9 - Asymmetric adjustment costs and sectoral shifts

Summary

The purpose of this chapter is to formulate and empirically assess an aggregate economic model that displays the feature that sectoral shocks – changes in either relative demands or the technology that requires labor to be reallocated among various sectors – causes short-run changes in aggregate employment and output. The model emphasizes the costs to the firm of changing its labor force. Like the treatment of the costs of changing the capital shock in Eisner and Strotz (1963), Lucas (1967), and Gould (1968), these costs are assumed to increase rapidly with the absolute rate of employment changes so that the firm will never jump to its desired long-run employment levels. However, unlike those contributions, the cost of adjustment is assumed to be asymmetric – an increase in employment costs more than a decline of equal magnitude. It is this asymmetry that yields a temporary decline in aggregate employment in response to a sectoral shock. Firms that experience a decline in their relative position are quicker to fire workers than those firms that are expanding hire additional workers. Over time, firms asymptotically approach their longrun desired employment, which, by assumption, is invariant to the cross sectional distribution of sectoral specific employment.

This chapter is motivated, in part, by recent work of Lilien (1982a, b), who has attempted to show empirically that a large part of fluctuations in measured unemployment in recent U.S. experience can be attributed to the unusually large structural shifts over this period.