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  Trends and Challenges for Work in the 21st Century
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Opinions and views in these papers are those expressed by the author(s). They are not to be taken as expressions of support for particular positions by the Department of Labor. Please do not cite these papers without prior permission of the author(s).

AN OVERVIEW OF ECONOMIC, SOCIAL,
AND DEMOGRAPHIC TRENDS
AFFECTING THE US LABOR MARKET

Robert I. Lerman
Stefanie R. Schmidt
The Urban Institute

V. Adapting to Tight Labor Markets

With the U.S. economy reaching the lowest unemployment rates in 30 years and the employed share of the adult population at an all-time high, today’s primary concerns are labor shortages and inflationary pressures resulting from tight labor markets. According to many predictions, the 1995-1996 unemployment rates of 5.5 percent should have already led to excessive wage growth. In a recent estimate, Akerlof, Dickens, and Perry (1996) concluded that the rate of unemployment consistent with no increases in the inflation rate was in the 5.5-6.0 percent range. The U.S. experience of 1997 and 1998 cast doubt on these and similar projections. Even after reaching 4.5 percent unemployment rates, the U.S. economy has yet to experience inflationary wage pressures.

How have these pressures been averted? Are they about to arise shortly? How are employers coping with the tight job markets? Is rapid wage growth taking place in the lowest unemployment rate areas? To what extent have new workers been drawn into the job market to mitigate shortages and wage pressures? What mechanisms other than wage increases are employers using to recruit and retain workers? Are employers turning to low-turnover strategies with job ladders and extensive training? To what extent are employers able to lower their formal job qualifications in response to a shortage of workers?

The National Trends

The impact of the 1990s expansion on the labor market is unusual in two respects. First, the absence of any observable wage pressure in the context of a 4.5 percent unemployment rate is unexpected. Figure 1 graphs the trend in unemployment with the trend in the Employment Cost Index (ECI), which best captures the potential inflationary pressures emerging from the labor market, and the Consumer Price Index (CPI). Note that from 1986 to 1989, when unemployment rates fell from 7.0 percent to 5.3 percent, the ECI rose from a growth rate of 0.7 percent per year to 1.2 percent per year and the CPI doubled from 2 percent to 4 percent per year. Yet, in the 1990s, even larger reductions in the unemployment rate have induced no increase at all in the ECI or CPI. Second, the dramatic reduction in unemployment rates has stimulated only a modest

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impact on participation in the job market. Note that in Figure 2 falling unemployment in the late 1970s and mid- to late 1980s attracted many new workers into the market, raising participation rates 1.5 to 2 percentage points. In contrast, the decline in the 1990s to 4.5 percent unemployment rates has only led to a 0.7-point increase in participation. Thus, large increases in labor supply cannot explain the limited impact on wages and prices.

One feature of the current expansion that follows past patterns is that the expansion has raised employment most among the more disadvantaged groups. Table 6 reveals that the percentage-point gains in employment-population ratios and declines in unemployment rates were substantially higher among minorities, teenagers, and less-educated workers than among prime-age males. For example, the unemployment rate among black men, ages 20 and over, fell an extraordinary 7 percentage points, from almost 16 percent to about 9 percent. White men, ages 20 and over, also experienced sizable reductions in unemployment rates, but virtually no movement in employment. Similarly, the unemployment rate of college graduates declined from 3.2 percent in 1992 to 1.7 percent in 1998, while the employment-population ratio of college graduates remained constant at 78 percent.

With the economy apparently running out of skilled workers, since nearly all were already employed earlier in the business cycle, employers must turn to less-qualified workers to fill the new job. These pressures are good for the disadvantaged—firms are more willing to take inexperienced, less educated workers; to expand training; and to lower hiring standards. But shortages of high-skilled workers could lead to inflationary wage increases, while adding low-skilled workers could lower productivity and raise costs.

Firms might have to alter their production approaches to the extent that the mix of skills

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Table 6: Gains in Employment-Population Ratios and Unemployment Rate Reductions by Age, Ethnicity, and Education: 1992-1998


(Text Only)

 

1992

1998 (1st Half )

Percentage Point Change

% Change

Employment-Population Ratios

White Males, 20+

73.0

74.7

1.7

2.3%

White Females, 20+

54.9

57.7

2.8

5.0%

Black Teens

22.8

29.6

6.8

26.1%

All Teens

41.7

45.3

3.6

8.3%

Black Males, 20+

64.3

67.3

3.0

4.6%

Black Females, 20+

53.6

59.4

5.8

10.3%

Hispanic Workers

59.1

63.6

4.5

7.3%

HS Dropout

36.5

39.6

3.1

8.2%

HS Graduate

61.8

62.7

0.9

1.4%

Some College

71.0

72.3

1.3

1.8%

BA or Higher Degree

78.8

78.9

0.1

0.1%

Unemployment Rates

White Males, 20+

6.4

3.2

-3.2

-69.3%

White Females, 20+

5.5

3.5

-2.0

-45.2%

Black Teenagers

39.8

27.5

-12.3

-37.0%

All Teenagers

20.1

14.3

-5.8

-34.0%

All Black Males

15.7

8.7

-7.0

-59.0%

All Black Females

13.2

9.4

-3.8

-34.0%

Hispanic Workers

11.6

6.9

-4.7

-51.9%

HS Dropout

11.5

7.1

-4.4

-48.2%

HS Graduate

6.8

4.0

-2.8

-53.1%

Some College

5.7

3.1

-2.6

-60.9%

BA or Higher Degree

3.2

1.8

-1.4

-57.5%

Source: US Bureau of Labor Statistics, unpublished tabulations.


among new workers differs sharply from the mix among existing workers. Employers would seem to face serious problems integrating large numbers of less-skilled workers into their organizations, particularly at a time when the demand for skill is increasing on a long-run basis.

Surprisingly, a close look at the data provides an entirely different picture of recent job market trends. As Table 7 reveals, fully 94 percent of the 11.7 million newly employed adult workers (ages 25 and over) had at least some college or a BA degree and over half of them came from the highest educational category. Demographics and educational distributions by age allow us to reconcile the substantial improvement in the position of less-educated workers with the high levels of education among the newly employed. The normal tendency at peaks in the business cycle for employers to draw on less-educated workers has been offset by the long-term increase in the educational status of the population.

While the typical dropout had a much easier time finding a job in 1998 than in 1992, dropouts did not account for any of the growth in employment. The reason was that the high school dropout population declined by 2.8 million, as the number of young high school dropouts becoming adults was smaller than the number of older dropouts dying. At the same time, while the typical adult college graduate was no more likely to be employed in 1998, the population of college graduates ages 25 and over increased by about 7.5 million, or 20 percent, well above the 7 percent growth in the total adult population. As a result, college graduates constituted 65 percent of the 11.5 million increase in the 25-and-over population.

Thus, the striking reality is that employers have been able to draw on a growing pool of highly educated workers, even over the 1992-98 expansion. Despite the fact that nearly all college graduates looking for work had jobs in 1992, the 20 percent increase in the population of

Table 7: Distribution of Net Employment Growth of Population,
Ages 25 and Over, by Educational Status: 1992 to 1998, 1st Half

(Text Only)

Educational Group

1992 Employment

1998 (1st Half) Employment

Change in Employment

Percent of Net Growth in Employment

High School Dropouts

11,845

11,754

-91

-0.8

High School Graduates, No College

35,305

36,090

785

6.7

Some College

25,523

30,480

4,957

42.5

BA or Higher

27,273

32,487

6,005

51.5

Total

99,946

111,601

11,655

100

Source: Tabulations by Urban Institute based on data from the US Bureau of Labor Statistics.


college graduates, ages 25 and over, provided a substantial pool of new educated workers. While the 25-and-over population has increased by 7 percent since 1992, the numbers with at least some college jumped by 18 percent.

These surprising figures put to rest a “worker mix” explanation for limited wage growth. Had the mix of workers become less educated, this compositional factor would have exerted a downward impact on average wages. Put another way, increased wages among existing workers could have been offset by a rising share of low-wage workers. In fact, the opposite took place. The average educational level of the workforce increased considerably over the period, thereby increasing average wage growth above the growth in wages among individual groups.

The rapid expansion in the supply of college-educated workers may explain why worker shortages have not become so widespread as to stimulate wage inflation. The long-term trend toward a rising demand for skilled and educated workers continued over the current expansion. In recent years, the structure of occupations has shifted dramatically toward high-skill positions. Professional, managerial, and technical jobs account for nearly two-thirds of the net growth in employment, far above the 28 percent of jobs in these occupations in 1988. Despite the shift toward high-skill occupations and the increased demand for skill within occupations, the substantial growth in the supply of the college-educated population apparently provided enough of an inflow to prevent the types of shortages one would expect at this stage of the business cycle.

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Area Variation in Unemployment Rates and Wage Pressures

The national picture captures the average market conditions for the nation but does not show the variation across labor markets in the degree of tightness and any induced pressures on wages. In Figure 3, we can see the wide variation in unemployment rates, ranging from about 3 percent in the 10 states with the lowest unemployment to almost 6 percent for the 10 with the highest unemployment. Fully half (25) the states had unemployment rates at 4 percent or below and only 5 states at about 6 percent or higher. Growth in employment is a second indicator of labor market tightness in an area. Figure 3 displays percentage employment change between the first quarter of 1995 and the first quarter of 1998, when employment in the nation rose by about 5.5 percent. It is striking that high employment gains did not necessarily go with low unemployment rates. In fact, the correlation between unemployment rates and percent growth in employment was slightly positive at .05.

The wide variations across states might provide indications as to whether inflationary wage pressures are finally emerging from tight labor markets. After all, 15 states now are experiencing unemployment rates at about 3.5 percent or below. If migration is limited, one would expect to observe faster wage growth in these low unemployment rate areas than in high unemployment areas.

To test this possibility, we compiled data on nominal wage growth between 1995:I and 1998:I by state and calculated growth in average weekly and average hourly wages and salaries from the outgoing rotation samples of the relevant Current Population Surveys. Next we tabulated growth in earnings by states ranked on the basis of 1998 unemployment rates, 1995-1998 percentage change in employment, and 1995-1998 percentage change in unemployment rates. The calculations grouped areas by quartiles of each labor market indicator. The unemployment rate groupings were those at 3.7 percent or below, 3.7 to 4.7 percent, 4.7 to 5.1 percent, and over 5.1 percent.

The well-known Phillips curve relates wage growth to levels of unemployment rates. Looking at this relationship across areas, one finds that wage growth was no higher in the lowest unemployment areas than in other areas. The numbers in Table 8 show no apparent relationship between rates of wage growth and area employment conditions. For example, the mean wage rates and mean weekly earnings were virtually identical across all four quartiles of unemployment rates.

Employer Responses to Tight Job Markets

How have employers kept wages in check in the face of these extremely tight labor markets? The answer is unclear. However, two sets of strategies appear to have emerged. The first is common to expansions and involves widening recruitment, expanding training, upgrading


Table 8: Relationship Between Changes in Wage Rates and Weekly Earnings and State Labor Market Conditions: 1995 to 1998

Quartiles of Unemployment Rates, 1998

Wage Levels

Below 3.7%

3.7% to 4.7%

4.7% to 5.1%

Above 5.1%

Percent Change in Hourly Wage Rates: 1995-1998

Mean

7

8

7

7

Median

13

13

13

9

25th percentile

10

8

8

8

75th percentile

8

8

8

8

Percent Change in Weekly Earnings: 1995 -1998

Mean

11

11

12

11

Median

11

13

11

7

25th percentile

8

13

15

9

75th percentile

11

9

9

8

Quartiles of Percentage Change in Employment: 1995 - 1998

 

Above 7%

5% to 7%

4% to 5%

Less than 4%

Percent Change in Hourly Wage Rates: 1995-1998

Mean

10

8

5

8

Median

13

13

9

11

25th percentile

8

11

8

13

75th percentile

9

8

6

7

Percent Change in Weekly Earnings: 1995 -1998

Mean

11

12

7

14

Median

10

10

6

14

25th percentile

10

13

11

15

75th percentile

12

5

5

13


existing workers, and/or lowering normal hiring standards. The second involves the use of signing bonuses, stock options, profit-sharing, and other forms of non-wage compensation.

Types of Employer Responses

Employers engage in a number of strategies in response to a shortage of workers. Among the most common are:

  • To increase recruiting, by advertising more, turning more to employment agencies, reaching a wider geographic area, and even paying recruiting bonuses to employees;
  • To increase overtime work and turn part-time positions into full-time jobs;
  • To reduce education and other requirements for new hires;
  • To restructure work in ways that adapt to the available workforce;
  • To substitute capital for labor;
  • To expand the supply of qualified workers by conducting additional training;
  • To improve working conditions;
  • To offer bonuses, stock options, and other forms of non-wage compensation to new and/or existing employees; and
  • To improve wages and fringe benefits.

Although employers generally turn to increases in wages and fringe benefits only as a last resort, a significant impact on wages usually emerges by this point in the business cycle. A natural explanation is that employers are choosing to emphasize responses other than wage increases over the current expansion. While the evidence concerning non-wage responses is spotty, individual cases and limited data suggest employers are indeed adopting the strategy of emphasizing non-wage approaches.

Training

Employers are apparently increasing their training in a number of ways. Unfortunately, there are few consistent data sets documenting training practices over time. The 1994 National Employer Survey (NES) of over 4,000 employers, conducted by the U.S. Bureau of the Census on behalf of the National Center on the Educational Quality of the Workforce, University of Pennsylvania, gives a detailed picture of training patterns and expectations for growth over time. One striking finding is that over two-thirds of employers reported that the skills required to perform production or support jobs increased over the prior three years. Over three out of four employers said they had increased training outlays over the prior three years, while only about 3 percent or less had decreased their amounts of training. Employers reporting rising skill requirements on production and support jobs were especially likely to have increased training; 85 percent of this group increased training compared to 58 percent of employers who said skill requirements had not increased. In addition, the majority of employers projected a further increase in training.

Of the employers reporting an increase in training, over 80 percent cited changes in the work process, such as changes in technology or changes in the structure of work. Over 60 percent attributed the increases to product changes, and 90 percent saw expanded training as a way of upgrading quality. In addition, nearly two-thirds of employers indicated that increased training was motivated by the fact that new hires did not have the necessary skills.

The 1994 NES reveals that several types of training are offered by large proportions of employers (see Table 6). Note that over three in four employers reimburse workers for tuition at colleges and training institutes and that over 70 percent provide training in production equipment, computer literacy, cross training, and teamwork. Most of these training areas are expected to grow over the next three years.

A Department of Labor survey (Frazis et al., 1998) undertaken in 1995 showed that 70 percent of workers received some formal training in 1995 and virtually all (96 percent) spent time in informal training. Formal training is training that is planned in advance and has a structured format and a defined curriculum. Much of the formal, employer-sponsored training involved only a modest number of hours.(1) Employees reported averaging only about 13 hours of formal training during a six-month period and about 31 hours of informal training. Reports by employers showed an even lower number of hours. Still, the costs of training, counting wages and salaries paid to trainees, tuition reimbursements, wages of trainers, and payments to outside trainers, amounted to over $50 billion per year. The youngest (under age 25) and oldest (over age 54) workers experienced the least amount of training. Smaller firms provided somewhat less training, though few differences were observed between medium-size establishments (100-499 employees) and large establishments (500 and over employees). Firms implementing four or more new workplace practices, such as pay for skills, employee involvement in technology decisions, job redesign, quality circles, and self-directed work teams, reported almost twice as much formal training as other firms. Formal training varies significantly among types of workers. More training reaches the high-paid, well-educated, full-time workers, workers in establishments with medium or low turnover, and workers with long tenure at the firm. For example, 90 percent of workers with a BA or more received formal training, but only 60 percent of those with a high school degree or less did so. At the same time, average hours of training were higher among workers in the production, construction, and material handling occupations than among managers.

These BLS data contrast sharply with data reported by the OECD from the International Literacy Survey. Their report suggests only about 23 percent of workers received any job- or career-related training paid for by employers.

In any event, there is little indication that firms are providing depth in their formal training sufficient to raise significantly the capacities of less-skilled workers. Formal training averages less than one week per year. Despite these limitations, some firms are increasingly emphasizing training, not only to improve the productivity of existing employees but also to increase the supply of qualified workers in various fields.

Many companies have begun working with high schools to develop a new workforce.

Charles Schwab is a good example of a company making an effort to shift from recruiting only workers with a BA degree to developing its own workforce through a combination of work-based learning, work experience, and school-based learning. CISCO Systems is working with high schools to help young people qualify for jobs as computer network administrators. The auto industry has promoted a variety of programs to upgrade the quality of training for future auto mechanics. Other industries are working closely with career academies, which focus on industry or occupational fields in such areas as finance, travel, health, and computers.

Apparently, the involvement of employers goes beyond a few individual cases. According to the 1997 follow-up of the National Employer Survey of about 7,000 employers, an extraordinary 74 percent said they were participating in school-to-work partnerships and nearly 24 percent reported providing internships.

It will take time before many of these initiatives generate a substantial increase in the labor supply of skilled workers. However, in the interim, hiring and training young people as low-wage interns may allow many firms to limit the costs of expanding their workforce.

Several important questions arise about training responses. First, to what extent do firms perceive special barriers that limit the amounts of training they sponsor? Some firms may hold back on extensive training efforts because of their concern that workers will leave the firm once they undergo training. Second, can we learn anything about the nature of worker shortages from the training undertaken by firms?

Non-wage Forms of Compensation

Employers are apparently expanding their use of special forms of compensation that do not involve direct salary increases. Despite the thriving economy, firms see themselves in a highly competitive environment, one in which raising prices can mean large losses of sales.

Anecdotal evidence suggests firms are turning to bonuses and variable compensation as a way of attracting workers in today’s tight labor market. According to Louis Uchitelle (1998), signing bonuses are proliferating and reaching well beyond upper-level managers and skilled technicians. He cites examples such as the Labor Department’s offer of a $4,000 bonus to attract young economists and Price Waterhouse’s hiring bonus of $10,000 provided to newly hired management. Reportedly, the 1998 class of Cornell MBAs received an average bonus of $17,500, nearly double the 1996 average of $9,400. Increasingly, employers are willing to extend signing bonuses to other college graduates, including public school teachers.

A second expanding source of compensation is employee stock ownership and stock options. According to the 1994 National Employer Survey, 35 percent of employers were offering stock options to their workers. By 1999, the figure is no doubt considerably higher. The National Center for Employee Ownership estimates that nearly 8 million workers participate in employee stock ownership plans or stock bonus plans and at least 6 million are in broad stock option plans. Changes over time in the compensation provided through these and other stock option or stock purchase plans are unknown. The Bureau of Labor Statistics does not try to measure the implicit income provided to workers who receive stock options.

One related trend in compensation is the area of nonproduction bonuses. According to Schwenk (1997a,b), the proportion of compensation going to nonproduction bonuses nearly doubled, rising from about 0.7 percent in 1986 to 1.3 percent in 1996. As expected, year-to-year percentage changes in nonproduction bonuses are highly variable and presumably highly sensitive to the profits of firms paying such bonuses (Walker and Bergman, 1998). For example, since the 1991-92 period, percent changes in bonuses were 16 percent, 21 percent, 7 percent, 14 percent, and 5 percent.

The share of wages and salaries in total compensation seems to have declined only slightly, from 73 percent in 1986 to 71.9 percent in 1996, if we take account of bonuses and benefit costs, including paid vacations, sick leave, health insurance, retirement plans, and social security and workers’ compensation. However, these data ignore the value of stock options and possibly other types of special payments.

Whatever the facts, should policymakers promote compensation schemes linked to a firm’s performance? Might the apparent increases in bonuses and stock options help firms remain cost-conscious in today’s highly competitive environment? In the early 1980s, Martin Weitzman (1984) proposed “the share economy,” one in which compensation would be based less on fixed-wage contracts and based more on arrangements in which what workers received depended on the firm’s revenues or profits. Through the 1990s, Weitzman has continued to make the case for moving away from fixed wages, and his work has stimulated a lively debate in the economics profession. The debate deals with issues involving microeconomics (relating to the impact on individual firm hiring and performance) and macroeconomics (relating to aggregate unemployment and inflation).

Research on the role of pay incentives in firm performance certainly predates the work by Weitzman. A substantial literature has developed around these issues, and many of the findings suggest positive impacts on productivity and profitability from shifting compensation away from fixed-wage contracts.

The focus here is on whether variable pay helps firms respond to booming macroeconomic conditions. Although Weitzman’s primary argument was that variable pay could induce hiring and reduce the 1980s problem of stagflation, he (1988) subsequently argued that the shift to variable pay could lower NAIRU, the unemployment rate consistent with non-increasing inflation. Two key elements of the argument are 1) that incentive pay arrangements encourage firms to increase hiring, and 2) that increased flexibility in pay will permit reduced variability in employment. In the case of pure wage contracts, firms hire to the point where the marginal cost (the wage) of the extra worker is equal to the marginal revenue obtained from the extra worker’s contribution to sales. In this case, if sales or prices fall and thus reduce marginal revenue below the wage costs, then the profit-making firm is likely to lay off workers until it reaches a new equilibrium. On the other hand, if workers were to receive a percentage of sales, then the firm would have no incentive to lay off marginal workers so long as they contributed some amount to revenues (even if it were less than the wage or the average revenue per worker).

Overall revenue to the firm would have declined but the firm would continue to offer employment to existing workers, since the revenues generated by the marginal workers would benefit the firm. However, average pay to the remaining workers would be lower with a no-layoff policy than with the types of layoffs arising in firms with wage contracts.

One obvious implication is that workers might be able to gain increased employment stability but at the cost of increased variability of compensation. Workers confident in their ability to keep a job might well choose to avoid the risks of variable pay. On the other hand, workers vulnerable to layoff and workers optimistic about their firm’s future are likely to prefer compensation linked to their firm’s performance.

Notwithstanding the logic of the share economy, the advantages of an increased emphasis on profit-sharing or revenue-sharing might be illusory (John, 1991). In a profit-sharing firm, adverse shocks reduce profits and thus lower compensation per worker. Although firms have no direct incentive to lay off workers in this situation, they may be reluctant to allow average worker compensation to fall significantly. They may lose their best workers to competitors or may find that their jobs do not pay enough to deter workers from shirking. To avoid this scenario, firms may lay off workers even though the marginal workers do not generate any direct costs. Another possibility is that reduced compensation will lower the supply of labor and again induce reductions in employment in response to the shock to profits. Thus, while some labor market conditions suggest little gain from the shift away from fixed-wage contracts, other scenarios indicate more employment stability.

In today’s context, the more important question may well be the impact of profit-sharing schemes on NAIRU. Here, Weitzman (1988) sees some potential gains for the share economy but concedes that some causes of a high natural rate of unemployment would apply as much in a profit-sharing context as in a fixed-wage context. Neither would have any advantage if high NAIRUs resulted from high social benefits, excessive bargaining power by unions, or efficiency wages. However, if the problem was that firm insiders were so powerful that external unemployment did little to affect wages, then bias toward expanding employment in profit-sharing firms would help speed up reductions in unemployment when the economy expanded. A world emphasizing profit-sharing might also reduce frictional and structural unemployment.

Surprisingly, Weitzman says little about the potential impact on inflation or on how uncertainty on the part of the firm will affect employment and prices in a low-unemployment economy. Firms concerned about raising prices and uncertain about future sales may wish to avoid building high wages into their permanent cost structure. At the same time, they must recruit workers in the context of a tight labor market. The response by many firms is to try to make one-time payments, especially to newly hired workers, and to offer stock options and bonuses that will ultimately be linked to profits. To the extent firms can attract and retain the same quality of workers using these compensation schemes—perhaps because good workers are willing to take risks in return for high potential rewards—the package may make financial sense as a hedge for firms. Since payments to workers will be directly correlated with the firm’s performance, the losses due to weak firm performance will be mitigated by the lower compensation to workers, while gains due to strong firm performance will be moderated by the higher compensation going to workers.

Already, the government encourages profit-sharing in a number of ways. There are special rules that provide tax advantages to workers and firms who create Employee Stock Ownership Plans (ESOPs). The tax treatment of stock options is also favorable. A worker receiving an option to buy his company’s stock at the current market price obtains something of value even when the option price is the current market price. Modern financial economics can place a value on these options. Yet, workers will not pay any tax on the options until and unless they exercise the options and sell the stock at a price higher than the option price. A key question is whether the government should do more to encourage these and other profit-sharing arrangements.

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