FEDERAL RESERVE BANK OF SAN FRANCISCO ECONOMIC REVIEW

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STUDIES IN LABOR MARKETS AND UTILITY PRICING

\/\lINTER 1980 Rose McElhattan*

In the early 1960's, labor-market economists those in the labor-force reserve from other began to focus our attention on the historical labor market non-participants. correlation between movements in economic Published analyses of discouraged worker activity and the size of the labor force. They survey data, however, do not provide an une­ found that during economic downturns, sizable quivocal answer to the question of including numbers of individuals either left the labor such workers in the official labor-force count. force or postponed entering the market, while For instance, many workers who give personal during the initial phases of business recovery, reasons for their discouragement with ­ unusual amounts of workers joined the labor market prospects appear insensitive to changes force. These cyclical movements showed the in the availability of , and thus do not existence of a sizable labor-force reserve, a appear to represent a ready labor-force re­ group of workers willing and available for serve. A recent study by the National Com­ work according to the state of the economy. mission for and This labor-force reserve posed a special Statistics recommended that discouraged problem for policymakers. During ­ workers be counted outside the labor force ary periods, with some individuals leaving the until more could be learned about their avail­ labor force, the official unemployment rate ability and commitment to the job market. would not reflect the "true" cyclical amount of The resolution of this issue has major public­ unemployment. During the recovery period, policy implications. If discouraged workers in contrast, greater than average increases in were added to the labor force, they would sig­ the labor force would produce a stickiness in nificantly increase the official unemployment the unemployment rate, preventing it from sig­ rate-from 6.0 percent to 6.8 percent in 1978, naling an improvement in employment and for example. Under existing laws, such as the business activity. Consequently, policymakers Comprehensive Employment and eventually tried to get better estimates of the Act (CETA), more Federal funds hence would size of this labor-force reserve, to determine be allocated to states and localities, as a means whether the reserve should be included as part of meeting the government's full-employment of the official labor force. In 1967, the Census objectives. Bureau added a list of questions to the monthly The purpose of this paper is to study dis­ Current Population Survey, to estimate the couraged-worker behavior within the frame­ size of this reserve of "discouraged workers." work provided by job-search theory, to shed The survey counts as discouraged those who some light on the job-market availability and say they want a job but haven't looked recently commitment of discouraged workers. In its because they believe they could not find work study, the National Commission applied a con­ even after a job search. On this basis, the ventional unemployment model, relating dis­ availability of a person for work distinguishes couragement to changes in the unemployment rate-a proxy for overall labor-market condi­ 'Economist, Federal Reserve Bank of San Francisco. tions-and a time trend, which proxies for the

7 many other economic and social factors that Section I provides a brief discussion of the affect workers' decisions. A job-search model survey data and characteristics of discouraged also focuses upon general labor-market con­ workers. This is followed in Section II by a ditions (because they are associated with the discussion of the conventional unemployment cost of finding work), but in addition, it focuses and job-search models. Section III presents on unemployment-insurance benefit payments empirical results, and the final section dis­ and on the real the individual expects cusses the conclusions of the study. to receive in the market.

I. Characteristics of Discouraged Workers

Discouraged workers are persons who want 1. Believes no work available III line of jobs, but who have not looked for work re- work or area; cently because they believe they would be un- 2. Could not find any work; successful even if they looked for jobs. These 3. Lacks necessary schooling, training, people are not counted as part of the labor skills, or experience; force nor of the officially unemployed, because 4. Employers think too young or too old; or they do not meet the necessary criterion of 5. Other personal handicaps (such as dis- having actively searched for work in the last crimination by employers) in finding a four weeks. The U.S. Department of Labor job. defines "actively searching" rather liberally; it No questions are asked regarding the type includes registering for work when one collects of work or the pay the individual has in mind. unemployment-insurance benefits, talking to Since these issues are important to a job neighbors about job opportunities, and ac- seeker, analysts generally interpret an individ- tually being interviewed. ual's belief that no work is available as mean- The Bureau of Labor Statistics has been col- ing a belief that no "suitable" work is avail- lecting data on discouraged workers since able. 1967, through a set of supplementary questions Other reasons non-participants give for not on the monthly Current Population Survey- looking for work-although wanting work-in- the source of the basic employment and un- clude school attendance, ill health and home employment data. Questions regarding labor- responsibilities. A person will be classified as force non-participation, however, are asked not discouraged, even if giving reasons for dis- each month of only one-fourth of the sample, couragement, when other explanations such as and the data are published only as quarterly home responsibilities or ill health are also averages. given. The object of the classification scheme For each individual who is not in the labor is to separate those workers who are available force during the week the Current Population for work from those who supposedly are not, Survey is taken, two key questions differen- since these others have responsibilities or tiate discouraged workers from others: physical handicaps that would keep them from 1. Does...want a regular job now, either accepting work even if it were available. This full or part-time? availability is at the heart of the contention 2. What are the reasons.. .is not looking that discouraged workers should be included for work? in the official labor force. A person is classified as a discouraged Most people not in the labor force during worker if he/she answers yes or maybe to the the typical survey week in 1978 did not want first question, if his/her major activity during a job at that time (Table 1). About 5.3 million the survey week was not attending school, and people reported wanting a job-but only a por- if he/she did not seek work because of one of tion of these, 845,000 persons, offered reasons the following reasons: related to discouragement over job prospects

8 for not seeking work. Discouraged workers Table 1 represented 0.5 percent of the population in Civilian Employment, Unemployment and 1978, and if included in the labor force would Persons Not in the Labor Force, 1978 have increased the official unemployment rate (thousands of persons) from 6.0 percent to 6.8 percent. Noninstitutional population. aged 16 and over 161,058 Discouraged workers who believed that no Total labor force 102,537 Civilian labor force 100,420 work was available, or who could not find any Employed 94.373 work, were classified as discouraged for job­ Unemployed 6,047 market reasons. The others were classified as Not in labor force 58,521 Do not want job now 53,193 discouraged for personal reasons. The number Want job now, by reason for not seeking work: 5,328 of people giving job-market reasons for dis­ School attendance 1,374 couragement has exceeded those citing per­ III health, 720 Home responsibilities 1,226 sonal factors ever since the survey began, ex­ Think cannot get job 845 cept in the very first quarter of 1967 (Chart 1). All other reasons 1.163 The number of discouraged for job-market Source: U.S. Bureau of Labor Statistics, Employment and reasons (but not for personal reasons) has gen­ Earnings, January 1979, Tables 1 and 39, annual averages. erally reflected cyclical movements in labor­ market conditions. Since the early 1970's, dis­ all market conditions (Table 2). Between 35 couragement for job-market reasons has ac­ and 40 percent of all discouraged workers are counted for between 70 and 80 percent of the females between the ages of 25 and 59 years. total. The relative number of older discouraged Most discouraged workers are female; their workers, aged 60 and over, has fallen for both share of that total has remained close to two­ sexes since 1968, while the proportion of thirds over the past decade regardless of over- younger workers (16 to 24) has increased. Chart 1 Percentage of Discouraged Workers to Noninstitutional Working-Age Population 1967.1-1979.1 Percent 0.8 0.7 Total Discouraged Workers 0.6 ~

0.5 0.4

0.3 ... for Job-Market Reasons 0.2

0.1 for Personal Reasons

o 1967 1969 1971 1973 1975 1977 1979 9 How serious are these workers about want­ a plant shutdown which provides the major ing a job? If, for instance, an individual has source of employment in a small community.) not searched for work in over a year, we could Adding together those reporting either recent ask whether he/she actually wanted or was work or search experience in the 1978 survey, available for employment. The Current Pop­ 62 percent of the discouraged workers (and 70 ulation Survey does not regularly collect data percent of those discouraged for job-market which could help answer that question, except reasons) had some form of labor-market com­ for a special list of questions added to the mitment-were either employed or officially survey in September and October 1978. 4 This unemployed-during the prior twelve months. inquiry found that 44 percent of discouraged The evidence of labor-market attachment, workers (and 50 percent of those discouraged coupled with the National Commission's evi­ for job-market reasons) had looked for work dence that nearly 80 percent of the discour­ during the previous twelve months. For some aged contemplate searching for work in the people, however, the absence of recent search next twelve months,l suggests that the duration did not mean lack of labor-market commit­ of discouragement for many of these workers ment. (Some individuals go directly from em­ may be relatively short-lived. ployment to discouragement, as in the case of

Table 2 Discouraged Workers, by Age and Sex Thousands of Persons Percent Distribution 1968 1973 1975 1978 1968 1973 1975 1978 All Discouraged Workers 667 679 1,082 845 100.0 100.0 100.0 100.0 Males, 16 and over 213 225 359 305 31.9 33.1 33.2 36.1 16-19 42 58 72 6.3 8.5 8.1 8.5 20-24 10 23 57 43 1.5 3.4 5.3 5.1 25-59 53 67 lO6 110 7.9 9.9 9.8 13.0 60 and over 107 77 lO9 79 16.0 11.3 10.1 9.3 Females, 16 and over 455 454 722 540 68.2 66.9 66.7 64.0 16-19 67 75 90 60 10.0 11.0 8.3 7.1 20-24 47 75 110 75 7.0 11.0 10.2 8.9 25-59 240 251 433 305 36.0 37.0 40.0 36.1 60 and over lOI 54 88 lOl 15.1 7.9 8.1 11.9

Souree: Employment & Earnings, seleeted issues.

10 II. Unemployment and Job-Search Models The conventional framework for analyzing any individual employer. Searching for work discouraged-worker behavior is an unemploy­ is costly. We assume that search costs include ment model, l.2 which relates discouragement such direct expenses as transportation and the to the unemployment rate and time-trend var­ mailing of resumes, and that those costs are iables. The unemployment rate reflects the rel­ duplicated for each additional job contact. In ative availability of jobs, so that an increase this simplified model, wages and costs incurred (decrease) in joblessness is expected to in­ should be interpreted as discounted present crease (decrease) the number of discouraged values, and the individual is assumed to be risk workers in the population. The time-trend var­ neutral. iable represents other economic and social de­ Since the job seeker has knowledge of the terminants of discouragement about which not market distribution of offers and the cor­ enough is known to explain the trends. The responding costs of generating those offers, an unemployment model has been criticized for estimate can be made of the maximum ex­ assuming that labor-supply behavior is unre­ pected return from search-the "reservation sponsive to wages, and in general for not being wage." The individual's optimal search strat­ based on principles of rational economic be­ egy, then, simply is to accept any wage offer havior. 9 As an alternative, we turn to a model which is equal to or greater than the reserva­ based upon microeconomic theory, in which tion wage, and to reject all other offers (i.e., expected real wages and job-search costs influ­ continue to search). ence job-market participation decisions. The job-search procedure alternatively can Job-search models are simplified descrip­ be described in terms of an optimal stopping tions of how rational individuals who are seek­ rule. If the job seeker refuses a job offer, ing to maximize utility go about looking for he/she will incur additional search costs. At the 5 work and accepting job offers. ,6,8 The general same time, the individual has an expectation framework is applicable to the issue of whether of additional gains from further search; that is, to participate in the labor market, and may be an expectation of being offered a wage greater employed to study discouraged-worker or non­ than the current offer. If the expected wage 13 14 participant behavior in general. • At the gain is greater than the marginal cost, the job heart of the search model is the notion that Figure 1 job-market decisions must be made in the face of uncertainty, especially uncertainty about the $ wage that will be offered when a particular Marginal Revenue employer is contacted. This uncertainty leads Marginal Costs the job seeker to devise an "optimal search strategy"-a search procedure designed to en­ sure that the individual accepts only the job offer which provides the maximum expected return (see Appendix 2 for a presentation of the model). Co In constructing our job-search model, we begin with an individual who has entered the labor force, knowing that a search for work must be conducted before any offer can be expected. The job seeker presumably has ac­ curate information about the average wage and dispersion of wages in the market for a H(w) person with similar qualifications, but is un­ certain about the wage that may be offered by

W* 11 Wage Rate seeker will refuse the current job offer and Figure 2 continue to search. Similarly, if the expected $ wage gain is just equal to, or less than, the Marginal Revenue marginal cost, the current wage offer will be Marginal Costs accepted and search terminated. In this man­ ner, the optimal time to stop search and accept employment occurs when the expected wage gain is just equal to the marginal cost of con­ tinuing to search. At that point, the individual C has been offered the maximum expected re­ 1 turn-the reservation wage-from the job market (Figure 1). Each point on the locus, H(w), in Figure 1 gives the expected return an individual can anticipate from further search if the reserva­ tion wage corresponding to that point is ---H(w) adopted. At the reservation wage, W*, the expected marginal return from search is just matched by the marginal search costs. Conse­ quently, no further gains from search are ex­ W* Wage Rate pected, and the wage, W*, represents the re­ costs, depicted as the difference (c j - UIE). At servation wage the individual adopts in his/her such a level, an individual will search for em­ job search. ployment and accept a job offer equal to or H(w) slopes downward because the proba­ greater than W*. bility of being offered a wage equal to or Finally, an increase in the mean expected greater than w declines the higher the current real wage (current wages adjusted for expected wage offer. 5 Thus these jobs will be pursued inflation) would tend to decrease non-partici­ only if the marginal search cost is low. pation and vice versa. An increase in the av­ If search costs are increased sufficiently, the erage market wage, with costs constant, shifts individual would drop out of the labor market, the H(w) line upward and to the right as in because the marginal costs of finding a job are Figure 3. This shift leads to decreased dis­ greater than the expected gains offered in the couragement, since the wage of W* now rep­ market. This occurs at a cost equal to or resents a net gain from additional job search. greater than Co in Figure 1. Therefore, when Several qualifications should be noted, how­ relatively high search costs exist, or when they ever. First, we have assumed that the individ­ increase, some individuals can be expected to ual places no value on his/her non-market leave the market before finding suitable em­ time; that is, time spent in leisure, , ployment. home maintenance, and any other activity out­ Unemployment insurance benefits (UIE) side the labor force. For some individuals, non­ will help to cover the direct costs of search for market time carries a relatively high value, those individuals eligible to collect such ben­ while for others the reverse is true. A mean­ efits. By lowering the net costs of search, UIE ingful solution to the labor-market participa­ can be expected to keep people in the labor tion decision exists if, and only if, the reser­ force who might otherwise have dropped out vation wage (the maximum expected return because of high search costs (Figure 2). With from market work) exceeds the value the in­ 13 search costs relatively high at cp for instance, dividual places on his/her non-market time. the individual will find searching for work un­ According to our search model, labor-force profitable. The payment of unemployment-in­ participation is influenced by real wages. How­ surance benefits, however, reduces search ever, the model makes no distinction between

12 Figure 3 that an individual would have no motivation $ to drop out of the labor force once he/she made Marginal Revenue the initial decision to look for work. This was Marginal Costs because we placed no limit on the amount of time the individual would search for employ­ ment, and assumed that the individual had no prior information to differentiate among pro­ c spective employers. If either of these assump­ tions is relaxed, we find that the individual may indeed drop out, even in the absence of any changes in search costs or expected real wages. If a person sets a limit on the amount of time to search for a job, then as time goes on, the chances of finding suitable employment H(w') decline. As a result, the individual will tend to H(w) lower his/her reservation wage. Since search costs are positive, and the reservation wage w Wage Rate falls over time, a point can be reached when permanent and temporary (or transitory) real continued search becomes unprofitable and the wages, although recent theory and empirical person drops out fo the market. It may be results suggest that that distinction is impor­ argued that a person's age sets an tant in labor-supply behavior. Milton Fried­ effective upper limit on the search horizon, so man has suggested that the supply of labor that senior workers are more likely to drop may respond differently to a wage change ex­ out of the labor market than younger people.!3 pected to be temporary than to one expected In addition, an individual may have some to be permanent, i.e., expected to continue.3 information about wages that are likely to be According to this view, workers plan their time offered by particular employers. For instance, to take advantage of a temporary opportunity help-wanted ads regularly indicate which firms to earn higher-than-normal wages, and take are most likely to have vacancies. Conse­ more leisure or non-market time later. There­ quently, even before contacting an employer, fore, an expected temporary change in wages a job searcher may possess information which is likely to have a greater absolute impact upon permits him/her to distinguish among firms. labor supply than a wage change regarded as Under these circumstances, an optimal search permanent. Empirical results have found the strategy involves sampling specific firms in a distinction between temporary and permanent systematic fashion, rather than randomly, as wages relevant in the labor-supply behavior of assumed above. IS The individual first searches married women. l1 Other studies have found the firm with the highest expected return, and temporary wages to be statistically significant so on down the list, sampling his/her best op­ in explaining aggregate labor-supply partici­ portunities first and poorer ones later. In the pation and the labor-market decisions of major search process, the reservation wage declines age-sex groupS.7,17 Our job-search model may over time, and with positive search costs, the be amended, then, to consider the reactions of individual may thus find at some point that individuals to both transitory and permanent additional search is no longer profitable. The components of real market wages. person drops out of the market, discouraged Another question is whether a job seeker with having received no suitable job offer. will later drop out and become discouraged if Finally, income from other sources-such as there are no changes in search costs or ex­ the wage income of other family members-is pected market wages. Previously we assumed likely to affect an individual's labor-force par-

13 ticipation decision. All other things being where DW = proportion of discouraged equal, an increase in real wage income of other workers in the population family members allows that family to have c = direct costs of search more leisure (non-market time) and more uib = unemployment-insurance goods. In fact, a change in the average wage benefit payments paid in the market reflects changes in both the wP = permanent wages individual's expected wage and the wage of wt = transitory wages other family members. In the market, then, and the signs over the variables indicate the we might observe two opposing labor flows in direction of expected impact upon the propor­ response to a change in average real wages. tion of discouraged workers in the population. As wages increase, some individuals may leave The higher costs of search will lead to higher the labor market due to the higher family in­ rates of discouragement, while unemployment come (income effect), and others will enter the benefits act to decrease the net costs of search market enticed by the higher they can and the amount of discouragement. Wages, command (substitution effect). Which effect whether permanent or temporary, should work predominates will have to be answered empir­ in the same direction although with different ically, since economic theory provides no an­ strengths. An increase in wage levels should swer to this issue. Also, in light of our previous lead to a decline in the discouragement rate as discussion, these income and substitution ef­ individuals 1) enter the labor market in expec­ fects may differ in magnitude, according to tation of higher wages, or 2) decide that they whether the individual regards the change in do not want a job because the consequent in­ real wages as transitory or permanent. crease in family income enables them to en­ The job-search model may be summarized gage in more non-market activities. In this lat­ as follows: ter case, a person remains a non-participant, + but leaves the ranks of the discouraged for P t DW f(c, uib, w , w ) another non-participant group.

III. Empirical Results We are now ready to apply statistical tests to tion was estimated not only for the total num­ estimate the influence ofthe variablessuggested ber discouraged for job-market reasons, but by search theory on the number of discouraged also for age and sex groups within that total. workers in the population. Previous studies, as Finally, the equation was estimated for "other well as our initial work, suggested little con­ non-participants"-the total number of non­ nection between changes in economic condi­ participants in the population less all discour­ tions and the number of workers discouraged aged workers-as a means of comparing the 1 for personal reasons. ,2 Therefore, we have behavior ofvarious classes ofnon-participants. concentrated on those discouraged for job­ market reasons, who have accounted for 70 to 80 percent of the total number of discouraged workers over the past decade. According to search theory, discouragement is likely to be related to a measure of the direct The "a's" are constants estimated by ordi­ costs of search, to unemployment-insurance nary least-square regression techniques. The benefit payments, and to real wages. After subscripts refer to the current quarter "t" and some experimenting, equation (1) was chosen the previous quarter "t-1." The data sources on the basis of best fit, as measured by the are detailed in Appendix 1, and the variables higest correlation among variables. The equa- are defined as follows:

14 OW/Pop = proportion of discouraged work­ we dropped the permanent wage measure and ers for job-market reasons in the civilian pop­ included only the transitory component of real ulation, sixteen years and over. Separate wages as a determinant of labor supply. regressions were estimated for the total, and The two equations in Table 3 show the re­ for major age and sex classifications, divided sults of estimating equation (1) separately for by their respective populations. the percentage of females in the working-age V = unemployment rate. The unemploy­ population who are discouraged for job-mar­ ment rate of each age-sex category was used ket reasons (OJOBF), and similarly for males in the equation for the corresponding cohort (OJOBM). In neither case is the search frame­ of discouraged worker. In the aggregate equa­ work entirely successful in explaining the dis­ tion, for both discouraged workers and other couragement rate over the past decade. For non-partcipants, the unemployment rate of males, the unemployment rate-the proxy for males aged 25 to 54 was used as an indicator overall job availability and direct costs of of overall labor-market tightness. search-is the only statistically significant de­ VIE = the ratio of maximum weekly un­ terminant of their discouragement rate. (The employment-insurance benefits to spendable statistical F test also indicated that as a group average weekly earnings of a production the other variables did not add significantly to worker with three dependents. In estimating the determination of the male discouragement the net cost of job search, we assume that an rate.) In contrast, the net cost of search-as individual compares unemployment-insurance captured by both the unemployment rate and benefit payments to net after-tax potential relative unemployment-insurance benefits-is earnings, as measured by VIB. a statistically significant determinant of female W = measure of temporary real wages, discouragement. Real transitory wages, both equal to the difference between current real current and lagged one quarter, are also statis­ wages and permanent real wages (see Appen­ tically significant factors determining female dix 1). In line with previous time-series stud­ discouragement. According to search theory, ies, we uncovered no statistically significant the level of real wages should affect the dis­ association between permanent wages and the couragement rate over time, but our estimates 7 17 incidence of discouragement. . Consequently, instead find that the change in transitory real

Table 3 Equations Estimating Percentage of Female and Male Workers Discouraged for Job Market Reasons* (Sample Period 1969.1-1978.2) DJOBF = .286 + .102 U,.) .009 UIB,_) 1.02 W, + l.14 W,_) ( l.OO) (6.45) ( 2.28) ( 2.17) (2.17) Mean dependent variable .50 2 R , corrected correlation .66 Durban-Watson statistic 1.56

DJOBM = .228 + .032 U,.) .00l UIB'_l .026 W, .123 W,_) ( 1.59) (4.76) (- .799) (- .110) (- .46) Mean dependent variable .25 R,2, corrected correlation .67 Durban-Watson statistic 1.90

DJOBF number of female discouraged workers as a percentage of total female population, 16 years and over. DJOBM number of male discouraged workers as a percentage of total male population, 16 and over. U unemployment rate of the respective cohort UIB maximum unemployment-insurance benefit payments as a percentage of spendable average-weekly earnings of a production worker with three dependents. w Current real hourly compensation less permanent real hourly wages. *t-statistics = statistics in parentheses. 15 wages over a six-month period-rather than been found to have significant effects on fe­ the level-is the significant determinant among male discouragement decisions. females. The estimated coefficients associated As the earlier discussion suggests, discour­ with the real wage terms are of opposite signs aged males have not been as responsive as and are not much different from each other, females Over the past decade to changes in and their sum is not different from zero. This labor-market conditions. Males, on average, means that any given level of real. transitory place a relatively low value on their non-mar­ wages that has persisted for at least two quar­ ket time since, as a group, they constitute the ters will have no net impact, and only a change primary source of family income. Conse­ in real transitory wages remains as a determi­ quently, they are more likely than females to nant of the female discouragement rate. be labor-market participants, and are less The results suggest that the availability of likely to leave the job market after encounter­ work may be the sole factor influencing male ingchanges in real wages Or net search costs. discouragement with job-market conditions. For instance, a one-percentage-point change in Additional factors, however, are important in their own unemployment rate led to an aver­ the participation decision of the much larger age change of only .032 percentage points in group of females, who comprise two-thirds of the male discouragement rate, and to more discouraged workers. In particular, both the than three times that amount (.102) in the liberality of unemployment-insurance benefits female discouragement rate (Table 3). Other and the change in real transitory wages have factors than relatively high non-market value

Table 4 Discouragement Rates 1 of Female and Male Discouraged Workers for Job Market Reasons, by Age; (Sample Period 1969.1-1978.2) Mean Discouragement . 2 Females Constant U(t-1) UIB(t-1) W(t) W(t-1) T TSQ Rate R --DW 16-19 .532 .080 .018 .64 .21 1.89 (.614) (2.87) (- 1.65) 20-24 .938 .090 - .017 -3.16 2.95 .68 .23 2.50 (1.11) (2.58) (- 1.49) ( 2.27) (1.89) 25-59 .400 .134 -.009 .997 1.03 .55 .69 1.99 (1.21) (6.80) (2.06) ( -1.78) (1.65) 60 and .53 .035 .025 .0003 .21 29 1.09 over (4.13) (2.37) (- 3.3) (3.27) --Males 16-19 .586 .029 .56 .27 2.06 (1.04) (2.14) 20-24 .428 .037 .36 .52 1.88 (1.10) (4.05) 25-29 .058 .022 .15 .52 2.10 (.540) (3.54) 60 and .41 .049 .29 .29 2.34 over (1.12) (1.78)

1 Discouragement rate is the number of discouraged workers in a cohort as a percentage of their respective population. * Not significant at 10-percent level of significance. See Table 3 for explanation of variables. T is time (1969.1 = 1), and TSQ is time squared. :j: t-statistics in parentheses.

16 may be reflected in the greater sensitivity of discouraged workers would greatly diminish females to changes in unemployment condi­ under conditions of nationwide full employ­ tions. For instance, job against ment. However, our statistical tests indicate females will mean a higher average search cost otherwise. We reestimated equation (1) for for them when overall labor market conditions each age-sex group, substituting a measure of change. However, our tests cannot separate nationwide labor-market tightness for the co­ out these elements, which are not necessarily hort's own unemployment rate. However, we mutually exclusive. used the prime-age male (25 to 54 years) un­ The general pattern observed for the aggre­ employment rate for this purpose instead of gate male and female groups is also evident the overall unemployment rate, because the when the groups are broken down by age (Ta­ latter's value as an indicator over the past two ble 4). In particular, unemployment-insurance decades has become marred by various de­ benefits and the change in transitory wages are mographic and institutional changes in labor statistically significant only among the various markets. female groups. For females 60 and over, trend We derived estimates of the number of dis­ coefficients indicate that the percentage of dis­ couraged workers that could be expected un­ couraged workers has been declining over der full-employment conditions by assuming time, which is not true for any other age-sex full-employment values for each of the right­ group. Our results also suggest that the hand-side variables in equation (I)-specifi­ chances of discouragement decline with age, cally, by assuming a prime-age male unem which is contrary to the implication of our ear­ ployment rate of 3.1 percent, a value of 73 lier argument that years to retirement may set percent (the 1979 estimate) for the relative a significant limit on the work and search ho­ rate of unemployment-insurance benefits, and rizons of individuals. This may be because no change in transitory real wages. Under full­ younger workers expect to work a relatively employment conditions, we estimate that short time in a particular job, which may limit 523,000 individuals would be discouraged for the amount of time the individual can profit­ job-market reasons, or .32 percent of the Sep- ably spend on search. The various age groups also respond differ­ ently to changes in unemployment, with young Table 5 workers generally, being less sensitive than Responsiveness to a One Percentage­ others to changes in unemployment rates. For Point Change in Own Unemployment instance, a one-percentage-point change in Rates among Age-Sex Cohorts their own unemployment rate changes the dis­ (1969-78 average) couragement rate of females aged 25 to 59 by Percentage Change in 1 24.4 percent (Table 5), compared with changes Females Discouragement Rates 16-19 12.5 of 12.5 percent and 13.2 percent for females 20-24 13.2 aged 16 to 19 and 20 to 24, respectively. To 25-59 24.4 summarize, younger workers generally are 60 and over 16.6 more likely to become discouraged about job prospects than their older cohorts, but younger Males workers are relatively less sensitive to changes 16-19 5.2 20-24 10.2 in the availability of jobs and therefore less 25-59 14.7 likely to move out of discouragement when job 60 and over 16.9 opportunities improve. Discouragement at 1 Values are calculated at the mean discouragement rate According to a popular view, discourage­ of each cohort. For instance, for female teenagers, (.080/.64) x 100 = 12.5 percent. Values are derived ment depends solely, or to a great extent, on from coefficients of the unemployment rates and the lack of jobs available, so that the number of mean discouragement rates for each cohort (Table 4).

17 tember 1979 population (Table 6). Just over Table 6 half the discouraged at full employment would Estimated Discouraged Workers for Job be prime-age workers (40 percent female and Market Reasons Under Conditions of Full 12 percent male). Teenages and young adults Employment* (20 to 24) share about equally in the next larg­ Thousands Percent est group, comprising 35 percent of total dis­ of Persons Distribution couraged, and senior workers make up the Total 523 100.0 Females, 16 and over 345 66.0 remaining 12 percent. 16-19 49 9.4 It is perplexing that so many workers would 20-24 58 11.1 remain discouraged under conditions of na­ 25-59 212 40.5 60 and over 26 5.0 tionwide labor-market tightness. Over the en­ tire period 1967I-1978II, the discouragement Males, 16 and over 178 34.0 rate for job-market reasons has averaged .37 16-19 44 8.4 20-24 33 6.3 percentage points. At full employment, then, 25-59 64 12.2 the discouragement rate of .32 percent is 85 60 and over 37 7.1 percent of its mean level, and 60 percent of Discouragement rate, .32 the peak discouragement rate reached during total the 1975 recession. Search theory suggests several reasons for Average .37 discouragement rate this paradox. First, an individual's work hori­ (1967.1-1978.2) zon sets a limit on the time he/she can profit­ ably look for work, as long as the cost ofsearch * Numbers of discouraged workers derived from Septem­ is positive. Consequently, those with shorter ber 1979 population estimates, with assumptions of 3.1­ work and search horizons are more likely than percent unemployment rate (male, 25-54 years) and 73­ others to leave the labor market. Discouraged percent relative value of (early 1979 value). Based on estimates from 1969.1-1978.2 workers, as a group, may have relatively short sample period. work horizons. Again, we may expect discour­ agement to persist, on average, if the job mar­ ket is characterized by a dispersion of wages Discouraged vs. other non-participants paid for similar skills, and individuals search In its study, the National Commission asked, systematicaly rather than sequentially for "Is the criterion of availability a useful one for work, and so choose the "best" possibilities distinguishing between a ready labor-force re­ first. As an individual continues searching, serve and other non-participants?" The al­ his/her reservation wage declines. At some leged availability of discouraged workers is at point it may pay the individual to leave the the heart of the argument that they represent market for a while and wait for normal turn­ unutilized and ready resources which should over to open up higher-paying jobs, rather be considered as part of the official labor force. than accept a relatively low-paying job. Similar Yet special surveys have found that sizable behavior appears to be optimal under condi­ numbers of individuals who had stated that tions in which the highest expected pay is as­ they did not want a job (were unavailable al­ sociated with the . lO In that though wanting to work) were in fact in the case, individuals find it profitable to queue for labor force one or two years later-sometimes jobs in the covered sector rather than accept in greater numbers than those who had said lower wages in the noncovered sector. The earlier that they were available for work.! same type of behavior may be seen in the case To shed some light on this question, we have of discouraged workers when they state that estimated the job-search model equation (1) they plan to enter or re-enter the job market not only for discouraged workers for job-mar­ within the coming year-which suggests a ten­ ket reasons but also for "other non-partici­ dency simply to wait for the better-paying jobs pants," defined as total non-participants less to become available. workers discouraged for both personal and

18 job-market reasons (Table 7). These estimates deceleration in transitory real wages. An in­ are designed to compare the responsiveness of crease in these wages is associated with a de­ the labor-market participation rates of both cline in the discouragement rate, and with an groups to changes in unemployment and other increase in non-participation. Some families labor-market indicators. Both the one-quarter apparently regard an improvement in real lagged and long-run responses are given for wages, and resultant rise in income, as a means other non-participants, because our statistical of supporting more non-market time. Subse­ estimates indicate that non-participants re­ quently, some family members leave the labor spond slowly over time to changes in economic force, causing an increase in the aggregate variables, so that their initial response is other non-participation rate. However, the smaller than the ultimate one. In contrast, no same wage circumstances lead to a decline in lagged response can be identified in the dis­ the proportion of discouraged in the popula­ couraged-worker group. tion, as these individuals, motivated by im­ Our results indicate that individuals discour­ proving real wages, seek employment or leave aged for job market reasons are more respon­ the discouraged-worker category for other sive than other non-participants to changes in non-participation. labor-market conditions. For instance, an in­ Because discouraged workers represent a crease in the availability of jobs, as measured relatively small percentage of the population, by a one-percentage-point decline in the they generally fail to influence cyclical move­ prime-age male un~mployment rate, on aver­ ments in the labor force. When the unemploy­ age, led to a 20.8-percent decline in the dis­ ment rate of prime-age males increases by one couragement rate but only to a O.7-percent percentage point, the initial reaction is an al­ long-run decline in the other non-participation most equal increase in both the number of rate. The estimates generally suggest that dis­ discouraged and other non-participants, but couraged workers, as a group, show a greater ultimately, the movement in the labor force is willingness and availability to seek employ­ dominated by an increase in other non-partic­ ment than the other non-participation group. ipants rather than discouraged workers (Table Another distinction between the two groups 7, top line). However, unemployment benefit stems from their reaction to an acceleration or payments and changes in transitory real wages

Table 7 Response of Discouraged Workers for Job Market Reasons, and Response of Other Nonparticipants, to Various Economic Changes* Change (Percent) Change (Numbers)

DWR* Other Nonparticipants DWR* Other Nonparticipants First Long- First Long- Quarter Run Quarter Run Increase of 1 percentage point in 20.8 0.37 0.7 122.770 157.530 425.720 prime-age male unemployment rate Increase of 1 percentage point in -0.8 -0.2 0.5 4.780 122.770 331.810 relative unemployment-insurance benefits' Increase of .01 percentage points in -1.35 0.08 0.21 -7.970 45.920 124.110 the change in real wages

• Changes are stated in terms of an increase in each economic variable; for a decrease. the signs are reversed. The equations were estimated over the period 1967.1-1978.2. Percent changes are evaluated at the mean rates of .37 percent for discouraged workers for job-market reasons, and 37.46 percent for all other non-participants. Numbers are estimated relative to the September 1979 working-age population of 159.4 million. :j: Discouraged workers for job-market reasons, as a percent of the civilian noninstitutional population.

19 also affect participation behavior, and at times sion, these. benefit payments increased sub­ can reverse the response to changes in unem­ stantially, and tended to keep many individuals ployment. in the labor force who would otherwise have The general pattern can be discerned in both left and been included among other non-par­ of the business cycles that have occurred since ticipants. The Current Population Survey pur­ discouraged-worker data first became avail­ portedly is designed to distinguish between able (TableS). During the two recoverype­ those .individuals •• who want work (and. are riods, the decline.in .other noneparticipation available. for work) and all other noncpartici­ was responsible for between 80 and 94 percent pants. The question is whether the availability of the cyclical increase in the labor-force par­ criterion in fact captures the cyclical compo­ ticipation rate-and the same was true, only nentof the labor force.,...... the so-called labor­ in the opposite direction, during the 1970-71 force reserve. We found that between 80 and downturn. However, during the .more•recent 95 percent of the cyclical movementin .the decline, close to 70 percent of the drop in labor force is generally due to individuals en­ labor-force participation was associated with tering and leaving the non-participation cate­ an increase in discouragement about job-mar­ gory, and not to discouraged workers. Conse­ ket prospects. This reversal can be traced quently, we conclude that the availability largely to the fact that relative unemployment­ criterion is not sufficient to capture those insurance benefits playa somewhat larger role workers or groups of workers who actually in the labor-market participation decisions of comprise the major source of the labor-force other non-participants than they do for dis­ reserve. couraged workers. During the 1974-75 reces-

Table 8 Cyclical Responses of Discouraged Workers and Other Nonparticipants Cyclical Change In the Labor Force Decline Recovery Decline Recovery 1970.1-71.2 1971.2-73.4 1974.1-75.4 1975.4-76.1 Nonparticipation rate (total) .74 - .79 .29 - .15 Nonparticipation rate excluding .65 - .74 .08 .12 discouraged workers Percent of total rate (88.0) (94.0) (28.0) (80.0) Discouraged worker rate .09 - .05 .21 - .03 Percent of total rate (12.0) (6.0) (72.0) (20.0)

20 IV. Summary and Conclusions With the help of job-search theory, this pa­ not finding employment, would choose to wait per has analyzed the behavior of workers who for normal job -because that is the give job-market reasons for their discourage­ most profitable choice for them to make­ ment-a group which accounts for 70 to 80 rather than accept lower-paying jobs. percent of the total number of discouraged (3) The job-search approach was not en­ workers. Our approach suggests that unem­ tirely successful in explaining discouragement ployment-insurance benefit payments (by re­ behavior over the past decade. That approach ducing the cost of looking for work) and ex­ suggests that the individual job seeker re­ pected real wages will influence an individual's sponds to the expected market return, as es­ labor-force participation decisions-as well as timated by the direct costs of search (proxied his/her chances of finding a job. The results by the unemployment rate), the reduction in may be summarized as follows. such costs (measured by unemployment-insur­ (1) Although those discouraged for job"mar­ ance benefits), and the expected real wage ket reasons appear more responsive than other rate. However, we found that males, who ac­ non-participants to changes in labor-market count for one·third of the discouraged for job­ conditions, the discouraged generally repre­ market reasons, were sensitive only to changes sent only a small proportion of the total cycl­ in their unemployment rates. Females, who ical movement in the labor force. Conse­ account for the majority of discouraged work­ quently, the availability criterion of the ers, in contrast were also responsive to changes Current Population Survey apparently does in relative unemployment-insurance benefits not succeed in separating the labor-force re­ and to changes in real wages that were be­ serve from other groups of non-participants. lieved to be above or below average (that is, (2) Under conditions of nationwide full em­ a transitory real wage). Search theory suggests ployment, we should observe a relatively small that it is the level of real wages (transitory or percentage of discouraged workers. At least permanent), and not the change, which is per­ according to the popular impression, discour­ tinent in job-market decisions. Our results sug­ aged workers are readily available for work, gest, however, that factors other than the avail­ and therefore their numbers should greatly di­ ability of jobs (the conventional determinant minish, if not disappear, under general condi­ of discouragement) enter into the determina­ tions of high employment. In fact, this is the tion of discouraged workers' labor-supply de­ expected behavior of a labor-force reserve. cisions. Discouragement is not solely a conse­ However, we find that at full employment, the quence of the availability of jobs, but also of discouragement rate for job market reasons unemployment-insurance benefit payments actually tends to remain at about 85 percent of and expected short-run changes in real wage its average level, and at about 60 percent of payments. its peak (1975) rate. Our job-search approach Should discouraged workers be included in suggests several reasons for this highly per­ the labor force and therefore in the official plexing result. Workers with relatively short measure of unemployment? Since they repre­ work horizons generally find it profitable to sent only a small percentage of the cyclical limit the amount of job search, which is a movement in the labor force, their inclusion costly undertaking. If not finding work within will do very little towards correcting any dis­ that relatively short time period, they may tortions in official labor-force measures. More­ drop out of the labor force. Many discouraged over, most of these individuals appear unres­ workers thus would expect to hold jobs, once ponsive to changes in labor-market conditions. found, for relatively short durations. Or work­ Large numbers of discouraged workers remain ers may search the best-paying jobs first, and so even during periods of tight labor markets,

21 when substantial shortages of workers exist ualswilling and available for work according amid building inflationary pressures. This sug­ to the state of the economy-and therefore gests that most discouraged do not fit the cri­ should not be included in official labor-force terion of a ready labor-force reserve-individ- statistics.

Appendix 1 Data Sources The Bureau of Labor Statistics is the basic centage is equal to labor's share in total in­ source for U.S. employment and unemploy­ come produced (gross business domestic prod­ ment data. Discouraged-worker data, for ex­ uct)-a share which has trended slowly over ample, are found in the BLS publication, Em­ time. The share of labor can be written as an ployment and Earnings. identity: VIB: Maximum weekly benefits payable un­ k = total labor income/gross business do­ der the unemployment-insurance system were mestic product, where total labor income is deflated by the consumer price index and di­ equal to wages times the number of workers, vided by average spendable weekly earnings W X N, and gross business domestic product of production worker with three dependents. is equal to the general price level times the The maximum weekly benefits series was amount of real output produced, P x G. We taken from the Board of Governors MPS may rewrite the above as, model database, and the consumer price index and average spendable weekly earnings series k = (W x N)/(P x G), or rearranging were taken from the FRB San Francisco Da­ (W/P) = k x (G/N), tabase. V: The unemployment rate of each age-sex which states that real wages are a percentage category was taken from the FRB San Fran­ of labor productivity. We estimated permanent cisco database. real wages by first estimating the trend share W: Employee compensation rate in nonfarm of labor k" then the trend rate of output per private domestic business, deflated by the GNP worker (G/N)" implicit deflator, less permanent real wages. estimate of (W/P) = k, x (G/N),. This is estimaged as follows: for permanent wages, we assume that real wages are equal to The wage series was taken from the MPS a percentage of labor productivity. That per- model database of the Board of Governors.

Appendix 2 Job-Search Model of Labor-Force Discouragement Following the discussion in the text, the dis­ sumptions, does not depend on any past offers persion of offers considered by the job at the time the offer is made. We further as­ searcher is incorporated into the model by as­ sume that the individual seeks to maximize suming that there is a cumulative probability his/her expected net benefits, which are equal distribution, F, of wages which govern theof­ to expected wages less expected costs of fers tendered. We assume that the distribution search. of wages is invariant over time in this simplest In the following the symbols are defined as case (so that business-cycle effects are ig­ c = cost per period of search nored), and that wage offers are independent w = random variable denoting a wage offer random occurrences from that distribution, F. F(w) = cumulative probability distribution In any given search period, the probability that of w; few) is the probability density the individual will receive an offer of w or less function. is F(w), and this probability, given our as- y(w) = return from a job offer, w.

22 If a wage offer is accepted after the nth offer, and the mean duration of search is 1 then the return is the value of the nth offer, E(N) =T (4) w ' less the cost of search, which we assume n We may rewrite (2) as is a constant each period, times the number of job offers. 00 f *wf(w) dw

Y = wn - cN E(y) -:------cE(N) (5) f *f(w) dw Let w* signify a minimum acceptable wage; w the individual will accept an offer if it is equal h cE(n) to or greater than w*. The individual's task is to choose w* which maximizes his/her expected The first-order conditions for deriving the return. Symbolically the expected return from maximum expeated gain, max E(Y), is given search is by

E(Y) = E(w/w ~ w*) - cE(N) (2) dE(Y) d ~ - dw* (h cE(N) o The maximum, w*, is derived by maximizing 00 00 E(Y), with respect to w*. To derive w*, first = * wf(w)dw w* f * few) dw c = 0 f w note that E(w/w ~ w*) is the mean conditional w 00 wage, it is the expected wage conditioned on or, c = f * (w w*) few) dw = H(w*) (6) that wage being equal to or greater than w*. w 00 J* wf(w) dw The value w* is the wage offer which satisfies E(w/w ~ w*) = fooJ(w) dw = h (3) the equality in (6), The equality (6) has a fam­ w ilar economic interpretation. The cost, c, is the Secondly, note that the expected value of N, marginal cost of generating another job offer, E(N), is the expected period of search until a which is equal to the expected marginal return wage offer is equal to or greater than w*. It from searching another period, H(w*t The has a geometric distribution, critical value w* is also known as the reserva­ tion wage, or the minimum wage an individual P(N=k) = p(l_p)k.1 will accept. where the parameter p is the probability of "success", 1 Note that H(w*) is a strictly decreasing function of w*t, with slope equal to (1 - F(w*) = p, and with p = * few) dw rw

= 1 - F(w*),

REFERENCES

1. Finegan, T. Aldrich, "The Measurement, Behavior, and 5. Lippman, Steven A. and John J. McCall, "The Eco­ Classification of Discouraged Workers," Background Pa­ nomics of Job Search: A Survey," Part I, Economic In­ per No. 12, June 1978, National Commission on Employ­ quIry, June 1976, pages 155-189. ment and Unemployment Statistics, Washington, D.C. 6. . "The of Job Search: A Sur­ 2. Flaim, PaulO., "Discouraged Workers and Changes in vey," Part II, Economic Inquiry, September 1976, pages Unemployment," Monthly Labor Review, March 1973, 347-368. pages 8-16. 7. Lucas, Robert E. and Leonard A. Rapping, "Real Wages, Employment and Inflation," Journal of Political 3. Friedman, Milton, Price Theory, Aldine Publishing Co., Economy, September-october, 1969, pages 721-754. Chicago, Illinois, page 205. 8. McCall, J. J., "Economics of Information and Job 4. Hamel, Harvey R., "Job Search of Discouraged Work­ Search," Quarterly Journal of Economics, February, ers," Monthly Labor Review, March 1979, pages 58-60. 1979, pages 113-126.

23 9. Mincer, Jacob, "Determining Who Are the Hidden Un­ 14. Seater, John, "A Unified Model of Consumption, La­ employed," Monthly labor Review, March 1973, pages bor Supply, and Job Search," Journal of Economic The­ 27-30. ory, 14, 1977, pages 349-372. 10. . "Unemployment Effects of Minimum Wages," Journal of Political Economy, 84, 1976, Part 15. Salap, S. E., "Systematic Job Search and Unemploy­ 2, pages S87-S104. ment," Review of Economic Studies, 40, 1973, pages 191-202. 11. . "Labor Force Participation of Married Women," Aspects of Labor Economics, National Bu­ reau of Economic Research, 1962, pages 63-97. 16. Solon, Gary, "Unemployment compensation and La­ bor Supply," Monthly labor Review, May 1978, pages 12. Mortensen, D. T., "Job Search, the Duration of the 47-50. Unemployment, and the ," American Eco­ nomic Review, 60(1970), pages 847--862. 17. Wachter, Michael, "A New Approach to the Equilib­ 13. Pissarides, Christopher A., "Job Search and Partici­ rium Labour Force," Economlca, February 1974, pages pation," Economica, 43, 1976, pages 33-49. 35--51.

24