Evaluating cyclical fluctuations in total hours worked has been a central focus of business-cycle research since at least Kydland and Prescott (1982), and the very different labour-market outcomes observed during the 2008-09 recession across countries have generated increased interest in cyclical labour movements. As shown in Figure 1, between 2007:Q4 and 2009:Q4, output in the US fell slightly less than in Germany. However, total hours worked fell nearly 8% in the US but only 1% in Germany, and US employment declined 6% over the same period but edged up in Germany (that is, German hours per worker declined more than total hours worked). Even acknowledging that labour-market arrangements, including the size of hiring and firing costs, might differ considerably across countries, are these patterns consistent with previous historical episodes?
Figure 1. Changes in total hours and GDP during the Great Recession (percent change from 2007Q4 to 2009Q4)
Unfortunately, due to the very limited availability of systematic measures of aggregate hours worked in OECD countries, what we know about cyclical changes in total hours worked and productivity in countries other than the US is largely based on measures of employment, rather than hours worked (see, for example, Backus et al 1994). Our paper (Ohanian and Raffo 2011) constructs a new dataset for total hours worked at the quarterly frequency for 14 OECD countries and that spans the last 50 years. The dataset draws on a variety of international sources, including data from national statistical offices, establishment surveys, and household surveys, and to our knowledge presents the most comprehensive, international database of quarterly total hours worked for these countries.
These data reveal surprising features about labour fluctuations in international business cycles. Specifically, cross-country labour fluctuations until the Great Recession are as much as twice as volatile as standard, employment-based measures of labour input, as changes in hours per worker in a number of OECD countries are nearly as large as changes in employment. This contrasts sharply with the standard view about fluctuations in labour input based on US data, where the hours per worker are only half as volatile as employment (see, for instance, Hansen 1985 and more recently Rogerson and Shimer 2010). We also use these new data to analyse the implications of cross-country differences in hiring and firing costs at business-cycle frequencies. In particular, it is widely agreed that these costs are much higher in Europe than in the US, which implies that labour wedges – cyclical deviations between the marginal rate of substitution between consumption and leisure and the marginal product of labour – in Europe should be systematically different relative to the US.
However, we find that the size of labour wedges in Europe are too large compared to the US when labour input is measured using employment, suggesting that employment moves too much, conditional on firing costs. Moreover, we find that labour wedges are too small when labour input is measured using hours worked, meaning that hours per worker move too little, given firing costs.
These cross-country patterns change during the Great Recession, possibly indicating that the sources of the recession in the US and, say, the UK, France, and Germany differ considerably. In fact, the decline in real output in the US appears almost entirely due to a large drop in labour input, with very little role of changes in productivity, whereas lower real GDP in France, UK, and Germany is primarily due to lower productivity. However, there is a very large labour wedge in the US economy during the Great Recession that continues today, and almost no labour wedge in the major European countries. All told, these features are puzzling, and raise questions about why the US labour market, which typically has a much smaller labour wedge, and European labour markets, which typically have much larger labour wedges, changed so much during the Great Recession.
A possible resolution to this puzzle may be differential behaviour in housing markets. Specifically, the large labour wedge in the US has emerged amid large declines in house prices and construction employment, whereas housing activity has contracted much less in these other European countries where the labour wedge has not materialised. However, and similarly to the US, Ireland and Spain have experienced very large labour wedges during the Great Recession and significant declines in the housing market. Thus, the labour-market weakness in these countries may be fundamentally tied to the large decline in housing.
Figure 2. Housing sector during the Great Recession
Disclaimer: The views expressed in this article are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.
Backus, D, P Kehoe, and FE Kydland (1992), “International Real Business Cycles”, Journal of Political Economy, 100(41): 745-775.
Hansen, Gary D (1985), “Indivisible Labour and the Business Cycle”, Journal of Monetary Economics 16(3): 309-27.
Kydland, FE, and E Prescott (1982) “Time to build and Aggregate Fluctuations”, Econometrica, 50(6):1, 345-70.
Ohanian, LE. and A Raffo (2011) “Aggregate Hours Worked in OECD Countries: New Measurement and Implications for Business Cycles”, NBER working paper 17420.
Rogerson, R, and R Shimer (2010) “Search in Macroeconomic Models of the Labour Market”, Handbook of Labour Economics, Chapter 7: 619-700.