Monday, April 18, 2016

17/4/16: Start Ups, Manufacturing Jobs and Structural Changes in the U.S. Economy

In the forthcoming issue of the Cayman Financial Review I am focusing on the topic of the declining labour productivity in the advanced economies - a worrying trend that has been established since just prior to the onset of the Global Financial Crisis. Another trend, not highlighted by me previously in any detail, but related to the productivity slowdown is the ongoing secular relocation of employment from manufacturing to services. However, the plight of this shift in the U.S. workforce has been centre stage in the U.S. Presidential debates recently (see

An interesting recent paper on the topic, titled “The Role of Start-Ups in Structural Transformation” by Robert C. Dent, Fatih Karahan, Benjamin Pugsley, and Ayşegül Şahin (Federal Reserve Bank of New York Staff Reports, no. 762, January 2016) sheds some light on the ongoing employment shift.

Per authors, “The U.S. economy has been going through a striking structural transformation—the secular reallocation of employment across sectors—over the past several decades. Most notably, the employment share of manufacturing has declined substantially, matched by an increase in the share of services. Despite a large literature studying the causes and consequences of structural transformation, little is known about the dynamics of reallocation of labor from one sector to the other.”

“There are several margins through which a sector could grow and shrink relative to the rest of the economy”:

  1. “…Differences in growth and survival rates of firms across sectors could cause sectoral reallocation of employment”
  2. “…differences in sectors' firm age distribution could affect reallocation since firm age is an important determinant of growth or survival behavior” 
  3. “…the allocation of employment at the entry stage which we refer to as the entry margin could contribute to the gradual shift of employment from one sector to the other.”
  4. “…because the speed at which differences in entry patterns are reflected in employment shares depends on the aggregate entry rate, changes in the latter could affect the extent of structural transformation.”

Factors (1) and (2) above are referenced as “life cycle margins”.

The study “dynamically decomposed the joint evolution of employment across firm age and sector”, focusing on three sectors: manufacturing, retail trade, and services.

Based on data from the Longitudinal Business Database (LBD) and Business Dynamic Statistics (BDS), the authors found that “…at least 50 percent of employment reallocation since 1987 has occurred along the entry margin.” In other words, most of changes in manufacturing jobs ratio to total jobs ratio in the U.S. economy can be accounted for by new firms creation being concentrated outside manufacturing sectors.

Furthermore, “85 percent of the decline in manufacturing employment share is predictable from the average life cycle dynamics and the early 1980s distribution of startup employment across sectors. Further changes over time in the distribution of startup employment away from manufacturing, while having a relatively small effect on manufacturing where entry is less important, explain almost one-third of the increase in the services employment share.”

Again, changed nature of entrepreneurship, as well as in the survival rate of new firms created in the services sector, act as the main determinants of the jobs re-allocation across sectors.

Interestingly, the authors found “…little role for the year-to-year variation in incumbent behavior conditional on firm age in explaining long-term sectoral reallocation.” So legacy firms have little impact on decline in manufacturing sector jobs share, which is not consistent with the commonly advanced thesis that outsourcing of American jobs abroad is the main cause of losses of manufacturing sector jobs share in the economy.

Lastly, the study found that “…a 30-year decline in overall entry (which we refer to as the \startup deficit) has a small but growing effect of dampening sectoral reallocation through the entry margin.”

These are pretty striking results.

The idea that the U.S. manufacturing (in terms of the sector importance in the economy and employment) is either in a decline or on a rebound is not as straight forward as some political debates in the U.S. suggest.

Reality is: in order to reverse or at least arrest the decades-long decline of manufacturing jobs fortunes in America, the U.S. needs to boost dramatically capex in the sector, as well as shift the sector toward greater reliance on human capital-complementary technologies. It is a process that combines automation with more design- and specialist/on-specification manufacturing-centric trends, a process that is likely to see accelerated decline in lower skills manufacturing jobs before establishing (hopefully) a rising trend for highly skilled manufacturing jobs.

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