Regional Variation in Job Creation and Destruction

By Bauer, Paul W.; Lee, Yoonsoo | Economic Commentary (Cleveland), September 15, 2007 | Go to article overview

Regional Variation in Job Creation and Destruction


Bauer, Paul W., Lee, Yoonsoo, Economic Commentary (Cleveland)


Real market economies have always been much more turbulent than the static textbook descriptions of the competitive market equilibrium. People are perpetually adapting to new products, production technologies, and competitors. A manifestation of this economic dynamism is that at all times, whether in booms or busts, some jobs-and even whole firms-are being created while others are being lost. As a result, workers are reallocated from declining firms or sectors to other parts of the economy. Because of the human and economic costs of the resulting dislocation, community leaders frequently try to forestall job losses, even as they try to promote employment growth.

However, economists view worker reallocations as a necessary part of economic growth, as both job creation and job destruction appear to be necessary for a dynamic, growing economy. While everyone understands that entrepreneurs must be able to attract new labor in order to form new firms or expand existing ones, not everyone understands that without the ability to shed less-productive workers or those whose jobs are no longer needed, entrepreneurs will be less willing to hire in the first place.

It is easier for firms to adjust their workforces in flexible labor markets than in less flexible ones, creating or destroying jobs as necessary. Such flexibility is critical to economic growth, and regions with more of it grow more than those without.

In this Economic Commentary, we examine the flexibility of each state's labor market and find that it varies widely. Higher rates of flexibility are correlated with higher growth rates for both output and employment. Differences in the industrial structure and the size distribution of firms across states account for some of the interstate variation in rates of job creation and destruction, but a sizable portion remains unexplained. Some other likely factors are tax policies, economic regulation, and worker skill levels.

* Job Reallocation and Economic Growth

The flexibility of a labor market can be measured as the amount of "excess" reallocation of labor that occurs, that is, the amount of job turnover that goes on above and beyond what would have been required to achieve an observed net change in employment (see box). In figure 1 we show excess reallocation rates for U.S. states from 1989 to 2003. These rates are calculated from data on job creation and destruction-changes due to establishment startups, expansions, contractions, and shutdowns-obtained from the Statistics of U.S. Business (SUSB) from the U.S. Census Bureau and Small Business Administration.

The variation in excess reallocation rates is driven by differences in both job creation and job destruction. On average, states with higher creation rates also have higher destruction rates, leading to higher rates of excess reallocation. The statistical correlation between job creation and destruction rates across states is relatively high (0.536).

There is also a definite regional pattern: Rates of both job creation and job destruction are higher in faster-growing states in the South and on the West Coast than in slower-growing states in the Midwest. These findings tell us that labor markets are more dynamic in faster-growing states.

The Midwestern states of Wisconsin and Iowa exemplify a less dynamic labor market. Their rates of job creation and destruction were the lowest in the country. In an average year during the 1989-2003 period, about 14 percent of new jobs came from the expansion of existing firms or the creation of new ones. For those two states, about 12 percent of jobs were terminated as firms contracted or shut down, leaving a net gain of only about 2 percent per year over this period.

In sharp contrast, southern and West Coast states tended to have relatively high rates of both job creation and destruction. During this period, Florida, Arizona, and Nevada had the highest job creation rates (about 20 percent). …

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