Hiring, Job Loss, and the Severity of Recessions
Faberman, R. Jason, Business Review (Federal Reserve Bank of Philadelphia)
What drives movements in the unemployment rate during expansions and recessions? Obviously, much of it is driven by the hiring and firing decisions of individual businesses. When businesses hire more workers than they lose (whether those workers leave voluntarily or involuntarily), employment expands and the unemployment rate tends to go down. When businesses lose more workers than they hire, employment contracts and the unemployment rate rises. This does not mean, though, that boom times are driven entirely by hiring and recessions are driven entirely by job losses. For example, if firms cut back sharply on their hiring with little change in the number of workers they lose, the unemployment rate would rise because people would find it harder to find new work.
Whether a recession is driven by large job losses or weak hiring will greatly affect the composition and consequences of the unemployed and can therefore have important policy implications. Laid-off workers can come from a variety of backgrounds. Oftentimes, these workers lose valuable human capital in the process, especially if the laid-off employees are older, more experienced workers with a lot of job-specific skills. Weak hiring affects all individuals looking for work: those who were recently laid off, those just entering the workforce (e.g., recent graduates), and those who are currently employed but want a new job. Weak hiring implies that there are fewer jobs to apply for, which makes it more difficult for the unemployed to find work.
The recessions of the 1970s and 1980s, as well as the most recent downturn, saw steep declines in employment and sharp increases in unemployment. At the same time, the pace of layoffs was very high but relatively short-lived. In comparison, the fall in employment and the rise in unemployment during the 1990-91 and 2001 recessions were much less severe. During these recessions, there was a moderate rise in job losses but a relatively steep drop in hiring, particularly during the 2001 recession. Furthermore, the 1990-91 and 2001 recessions had declines that persisted well after the official end of the recession. (1)
In academic circles, the contrast in behavior has led to two diverging views on recessions and the labor market. Some economists, such as Robert Hall and Robert Shimer, focus on the more recent downturns and take the view that rising unemployment during recessions is driven by weak hiring and hence a low probability that the unemployed will find a job. Others, such as Shigeru Fujita and Garey Ramey, and Michael Elsby, Ryan Michaels, and Gary Solon, cite the historical evidence and argue that rising unemployment is driven by high rates of job loss.
In reality, the extent to which recessions are times of weak hiring or high job loss depends on the severity of the downturn. Severe recessions are typically characterized by a sharp drop in output and large amounts of job loss, while moderate recessions are characterized by smaller declines in output and relatively weak hiring. These results come about because, at any point in time, there is a distribution of businesses that are expanding, contracting, or keeping their employment steady. A recession is a time when the fraction of businesses that are expanding goes down and the fraction of businesses that are contracting goes up. A severe recession is one in which the shift in this distribution is more dramatic. Furthermore, when businesses expand or contract by a certain amount, they tend to do so with a fairly consistent mix of hiring, quits (voluntary worker separations), and layoffs (involuntary worker separations). Fast-growing businesses tend to have mostly hires, fast-declining businesses tend to have mostly layoffs, and businesses with smaller employment changes tend to have a mix of hiring, quits, and layoffs that occur simultaneously. During a severe recession, the number of businesses with large contractions increases sharply. …