Getting laid off and being unemployed for a long stretch ranks right up there with divorce or a death in the family as one of life’s most stressful events.
Beyond the psychological and health effects, prolonged unemployment can be a life-altering financial setback. When people are jobless for a long time, their skills atrophy and they become less employable. They miss out on chances to move up in the workforce, particularly if they just started their careers, and they earn less over time.
“Job loss has a huge impact on one’s well-being, especially when it occurs during recessions,” says Michael Blank, an assistant professor of finance at Stanford Graduate School of Business and a fellow at the Stanford Institute for Economic Policy Research. “A worker who gets laid off during a recession experiences an almost 20% decline in the net present value of their lifetime earnings. Their earnings drop upon being laid off, of course, and those earnings don’t really tend to recover even 10 or 20 years after the recession has ended.”
Economists have long been puzzled by the size and persistence of this well-known effect. The underlying mechanisms that generate these “scarring” effects are poorly understood, making it harder for policymakers to devise better programs to ease the pain of layoffs during recessions.
Research from Blank and Omeed Maghzian, a PhD student in economics at Harvard University, offers new insights into this dynamic. Much like a factory can pollute the local environment, a business laying off many workers can “congest” the local labor market. More than a quarter of the negative financial impact of job losses during recessions is due to the stress placed on the entire labor market by waves of layoffs. In other words, mass layoffs cause mass suffering, even for workers who keep their jobs.
That’s where governments can step in to mitigate the effects of “job destruction” – although Blank notes that it can be tricky for policymakers to figure out how to save jobs without subsidizing failing companies.
To get a better picture of why recessions can be so painful for workers, Blank and Maghzian dug into the numbers. Using Census data, they designed a novel way of teasing out the effects of firms laying off relatively large numbers of people across the country, separate from the individual economic conditions in a particular region. They studied mass layoffs at large companies across multiple regions. Large layoffs at a major regional employer force a flood of people into the workforce, where they compete with each other in an oversaturated job market. “People are looking for new work at the same time and kind of clogging up the labor market or congesting it for everybody else,” Blank says.
He and Maghzian found that a wave of unemployed workers tends to depress wages for both workers who are currently without a job and, somewhat surprisingly, workers in existing jobs. That’s because workers have less bargaining power to demand higher pay and fewer opportunities to move to better jobs. The effect is pronounced for younger, less-skilled workers who often change employers to “climb the ladder” and increase their pay. During recessions, their productivity dwindles as opportunities for job mobility decline.
“Your 20s and 30s are a very important formative time for the rest of your career,” Blank says. “It’s when you find a good job, which allows you to gain a foothold and begin learning about your trade. And if, straight away, you’re hard-pressed to find a job, or you get laid off just as soon as you begin that process of development, it can stunt your ability to reach your full potential.”
Help wanted
Given these long-lasting scarring effects, politicians and policymakers might be keen to avoid the worst impacts of layoffs. In the U.S., the typical response to layoffs is to offer short-term unemployment insurance to take away some of the sting of losing a job. The temporary income won’t replace the security of a full-time job, but at least job seekers won’t starve.
An alternative is to subsidize jobs that might otherwise be lost. During the COVID pandemic, the federal government spent about $800 billion on the Paycheck Protection Program, which covered payroll costs for small businesses so they could keep people employed. While PPP was credited with helping to save nearly 3 million jobs and staving off an even worse recession, it was criticized for throwing billions of dollars at the wrong people, such as well-off small-business owners and low-level scammers.
Job loss has a huge impact on one’s well-being, especially when it occurs during recessions.”Michael BlankAssistant Professor of Finance
With its model of direct payments to employers to preserve jobs, the effort was similar to existing job retention efforts in Western Europe and Japan that pay companies to maintain the size of their workforces. Workers are often kept on at reduced hours; in Germany, this is known as Kurzarbeit, or “short-time work.” The thinking is that these programs may mitigate some of the scarring effects of mass layoffs.
However, poorly designed employment protection policies can lead to “zombification,” in which unproductive firms are sustained unnecessarily, potentially dragging down long-term economic growth. “You might end up propping up firms that should have gone out of business,” Blank says. “Policymakers should instead put a speed bump on layoffs so that the labor market can adjust more smoothly. They shouldn’t prevent bad jobs and firms from eventually going away altogether.”
Short-work programs aim to mitigate such risks by focusing on employers that are experiencing temporary distress. Yet even in countries where these policies are common, distinguishing viable firms from failing ones and giving firms temporary breathing room rather than a permanent lifeline remains challenging. Blank hopes to focus future research on finding the right mix of programs that balance the costs of job retention subsidies with their benefits while limiting any unintended consequences.
“The optimal mix of unemployment insurance versus job retention policies in terms of federal and state spending in the U.S. during recessions is likely too tilted toward unemployment insurance currently,” Blank says. He says his research represents a first step toward gathering high-quality evidence to guide policymakers in navigating these tradeoffs. After all, a dollar spent now on saving jobs prevents significant damage down the road to all workers, even those who don’t lose their jobs.
“As they seek to avoid the high cost of layoffs, policymakers must attempt to ensure the amount invested is not far greater than the amount of damage averted,” he says. “That’s the goal.”
For more information
This story was originally published by the Stanford Graduate School of Business.