RBA: Unemployment hangover could last a decade

The latest RBA Bulletin contains an interesting report on COVID-19’s impact on Australia’s labour market, in which the RBA warns that unemployment may take a decade to fully recover:

The COVID-19 pandemic has led to a rapid deterioration in labour market outcomes, some of which may be long-lasting. This article examines the long-lived effects of previous downturns on unemployment in Australia, including by assessing how regional labour market outcomes varied during and after the GFC and early 1990s recession. We find that recessions have enduring effects on unemployment rates: regions that experienced larger-than-average downturns had significantly higher unemployment rates for around a decade afterwards.

COVID-19 and the Labour Market

The COVID-19 pandemic has led to the sharpest deterioration in Australian labour market conditions in several decades. At the time of writing, employment had contracted by around 4 per cent since the beginning of the year. Over that period the unemployment rate had increased by 2¼ percentage points and a further 1½ per cent of the working-age population exited the labour force (Graph 1). Average hours worked also decreased as many firms wound back operations but retained employer-employee connections, particularly via the JobKeeper program.

Many of those affected will be re-employed or have their hours increased once the virus is contained. However, COVID-19 may also have persistent effects on some segments of the labour market…

In both the GFC and 1990s recession there was a large and persistent increase in the aggregate unemployment rate. In the early 1990s, the unemployment rate rose by 5 percentage points and took around 10 years to decline to pre-recession levels. The size of the GFC-related increase was smaller, although the unemployment rate declined only gradually after the crisis. Both episodes tentatively suggest that downturns have long-lived effects, consistent with the international literature…

During the GFC most regions experienced a sizeable increase in their unemployment rates. However, in some regions the increase was larger than in others and in some areas the unemployment rate actually declined. The early 1990s recession led to an even wider range of outcomes, with regional unemployment rates changing by between −5 and 13 percentage points (Graph 2). These differences in the ‘initial exposure’ of regions to national recessions can reflect differences in industry composition, demographics and average skill levels, among other factors…

As a first pass, we make a simple comparison by grouping regions into those that experienced larger and smaller initial shocks, with each group containing roughly the same number of regions. This exercise points to substantial persistence in labour market outcomes: regions that experience larger initial increases have higher unemployment rates for up to a decade afterwards (Graph 3)…

Estimating Labour Market Persistence

To further explore the nature of the persistence identified above, we model regional unemployment rates as a function of their exposure to the downturn and a set of control variables, with separate models estimated for the GFC and early 1990s recession…

Graph 4 shows our baseline regression estimates. The estimates reflect the degree of persistence from recessions on local labour markets. For example, a value of 0.3 in 1997 implies that a region that experienced a 1 percentage point larger-than-average increase in its unemployment rate during the early 1990s recession will have a 0.3 percentage point higher-than-average unemployment rate in 1997. The results show that unemployment rates in the regions most adversely affected by the GFC remained significantly higher for around 10 years, relative to less-affected regions. There was an even greater degree of persistence following the early 1990s recession; the effects of the recession on unemployment rates were still statistically significant in the mid-2000s, around 15 years after the initial shock.

Using the same approach, we can also explore the lingering effect of recessions on other labour market indicators, such as the participation rate and the employment-to-population ratio. Regions with high exposure to the 1990s recession experienced large and enduring declines in both their rates of workforce participation and their employment-to-population ratios, relative to less-exposed regions (Graph 5). This is consistent with a discouraged worker effect where some individuals leave the labour force rather than actively look for work. The evidence for persistent effects from the GFC is mixed; while our estimates show a fall in the participation rate, this effect is not statistically significant after a few years. This might partly reflect that the GFC was a much milder downturn than the 1990s recession in Australia…

Insights for the COVID-19 Pandemic

The unemployment rate has risen by around 2¼ percentage points since the start of the year, and is expected to continue to increase further to around 10 per cent over the second half of 2020. Heightened activity restrictions and precautionary social distancing in Victoria are likely to more than offset a pick-up in conditions elsewhere. In addition, people who initially left the workforce and were therefore not recorded as unemployed may start to actively look for work.

Some features of this episode are very different to the early 1990s recession and GFC. The current episode stems from a pandemic, rather than an economic or financial crisis. Accordingly, health outcomes and the severity of containment measures needed to control the pandemic will play a large role in determining the persistence of unemployment outcomes. Another unique feature of this episode is that job losses have been largest in industries which typically have higher staff turnover, particularly food and accommodation (D’Arcy, Gustafsson, Lewis and Wiltshire 2012). This may enable workers to transition more quickly to new jobs when normal activities resume than would be the case if the job losses were concentrated in industries with typically low staff turnover.

Other features are similar to previous downturns. The unemployment rate has risen by the most for young people, which is common in recessions both in Australia and overseas (Graph 6). Previous research both domestically and overseas finds that cohorts of students who graduate during a weak labour market have persistently lower employment and wages than similar people from cohorts that graduated during better times, with these effects lasting up to a decade (Andrews, Deutscher, Hambur and Hansell 2020; Rothstein 2019). This sensitivity is often explained with reference to the shorter work history of younger workers or the increased likelihood of poor early career firm-worker matches created by recessions (Fontenay et al 2020). A modified version of our model provides tentative evidence that younger and older cohorts experience similar degrees of persistence in their unemployment rates following recessions.

Another common feature has been a reorganisation of some economic activity, some of which may outlast the pandemic. The need for social distancing in response to COVID-19 has led to an increased uptake of online retailing, while there has also been a shift towards goods consumption as many service industries have been unable to operate at full capacity under social distancing restrictions. However, it is too early to tell whether structural changes in the economy induced by the virus will lead to persistent dislocations in the labour market, such as skill mismatches.

Evidence from previous downturns, both domestically and overseas, shows that recessions can have long-lived effects. This suggests that the current episode may affect the economy beyond the time the pandemic is contained. The large scale fiscal and monetary policies introduced since the pandemic began were designed, in part, to reduce the risk of these persistent effects. In particular, wage subsidy programs such as JobKeeper should help reduce scarring effects by maintaining employee-employer relationships and limiting the rise in unemployment.

This data augers badly for Melbourne, which has borne the brunt of restrictions and the COVID-19 economic downturn.

Leith van Onselen
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