Thursday, September 15, 2011

Rambling thoughts on job creation

In this earlier post, I had wondered how fiscal stimulus would translate into jobs when industries are undergoing structural change from one with a manufacturing base to a service based economy. If we think of structural change as one where the economy is dominated by changes in employment in the same direction before and after a recession (i.e. Groshen and Potter, 2003) we would find that the manufacturing industries have been declining before and after each recession while service based industries have been increasing their share of employment before and after recessions. But why would industries/firms create jobs in the first place, and are manufacturing and service industries different in terms of why they create jobs?

Haltiwanger, Jarmin and Miranda (2010) find that small and young firms are mostly responsible for job creation. They don’t address the question of why jobs are being created and some introspection indicates that they would probably be hiring in order to grow by either product development or revenue enhancement. It is possible that they are experiencing losses when they are doing this and the “up-and-out” hypothesis that Haltiwanger et. al advocates is consistent with the idea that after a certain period, some these firms are overextended and crash and burn.

In a recession or at least in uncertain economic times, these firms are unlikely to overextend or at least be more cautious. This certainly contributes to jobless recoveries. But how is their behavior any different when fiscal stimulus appear to have worked in the past? As previously mentioned, a fiscal stimulus (or a tax cut) that increases AD in manufactured goods shifts the demand for goods and increases the MP of workers therefore increases demand for workers by firms. But with this sector in decline any AD based policy cannot create that many jobs, especially when the bulk of goods are imported from overseas.

One possibility for the jobless recoveries is that job creation is not only concentrated among young and small firms but most of these firms are in the service sector (unfortunately, Haltiwanger et. al. do not break their study down by sectors). If this is indeed the case, then why and when would these firms engage in job creation? Does demand for services respond as elastically as goods? If not then fiscal stimulus/tax cuts would not increase demand as much and hence would not create many jobs.

In any case, it is unclear to me whether any policy can actually spur job creation given that uncertainty faced by small young firms are as much (or perhaps even more so) a matter of perception as it is of reality. Moreover, in order to create more jobs, the economy needs to also create more firms. But why firms and jobs are created is not a very well understood phenomenon. (the former falls under the study of entrepreneurship, but the dot-com bubble and the growing importance of ICT industries may have biased studies toward high-tech start-ups rather than firm formation in general.)

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