Declining Labor Force Growth Explains Declining Dynamism

The best paper I have read in a long time is Hopenhayn, Neira and Singhania’s From Population Growth to Firm Demographics: Implications for Concentration, Entrepreneurship and the Labor Share. HNS do a great job at combining empirics and theory to explain an important fact about the world in an innovative and surprising way. The question the paper addresses is, Why is dynamism declining? As you may recall, my paper with Nathan Goldschlag, Is regulation to blame for the decline in American entrepreneurship?, somewhat surprisingly answered that the decline in dynamism was too widespread across too many industries to be explained by regulation. HNS point to a factor which is widespread across the entire economy, declining labor force growth.

Figure Two of the paper (at right) looks complicated but it tells a consistent and significant story. The top row of the figure shows three measures of declining dynamism: the rise in concentration which is measured as the share of employment accounted for by large (250+) firms, the increase in average firm size, and the declining exit rate. The bottom row of the figure shows the same measures but this time conditional on firm age. What we see in the bottom figure is two things. First, most of the lines jump around a bit but are generally flat or not increasing. In other words, once we control for firm age we do not see, for example, increasing concentration. Peering closer at the bottom row the second thing it shows is that older firms account for a larger share of employment, are bigger and have lower exit rates. Putting these two facts together suggests that we might be able to explain all the trends in the top row by one fact, aging firms.

So what explains aging firms? Changes in labor force growth have a big influence on the age distribution of firms. Assume, for example, that labor force growth increases. An increase in labor force growth means we need more firms. Current firms cannot absorb all new workers because of diminishing returns to scale. Thus, new workers lead to new firms. New firms are small and young. In contrast, declining labor force growth means fewer new firms. Thus, the average firm is bigger and older.

HNS then embed this insight into a dynamic model in which firms enter and exit and grow and shrink over time according to random productivity shocks (a modified version of Hopenhayn (1992)). We need a dynamic model because suppose the labor force grows today, this causes more young and small firms to enter the market today. Young and small firms, however, have high exit rates so today’s high entry rate will generate a high exit rate tomorrow and also a high entry rate tomorrow as replacements arrive. Thus, a shock to labor force growth today will influence the dynamics of the system many periods into the future.

So what happens when we feed the actual decline in labor force growth into the HNS dynamic model (calibrated to 1978.) Surprisingly, we can explain a lot about declining dynamism. At right, for example, is the startup rate. Note that it jumps up with rising labor force growth in the 1950s and 1960s and declines after the 1970s.

The paper also shows that the model predictions for firm age and concentration also fit the data reasonably well.

Most surprisingly, HNS argue that essentially all of the decline in the labor share of national income can be explained by the simple fact that larger firms use fewer non-production workers per unit of output. That is very surprising. I’m not sure I believe it.

If HNS are correct it implies a very different perspective on the decline in labor share. In the HNS model for example non-competitive factors do not play a role so there’s no monopoly or markups . Moreover, if the decline in labor share is caused by larger firms using fewer non-production workers then this is surely a good thing. In their model, however, there is only one factor of production so declining labor share means increasing profit share which I find dubious. If production and non-production labor are distinguished it may also be that declining non-production share will redound to production labor so the labor share won’t fall as much. Nevertheless, the ideas here are intriguing and the results on dynamism, which are the heart of the paper, do not rely on the arguments about the labor share.

Comments

Raghuram Rajan has a different view. Here is a summary by him of his presentation at the 2018 Economic Policy Symposium at Jackson Hole: https://www.livemint.com/Industry/nOluMKdiSLMuOt7EEstI2L/Disruption-concentration-and-the-new-economy-by-Raghuram.html

'So what explains aging firms?'

They are successful, and thus remain in business longer than unsuccessful firms?

'Thus, new workers lead to new firms.'

The voodoo that creates supply side thinking is truly powerful.

I imagined the rising share of non-production workers per unit output being a direct consequence of government regulation. Everyone who's been at a university or a hospital knows that you need an army of compliance people and procedures to get anything done. But maybe that's not primarily a feature of government regulation, but rather internal regulation to manage the politics within the firm.

With size comes economies of scale, but economies of scale reaches a diminishing return when firms become too large to manage.

I would suggest that the diminishing returns problems with scale are more evident in heath care and education that are largely third party funded and less sensitive to profit.

Even a very large (e.g. S&P100) feels more pressure to be efficient than a university or hospital.

When is the last time an Econ department optimized their teaching arrangements to get the job done with 7 people rather than 8? But this is fairly common in many firms.

"When is the last time an Econ department optimized their teaching arrangements to get the job done with 7 people rather than 8?" A penetrating question, my dear sir.

I can remember one economising tactic from my university days, namely merging departments to save on the costs of assistant staff (workshop staff and so forth). Shrinking the number of academics came only from external pressure, never from a department choosing to re-organise itself.

Machst du deinen Schwanz zu!

Hilarious - even google translate cannot figure out what that is supposed to mean when converting from German to English.

Who knows what filters are in place here, but let us just say you cannot close the member in question (zumachen = close).

This is getting really quite fun. I'd give you a couple of tips for future improvement, but simply watching such kleckern in public is much more entertaining.

There are economies of scale, and diseconomies of scale, always in contention. I think in the past 20 years technology has lessened the diseconomies, allowing greater size.

Oh my God...the culprit being email makes a ton of sense

A few things strike me as somewhat tenuous:

"Is regulation to blame for the decline in American entrepreneurship?, somewhat surprisingly answered that the decline in dynamism was too widespread across too many industries to be explained by regulation. "

Looking that link, it's clear they determined this via Federal Regulation. But the leaves out enormous amounts of state and local regulations. We know that Occupational licenses have extended down to low skilled jobs. And it's clear that licensing requirements are a direct barrier to entry.

This seems to be leave a hole big enough to make the conclusions questionable.

"So what explains aging firms? "

And here they leave out acquisitions. Clearly tech firms are being bought out by larger existing firms at a very high rate. Assumably if it's become more common to buy out small firms that will result in the aging of firms, since a good chunk of the middle aged firms will now be divisions of larger, older firms.

This data shows a clear upward trend over the last 13 years, but it doesn't go back far enough to really answer the question.

https://www.statista.com/statistics/914665/number-of-ma-deals-usa/

They also leave out the lengthening business cycle. Perhaps longer time between recessions means we get less pruning of mediocre companies?

I still don't buy it. Maybe not regulation by itself, but non-regulatory factors that contribute to multi-parties consciously or sub-consciously working to prop up Bernie for his weekend. The old firms will not die because someone/s won't let them, vested interests are present, meaning the carcass still has value.

Also, that Civilian Labor Force graph is giving me the finger. Appropriate...

One reality I have come to accept...The longer I live the more evidence I see the great period of creative destruction was the 1970s. We can say a lot wrong with the 1970s, but even the Reagan Revolution really started in the Carter Administration.

This is pretty conventional, that Carter started deregulation (Volcker, Kahn), as articulated among others in "The Politics of Rich and Poor: Wealth and the American Electorate in the Reagan Aftermath" [Kevin P. Phillips

Bonus trivia: it may be a coincidence, but not the data that is 'above trend' happened from 1980s to 1999, the period of time when a new pro-patent Federal appeals court was founded by Reagan (the "CAFC") and patents were in vogue. The time the data trended downwards to catch up with the model was the 'anti-patent' period of 2000 to now. It's also the time when the US de-industrialized the most, losing a lot of industries to IP-unfriendly, pirate-prone China. Coincidence? AlexT would probably say so, but I, and economists like V. Smil, would disagree.

So that is what America has become: a hopelessly divided land caught in endless decline.

yeet ribby
here is why we will win.
biological explanations for sociology are
better than sociological explanations for sociology.
https://www.youtube.com/watch?v=1oVyQGmD3d8
Estamos enamorados de la voz de la razón.
Heather "La Biologistsa" Heying
¿Qué sabes sobre el marido

el marido es también biólogo

Demand side view: The quality of demand is changing.

The young, ages 18-29, punch well above their weight in adoption curves. No matter what product or service. They increase market dynamism with their choices more than their share of income would suggest.

As a result:

1) Aging population naturally reduces dynamism of demand. Old brands supporting
old habits produced by big established companies serve aging population well.

2) Millenials are poorer than previous generations were. Millennials on average less than people in Generation X did when they were the same age.

"Millenials are poorer than previous generations were. Millennials on average less than people in Generation X did when they were the same age."

Sure, the US has drastically tightened up the labor laws for teenagers. The US had a surge in illegal immigration during the 1990's leading to higher labor supply and more competition for low skilled jobs. The cost and time involved in getting a college degree has increased. Meanwhile, the percentage of Millenials attending college is the highest ever. All of this means that Millenials will take longer to transition from low to high skilled jobs.

This is not US specific issue, although it started earlier in the US with gen Z.

The fact that the same happens almost everywhere: US, Canada, Australia, Japan, UK, France, Germany, Italy, Spain seems to indicate that it's general trend with the demographic change.

Since US policies and US specific events in labor environment did not affect these countries, they are likely inconsequential.

Evidence it happened in all those countries would indicate that it's not a US only issue.

Do you have a link to data that confirms it?

That being said, I would imagine that all those countries saw an expansion of regulations on teenage labor, an increase in the newer cohort attending college, and (outside of Japan) and increase in low skilled wage competition.

Not sure they are poorer, but do they have to poorer? If their consumption is mostly used up on the same products their forebears consumed, might not be so much margin for new consumption.

(Again not that I suspect they do have low consumption, viewed from electronics, entertainment, food, vacations).

Immigration = labor force growth?

Oh I'm sure that's the point being pushed. But it's still a much more interesting topic than many "self-recommending" ones are.

Or else get the white dudes out of their moms basements.

Getting enough labour force growth from migration to offset peak female employment and greying pop would be tough.

It would certainly require dipping into mass low skill migration. As well as a level of cultural dislocation which would challenge any kind of institutional continuity and sense of shared nationhood.

Worth it for a younger firm distribution?

I think the Silicon Valley visas for engineers and computer scientists, the grad school visas, foreign undergrads, and foreign medical graduates (doctors and nurses) becoming licensed in the US are all examples of higher end 'immigration'. They may not outnumber the produce pickers, abattoir workers or unskilled construction workers but they constitute a population that has the potential to stimulate economic activity beyond mere consumption.

Great, but if you follow the premise of this work, the age of the firm distribution nationally depends on the overall growth rate of the overall labour force, and more Silicon Valley visas will do nothing for the age of firms at a national level (possibly even at the level of California!), because as a relatively small migration stream they won't generate much growth in the overall labour force growth rate.

"Current firms cannot absorb all new workers because of diminishing returns to scale. Thus, new workers lead to new firms. "

This would seem to imply that rising unemployment would lead to the creation of more new firms. But I thought it was more demand that would cause more new firms to be created, not more new workers.

Two points
Firstly, Is controlling for age valid? Is there really no causal relationship between age of the industry and the age of the firms remaining in it and hence the concentration and size of firms?
Secondly
"Most surprisingly, HNS argue that essentially all of the decline in the labor share of national income can be explained by the simple fact that larger firms use fewer non-production workers per unit of output. That is very surprising. I’m not sure I believe it."
Isn't it saying the data suggest managerial economies of scale outwiegh bureaucratic diseconomies of scale

I would assume that Tyler is surprised by the "all of the decline in the labor share of national income " can be explained by firms thinning out middle management.

Tyler???

Oops. Sorry Alex.

True or False: global economic performance is sure to decline markedly for the duration of the 21st century CD as the advent of Technogenic Climate Change commences without any possibility of forestallment, much chance of mitigation, and only tardy assimilation here and there to new environmental realities.

?

Technogenic Climate Change IS HERE, it is with us, as we begin to see: as scientists and technologists scurry to deny and/or conceal their culpability for unleashing adverse climatic phenomena, they scurry to conceal their unique institutional responsibilities for unleashing the phenomena and the climate mechanisms so poorly modeled and predicted in days of yore by devout scientists and technologists.

Is it still too late for MR to offer forum commenters and posters a working edit function (even were edits limited to being made within minutes of the original post)?

CD = CE above.

I second that.

"Technogenic Climate Change IS HERE"

I was promised Global Warming in the past. Yet once again January is too cold outside. Can we not do something about that? How hard is it too warm the globe up a few degrees?

Our corrupt and corrupting Media Establishment makes its on-again/off-again reporting available to any willing to consult it (the following link came along as recently as yesterday):

https://www.forbes.com/sites/trevornace/2019/01/16/ocean-warming-continues-to-break-every-record/#32bdcd646d8f

(As I've related to Tyler privately, our Science and Technology Establishment cannot decide exactly how forthcoming to be, or how to be forthcoming, from year-to-year, month-to-month, week-to-week and day-by-day.)

What's with 'Technogenic' Anthropogenic been abused so badly that you can no longer use it?

"Technogenic Climate Change", I continue to argue and insist, is the ONLY accurate name for the phenomena of climatic changes we are witnessing.

Taxonomists of science may disagree, but they have literally TONS of measurement errors or failures of empirical research to account for, so their apologetics need not be trusted implicitly.

'Yet once again January is too cold outside.'

Well, the Australians would certainly appreciate a bit of that Northern Hemisphere coldness.

Coldness, oddly enough, likely resulting from a certain disruption in this, at least when using available empirical data collected in real/ner real time over several decades - 'The variability seen in the polar vortex has been linked to both unusually cold winters in much of the Southeast as well as unusually warm weather in the North Pole. The polar vortex is an upper-level low-pressure field of air which rotates around the North (and South) Pole. The polar vortex acts as a barrier to isolate arctic air from warmer air to the south. However, variations in the strength of the polar vortex can cause disruptions in expected weather patterns across the northern hemisphere. This can be experienced as both masses of cold arctic air pushed southward, as well as masses of warm equatorial air pushed northward.

What's concerning is the frequency and duration of breakdowns in the polar vortex, indicating its potential collapse. While the strength of the polar vortex relies on the temperature difference between the mid-latitudes and the Arctic we concurrently see increasing average temperatures in the pole. In addition, NASA puts the rate of declining Arctic sea ice at 13.2% per decade. These signs point to a continued weakening of the polar vortex and a potential collapse.' https://www.forbes.com/sites/trevornace/2018/02/27/collapse-polar-vortex-arctic-melting-winter/

A cold winter period in North America or Europe does not occur in isolation, and as our ability to collect real/near real time data involving complex variables and dynamic systems improves, our ability to understand what is going on would also improve.

Well, one can hope, at least.

It's interesting. Economists are very agreed that GDP growth, especially cumulative and compounded, is a tremendous boon to humanity. But I would say even economists, when they shift to political economy, are somewhat selective about when they really support growth tools. Can one person be for more points-based immigration, deregulation, protection of worker rights including killing the non-compete, and high government expenditure on education and research and development? Or is everybody going to pick and choose from those according to a political template?

I should probably add a simple national health as growth-enhancing.

When defining production workers, are we using the OECD definition?
https://stats.oecd.org/glossary/detail.asp?ID=4838

This would be informative in a way, but also severely limiting as many large firms don't do much manual labor. Would an accounting firm employee that employs people to produce reports for client consumption be considered a production or non-production worker?

My argument would be that they are essentially machine operators producing a good, but I do not know if the economic community agrees.

Who would have guessed that the largest companies increasing share of the market would result in the average company size increasing?
I've come to believe "labor" needs to be re-defined. I find the claim that "the trend is too broad to be due to regulation" and the FACT that federal regulation has ballooned (especially in scope) to require a fuck of a lot more justification than the hand-waving presented here. Thank God we don't have an EPA that regulates rain run-off as "navigable waters" or an OSHA that regulates the height of the partitions in toilet stalls!

Indeed. Regulation is an expense best amortized by size and volume. If you need an industrial hygienist on staff, a pure expense, you need large volume to pay their wages.

That isn't the only thing. Canadian retailers have extreme difficulty dealing with the IT costs. Target Canada failed due to of the shelf IT solutions. The US retailers are large enough to have full development staff to build and maintain their complex systems, which are what keeps them in the business. So smaller companies cannot compete.

Sorry, I don't believe your comments about regulation. "The reason is essentially simple, the decline in dynamism is widespread and exists across highly regulated and less regulated sectors of the economy." doesn't capture the observations.

We do have dynamic innovation in Silicon Valley where regulations and standardization are minimal. Yes, the government wants to regulate, but the area keeps changing faster than the politicians/bureaucrats can adapt. My friends in AI (angel investing) and VC who see the dynamic possibilities. One AI friend screens about 10 to 20 a week and one of his big questions has to do with regulation. He drops all projects when regulators or activists idiots have effective "veto" power that can kill it. Market risk is understandable. Most projects requiring the FDA take more time than our "planning horizon" (aka expected remaining life) and are not taken.

Using cross country regulatory variations we see another signal. For example, take the offshore aquaculture industry that has sales in the 2 million euro / FTE level and returns on equity to match. The growth rate in Norway, and Europe (including Turkey), China, SE Asia, India, Australia, New Zeland along with Korea and Japan etc. is in the double-digit range and in the US it is zero even though we have the largest EEZ (ocean water) of all countries and one of the largest seafood markets.

This situation is purely regulatory.

Another example would be desalinization in the SW US (water-short areas) where Israel, Singapore, Qatar, etc. all have massive desalinization at economical cost (less than the price we are paying in LA area for using river water from N. Califonia) using equipment from the US (energy recovery devices come from San Lorenzo California with membranes from San Diego -- invented at UCLA in the late 50's). When I follow the 12 years of regulatory nonsense on an application for a facility down the street from my house using an existing saltwater intake (for a power plant) I note that the actual cost of the water without bureaucratic nonsense is about 1/3 the cost they want us to pay and this money is just to cover the decade of upfront regulatory cost.

With 2/3 of the cost being regulatory nonsense, this is regulatory inhibition. Note the science by used by the regulators is provably false and pure junk science, but when you bury false assumptions in mathematical models being applied by political bureaucrats it is impossible to get the math fixed. Law and regulators don't understand the significance of implicit assumptions in Math Models.

+1 if this comment was sourced, it might be an important article in a venue like Reason magazine, but, as it is, it sounds too incredible to be true. LA water is under-priced, last I checked and lived there in the 1990s, from the days of LA mayor Tom Bradley.

I find your arguments more credible than those of our host. I think regulation extracts a huge cost out of the economy, both in direct costs as well as inhibition of future possibilities. Note the differential rates of innovation in semconductors vs. bio-medicine even though the actually capital costs of the former (multi-billion dollar fabs) are much greater than the latter.

It seems logical to assume that aging populations would exhibit less dynamism than younger populations. After all, older people tend to be risk averse and that they have more to loose (and less of a future to make it up) than younger people. However, Alex's argument is not based on this aging effect itself, but rather the number of new entrants into the job market. I find this latter argument unpersuasive as suitably motivated young people should feel repelled by the ossifying established companies, instead preferring to go out onto their own. This would especially be the case if the potential payoff is good and there is lots of investment capital available.

Isn’t ggplot gorgeous though?

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