Why is the Recovery of Modern Labor Markets So Slow?

Arnold Kling is puzzled by current macroeconomic developments, particularly that banks are doing better than expected, and labor doing worse. I want focus on the second:

Relative to what a consensus forecast might have predicted last October, it appears that:

Two Puzzles of Current Macroeconomic Condition, Econlog: ...[E]mployment has fallen more than expected. ... Why is the severity of the recession so much greater in the labor market than in the goods market? ...

My answer ... is that we are superimposing a heterogeneous labor force on top of a trend of rapid productivity growth. In some sense, we are seeing an amplified version of what took place from 2001 through 2003. This was dubbed a "jobless recovery," but I called it a "productivity-cushioned recession." That is, growth in trend productivity of 2 to 3 percent per year is maintaining output higher than it would be if the trend were less than 2 percent. (Trend productivity growth is productivity growth measured over periods of five years or more, to iron out short-term fluctuations.)

The heterogeneous labor force means that it is very hard to reallocate labor from sectors that decline. Forty years ago, there were lots of industries that employed men with only a high school education. Today, there are fewer such industries, so that when the construction sector and the automobile sector shrink, the job losers have almost nowhere to go. These guys aren't going to turn into school teachers or nurses next month--or ever. It would be nice if the stimulus were actually creating construction jobs, but the reality is that the net increase in state construction projects is probably infinitesimal, as the states wind up juggling their budgets to keep Medicaid going. ...

There may be another factor as well. I think part of the problem - and the statistics support this interpretation - is that the economy is not creating jobs that pay as well as the jobs people are losing. Being unwilling to take a cut in pay, unemployed workers resist for awhile and keep looking, as long as they can anyway, and it isn't until they begin to exhaust the resources supporting the search and to accept the reality of a new job market that they finally lower their aspirations and take a cut in pay (or exit the labor force altogether). So it's not just that workers can't be retrained fast enough for the new, good jobs that are available, it's also that the availability of the jobs is not sufficient to reemploy workers at their previous rates of compensation.

But there is a factor that works against a long, drawn out search for a job that is a good fit with skills. If unemployment compensation is low, or does not last very long, then a worker may not be able to take the time needed to find a good employment match (though for workers with more personal assets to rely upon, i.e. higher paid workers generally, or another source of income such as an employed spouse that can help to tide them through, searches could still be relatively extended):

US Unemployment Benefits in International Context, by Mathew Yglesias: Gary Burtless has an interesting paper reviewing the social safety net measures in the American Recovery and Reinvestment Act. If you read the paper you’ll see that even though these elements of ARRA have gotten less discussion than the state aid and infrastructure elements, boosts in safety net spending are actually the largest segment of ARRA spending. For blogging purposes, though, I really just wanted to reproduce this chart showing how relatively stingy unemployment benefits are in the United States:

In addition to being relatively stingy, unemployment insurance in many ways fails to protect people from the most salient economic risks. Older workers tend to earn more money than younger workers, in part because over the years they’ve acquired sector- and firm-specific skills that their younger colleagues lack. When they get laid off, however, these skills become devalued and even when recovery comes it’s often difficult to get a new job that’s as remunerative as the old one. This, in turn, encourages the political system to focus a lot of preservation of the status quo which winds up reducing long-run growth potential. Gene Sperling’s idea of comprehensive wage insurance would help solve this issue and do a lot of good.