Utopia, you are standing in it!

Willems and van Wijnbergen (2013) identified reduced clarity in information about business cycle fluctuations as a factor that is the lengthening the lag in the response of employment to output changes in recent US recessions.

Willems and van Wijnbergen (2013) – ungated – found that the trough in employment in the 1991 and 2001 recessions was much later than the troughs for earlier US recessions.

• There was a stronger immediate reduction in employment in pre-1990 US recessions and a faster recovery, so the 1991 and 2001 recessions were initially job-preserving – the rate at which workers were laid off was less than in prior recessions.
• Employment in the 1991 and 2001 recessions continued to fall for another year after the trough in output.
• The job-preserving recessions in 1991 and 2001 were then followed by this delayed recovery in employment growth.
• There is a lengthening labour adjustment lag that slows the loss of jobs at the start of recessions and delays the renewal of recruitment at the end of recessions.

Willems and van Wijnbergen (2013) attributed this combination of job-preserving recessions and delayed employment recoveries in 1991 and 2001 to the interaction of rising labour adjustment costs and a reduction in the clarity of entrepreneurial information about the business cycle.

The rising labour adjustment costs arose from the capital losses to employers of laying off employees who are increasingly rich in firm-specific human capital. The risks of laying off and investing precipitously have increased in recent decades because output growth subsequent to the great moderation in real output growth volatility is less predictable.

The US economy experienced a 50% reduction in volatility for many leading macroeconomic variables as well as low inflation since the early to mid-1980s. Similar declines in the real volatility and inflation rates occurred at about the same time in other industrial countries.

Prior to the mid-1980s, US real output growth was more variable, but this variation was more predictable. Frequent recessions were soon followed by recoveries. Since the early to mid-1980s in the US, major variations in real GDP growth have come increasingly as genuine surprises – 1983–2007 was one long boom punctuated by two mild recessions in 1991 and 2001.

The delay in the official dating of the peaks and troughs in business cycles in the US has increased from an average of 7½ months before 1990 to about 15 months in the post-1990 period (Willems and van Wijnbergen 2013).

With recessions more of a surprise – and the scope and depth of the panic of 2008 is an example of such a surprise in New Zealand and abroad – the value of waiting for better market information has increased.

Less certain information makes it more profitable than before for entrepreneurs to invest in waiting before laying off increasingly human capital-rich employees, making new investments and undertaking fresh recruitment. The impact of the business cycle on employment will be more muted.

Modern recessions can be initially job-preserving – layoffs are postponed for longer because the rising cost of laying off experienced labour is higher and because of the increased value of waiting to see. Recoveries in employment can be more sluggish as investors wait to be sure about the latest trends. These employers can use the employees they hoarded in larger numbers in the downswing to fill orders in the early days of the upswing in business:

We have presented evidence that the lag with which labour input reacts to structural economic shocks went up in the 1980s, thereby bringing jobless recoveries and recessions that were relatively job preserving to the US economy.

Using a real option model, this lagged response is shown to be optimal in a setting where labour input is costly to adjust and where employers are uncertain about the persistence of shocks that drive the business cycle