of employment also experienced rising value-added. Therefore value-added per job—a measure that correlates closely with annual income—rose, in some cases dramatically (e.g. electronics saw a 250 percent increase in value added per job from 1991 to 2011). High-income jobs remained in the tradable sector (e.g. in industries like finance and consulting). For the tradable sector as a whole, value-added per job rose substantially, an increase of 53 percent from 1991 to 2011, far above the increase of 37 percent in the economy as a whole. The tradable sector is gravitating toward higher value-added components of global supply chains. These consist, in broad terms, of high-end services, some in manufacturing industries, and some, like finance and insurance, in pure service industries.

Notably, and in contrast to employment trends where the sector drove increases, the nontradable sector saw growth in value-added per job of only 18 percent, far below the tradable sector’s 53 percent increase. The health care sector, the second largest employer after government, actually saw value-added per job fall by 5 percent over the 1991 to 2011 period, implying that, on average, health care workers are making 3 thousand dollars less in per year today than they were making in 1991, in real terms.

Turning to the short term, employment experienced a larger drop than value-added during the crisis and has also been slower to recover; on average, value-added has rebounded two percentage points faster than employment in 2010 and 2011, which should come as no surprise. Tradable industries like professional services, auto manufacturing, and electronics are driving the value-added rebound, while largely nontradable industries like health care and education are driving employment’s recovery. Ongoing job losses in government, information, and manufacturing account for employment’s relatively muted recovery. Unfortunately, the short-term dynamics of the U.S. recovery are reinforcing a long-standing trend--the mismatch between the sectors driving employment and the sectors driving value-added and value-added per job, resulting in rising income inequality.

Until the crisis of 2008, the economy did not have a conspicuous unemployment problem. The expanding labor force was absorbed in the nontradable sector. In our view, it is unlikely that this pattern will continue. Chances are good that the pace of employment generation on the nontradable side will slow. As mentioned above, government—the country’s largest employer—has already started to shed jobs, with employment falling two percent from 2010 to 2011, a fall of almost 400 thousand jobs occurring largely at the state and local levels. Moreover, incomes in the nontradable sector have been stagnating for years. Fiscal conditions, the costs of the health-care sector, a resetting of real estate values, and the elimination of excess consumption all point to the potential for a longer-term structural employment problem.

To avoid this predicament, expanding employment in the tradable sector almost certainly has to be part of the solution. Otherwise, our current unemployment predicament will become a permanent feature of the American economy. The absence of rewarding employment opportunities in the lower- and middle-income ranges breaks an important part of the social contract in America, which holds that you are largely on your own but that if you work hard the opportunities will be there. The second part of that contract is now in question.

In describing these trends, we have been asked several times what the nature of the market failure is. The answer seems fairly clear. Multinationals, businesses that operate in the global economy, and those who have a role in creating and managing global supply chains are good at what they do and getting better all the time. They identify and respond to growing market demand, especially in the emerging economies, and to evolving supply chain opportunities. The resulting efficiency of the global system is high and rising. So we argue that there is no market failure. The system is complex and constantly evolving, but the operatives in the system adapt to the shifting sands of comparative advantage and market size, and move economic activity to the places where it can be performed at high efficiency and low cost.

If the issue is not about efficiency or market failure, what then is the problem? The answer is that market forces have distributional consequences for employment opportunities and incomes. Subsets of the world’s population, including those within advanced economies, experience adverse effects. What our policy makers need to address is the fact that there are real choices between aggregate income levels and efficiency on one hand, and distributional equity and employment opportunities on the other.

Assuming that the markets will fix these problems by themselves is not a good idea; it may be approximately true for the global economy as a whole, but is not necessarily for its parts. In truth, all countries, including successful emerging economies, have addressed issues of inclusiveness, distribution, and equity as part of the core of their growth and development strategies. Now advanced countries need to follow suit.

The late Paul Samuelson once said that every good cause is worth some inefficiency. Morally, pragmatically, and politically that seems right. Delivering on the opportunity part of the social contract is one such cause.