RDP 2016-06: Jobs or Hours? Cyclical Labour Market Adjustment in Australia 1. Introduction^[1]

A firm's demand for labour is derived from the demand for its output. During a downturn in demand, firms can reduce their use of labour by reducing either the number of workers they employ (the ‘extensive margin’ of labour adjustment) or by reducing the hours worked by their employees (the ‘intensive margin’ of labour adjustment).^[2] From an economy-wide perspective, whether adjustment occurs through the number of employees or average hours worked by each employee has implications for the costs of a downturn. If workers have their hours reduced but remain employed, many of the costs associated with unemployment, such as skill atrophy and reliance on government assistance, are mitigated. The nature of adjustment also has implications for the measurement of spare capacity in the economy. If significant adjustment can occur through average hours, then policymakers should monitor alternative measures of spare capacity – such as the underemployment rate, which takes into account whether employees would like to work more hours – in addition to the unemployment rate, which is based on headcount.

A firm's choice of whether to adjust the number of employees or the hours worked by current employees depends on a range of factors. If the costs of hiring and firing workers are non-trivial, then firms may choose to adjust hours rather than make employees redundant. Expectations of future demand are also important, as firms may be more inclined to adjust working hours if the downturn in demand is expected to be relatively short and shallow. Labour market institutions are also relevant. For example, laws and regulations or wage determination processes may provide incentives for firms to adjust via employee numbers or hours worked. Figure 1 provides tentative evidence that Australian firms have made use of both types of adjustment, with downturns in total hours worked reflecting declines in both employment growth and average hours worked.^[3]

In this paper we explore the nature of cyclical labour market adjustment in Australia. That is, we focus on deviations of labour inputs from their longer-run trends, such as during downturns in the economy. The first part of our paper uses aggregate time series data to estimate the relative importance of employment and average hours adjustment. We find that, while both employment and average hours worked tend to adjust over the cycle, the share of labour market adjustment due to changes in average hours worked has increased since the late 1990s. Indeed, the contribution of average hours to the cyclical variability in total hours worked has tripled, from 20 per cent over 1978–98 to 58 per cent over 1999–2016. Such a large increase in the importance of average hours adjustment was not observed in other developed economies, such as the United States, Germany and Japan (e.g. Merkl and Wesselbaum 2011; Kakinaka and Miyamoto 2012).

We investigate several plausible explanations for this change. We argue that the less severe nature of economic downturns in the 2000s, labour market reforms and increases in hiring costs may all help explain the relatively larger contribution of average hours adjustment in Australia since the late 1990s. However, it is difficult to assess the relative importance of these explanations using statistical models that relate average hours to GDP (or the output gap), as each explanation implies that changes in average hours worked have been more sensitive to the business cycle since the late 1990s.

Changes in the composition of employment between jobs involving longer hours of work and jobs involving fewer hours have also contributed to declining average hours during downturns.^[4] However, we find that the primary driver of declines in average hours during downturns has been declines in average hours worked within the different categories of employment. This is confirmed through our analysis of individual-level panel data from the ABS Labour Force Survey (LFS), which suggests that the main driver of the decline in average hours worked during the 2008–09 downturn was a reduction in the average number of hours worked by employees who remained in the same job (i.e. labour hoarding), rather than changes in the average number of hours worked by individuals who changed jobs or entered or exited employment.

The remainder of the paper is structured as follows. Section 2 provides estimates of the contribution of average hours worked and employment to the overall cyclical variability in total hours worked, and how this has changed over time. Section 3 outlines the main explanations for the increased role of average hours adjustment and the evidence for each. Section 4 sheds further light on cyclical labour market adjustment in Australia by decomposing the fall in average hours worked during the 2008–09 downturn using data on individual workers. Section 5 concludes.

Footnotes

Bishop and Plumb (2016) summarise many of the key results of this paper. The Australian Bureau of Statistics (ABS) has since made revisions to its modelled monthly hours worked series and these revisions have been incorporated into the analysis in this paper. [1]

In addition to reducing hours worked and/or employment, a firm can also reduce growth in its labour costs by reducing growth in the wages it pays its employees. In this paper, we only consider adjustment in the quantity of labour (employment and average hours worked) and not the price (wages). [2]

In this paper, total hours worked is based on the ABS measure of ‘monthly hours worked in all jobs’ and average hours worked is implied from total hours and employment. [3]

Compositional changes in employment are important for explaining longer-run trends (as opposed to cyclical adjustment) in average hours. In this paper we focus on cyclical adjustment. [4]