Employment, Capacity Utilization and Business Cycles

Thursday, October 13, 2016
capacity utilization

Two measures commonly used to gauge the country’s economic activity have started to move in opposite directions, according to an Economic Synopses essay.

Economist Ana Maria Santacreu examined these two measures:

  • The capacity utilization rate, which is the percentage of resources used by corporations and factories to produce finished goods
  • The fraction of the labor force currently employed, which is measured as 100 percent minus the unemployment rate

Santacreu noted that companies typically use around 80 percent of their available productive capacity (measured by the capacity utilization rate). This number is higher during economic expansions and lower during recessions. She noted: “Indeed, during the most recent recession, U.S. capacity utilization dropped below 67 percent, the lowest point since the late 1960s.”

The figure below plots the two measures at quarterly intervals from 1967 through the first quarter of 2016.

As the figure shows, employment as a fraction of the labor force tends to move in a similar fashion to the capacity utilization rate. Santacreu noted that the correlation between the two measures was 0.90 for the period 1967:Q1 through 1990:Q1.

However, the correlation became less pronounced during the early 1990s economic crisis and the early 2000s dot-com bubble. Santacreu wrote: “During both episodes, capacity utilization dropped before employment did and began recovering earlier. That is, industrial activity was booming while employment was still low. This phenomenon is known as a jobless recovery.”

Following the Great Recession, these two measures didn’t follow the same pattern as in the previous two recessions. Both measures dropped initially, but employment has been recovering quickly since 2009, while capacity utilization recovered initially but began falling again in 2015.

Why the Divergence?

Santacreu noted that there are several potential reasons why unemployment took longer to recover following the recessions of the early 1990s and early 2000s:

  • Firms may have postponed hiring to be sure the recovery was strong.
  • Firms may have purchased new equipment instead of hiring additional workers.
  • Workers may have had to switch industries, which may have lengthened the time it took to fill positions.

Santacreu wrote: “This is important in comparing capacity utilization and employment as measures of economic activity. Capacity seems to be mainly affected by cyclical factors. Employment, however, is also affected by a structural factor that makes it adjust more slowly than industrial capacity adjusts to recessions and recoveries.”

Regarding the recent divergence, Santacreu noted that two factors may be at play:

  • The unemployment rate may have decreased initially because some displaced workers became discouraged and simply dropped out of the labor force.
  • More recently, new jobs have been created, bringing the U.S. closer to full employment.

Santacreu concluded: “Capacity utilization and employment tend to comove along the business cycle. However, they may drift apart when labor markets are less flexible or there are structural changes in the economy.”

Additional Resources

Posted In LaborOutput  |  Tagged ana maria santacreucapacity utilizationemploymentunemploymentbusiness cyclegreat recession
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