Help Companies Avoid Layoffs in Recessions

(Bloomberg View) -- One of the hardest questions in economics is mobility versus stability. What happens to workers who are displaced by recessions, technological and industrial change, regional shifts, or corporate failure? Can humans move fluidly from occupation to occupation, industry to industry, and city to city, like interchangeable parts in a well-oiled economic machine, always going to where their contributions will be most rewarded and their talents utilized most effectively? Or would workers be better off if the government and corporations helped them weather the economy’s ups and downs by staying in place?

There’s no good single answer to this question. In general, there will be some optimal mix of stability and mobility that doesn’t go to either extreme. For long-term technological and industrial changes, people will eventually have to move, so policies should be focused on easing the inevitable transition. When the geography of the economy changes, governments should strike a balance between rescuing struggling places and helping people move out.

When it comes to recessions, there’s good reason to believe that stability is more important. The reason is that the economy, and most companies, usually recover from temporary downturns.

But that doesn’t mean that the harm recessions inflict on laid-off workers is temporary. People who are out of work for long periods may see their work ethic, job skills and professional networks degrade. Also, workers at a company learn lots of important knowledge about how that company works — how to navigate the corporate culture, strengths and weaknesses of other employees and teams and so on. Economists call this “firm-specific human capital.”

On top of all this, a job represents the culmination of a long search process. Workers go from job to job, trying to find the best match for their skills and personality, while companies try out various workers to see who fits. When someone gets laid off in a recession, she might not go back to the same company afterward, even if it would be economically optimal to do so — the trust and comfort might simply not be there anymore. Instead, she may have to go back to square one, starting her long job search all over again.

Some new research gives an idea of just how severe the long-term scars left by recessions can be. Economists Marta Lachowska, Alexandre Mas and Stephen Woodbury use data from Washington state’s unemployment-insurance system to track workers who were laid off during the recession that began in 2007. They find that the earnings of laid-off workers fall significantly — about 16 percent after five years — relative to similar workers who managed to keep their jobs. About 55 percent of the long-term earnings drop is due to lower wages.

There’s always the possibility that workers who are laid off are simply less productive than those who keep their jobs, and that for whatever reason, companies don’t lay them off until recessions force them to do so. But Lachowska and her colleagues focus only on workers who’ve spent six years at the same company — plenty long enough for the employer to know who’s productive and who isn’t. And when comparing laid-off workers to those who retain their jobs, they make sure to compare people with similar wage trends. In other words, if laid-off workers are losing out because they’re less productive, then the system by which companies compensate employees is utterly broken, and the efficiency and fairness of the entire corporate economy needs a deep rethink.

A simpler, more believable explanation is that recessions simply damage careers by taking workers out of companies where they fit well. This explanation is supported by the authors’ finding that the longer a worker’s tenure at a job, the greater the long-term wage loss from a layoff.

These results bolster the case for stability over mobility — for encouraging companies to keep workers around instead of letting them go during recessions. In the old days, keeping workers during downturns was common. In most countries, it’s still the norm. But in the U.S., the Great Recession marked a shift toward big layoffs. The long-term harm caused by those layoffs is probably one reason why wages have grown only sluggishly since 2009:

Help Companies Avoid Layoffs in Recessions

The U.S. can’t afford to have this become the norm. The government should give companies incentives — perhaps in the form of tax credits — to keep workers on payrolls during recessions, even at temporarily reduced wage rates. The economy isn’t the flexible, frictionless, well-oiled machine that we wish it were; a little stability in the short term will pay off down the road.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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