Economic recessions are bad for everyone. Unemployment spikes, wage growth slows, investors suffer losses as stock and bond markets reel, and businesses fail. But economists have long seen a silver lining in economic downturns. Joseph Schumpeter famously wrote of “creative destruction,” where the destruction of job and firms help more efficient firms spring up, boosting long-run economic growth. Some economists also talk about the “cleansing effect” of recessions. Yet a new working paper released by National Bureau of Economic Research shows that this silver lining is quite thin, particularly when it comes to workers.
The authors of the paper, Yale University’s Lisa B. Kahn and the U.S. Census Bureau’s Erika McEntarfer, look at data linking employees to employers to better understand changes in the movement of workers during recessions and booms. The first trend they note is that employment at high- and low-paying firms expand and contract in different patterns. The expansion of high-paying firms is quite pro-cyclical, meaning they expand quickly as the overall economy does, and contract during recessions. Low-paying firms are less sensitive to the fluctuations of the overall economy. The result is that the average “quality” of employers, measured by how much they pay their workers, declines during recessions.
At the same time, Kahn and McEntarfer look at the movement of workers at the different types of firms. They find that pro-cyclical, high-paying firms are more likely to have workers leave the firm compared to low-paying firms. In fact, low-paying firms are less likely to have workers separate during recessions. This decline in separations is the reason why low-paying firms have relatively stronger employment growth during economic recessions. These firms aren’t hiring more workers, they are just retaining more of them. The authors find evidence that the decline in separations at low-paying firms is primarily driven by a decline in “voluntary separations,” better known as quitting a job.
So if low-paying firms don’t contract as much during recessions because workers are less likely to quit, then the idea that recessions improve the allocation of workers to companies seems unlikely. Unless we think all workers at low-paying firms at the beginning of a recession are ideally matched with their employers, then the downturn is holding back the advancement of workers.
Basically, the two authors find what economists call the “job ladder”— the ability of workers to move onto higher-paying companies —is pulled up during recessions.
Kahn and McEntarfer document that workers at low-paying firms are 20 percent less likely to advance to higher-paying firms during a recession than during an economic boom. And workers that get a job during a recession are likely to pay a wage penalty. These workers are more likely to get a job with a low-paying firm and, according to the authors’ calculations, a worker will be at a firm that pays about 3 percent less on average than if she had gotten a job during an economic boom.
Rather than cleanse the economy, recessions actually restrict workers from advancing to jobs that are better matches. And the loss isn’t just for the worker who makes less but for the overall economy as well. Workers who are better matched to the demands of their jobs will be more productive and therefore boost overall productivity. Kahn and McEntarfer’s paper is another reminder that the line between the short- and the long-run consequences of economic recessions can be quite blurry.