14/8/2014: Recessions and the Cost of Job Loss

Long-term unemployment has serious consequences in terms of

1. Reducing life-time earnings, including post-unemployment spell earnings;
2. Increasing life-time probability of future unemployment spells; and
3. Carrying severe costs in terms of reduced health, quality of life, mental health and social wellbeing.

This far we know. We also know that:

• Long-term unemployment effects start kicking in at around 3-6 months spell, rather than conventionally-measured 12 months spell
• Long-term unemployment is a problem most commonly associated with recessions; and
• Recessions-linked unemployment impacts those who have held the job prior to unemployment spell and those who are just starting their careers, with the latter suffering more significant effects of unemployment than the former.

A recent (December 2011) study by Davis, Steven J. and von Wachter, Till, titled "Recessions and the Cost of Job Loss" (NBER Working Paper No. w17638: http://ssrn.com/abstract=1967372) looks are the evidence on "the cumulative earnings losses associated with job displacement, drawing on longitudinal Social Security records for U.S. workers from 1974 to 2008."

The findings are striking:

• "In present value terms, men lose an average of 1.4 years of pre-displacement earnings if displaced in mass-layoff events that occur when the national unemployment rate is below 6 percent." So when national unemployment rate is close to frictional (or voluntary or alternatively when employment is close to full-employment rate - in the U.S. case around 5 percent), losing one job in large-scale unemployment generating event is bad. 
• But, "they lose a staggering 2.8 years of pre-displacement earnings if displaced when the unemployment rate exceeds 8 percent." So rate of losses doubles for a 50% rise in unemployment.
• The authors also "…characterize how present value earnings losses due to job displacement vary with business cycle conditions at the time of displacement. For men with 3 or more years of prior tenure who lose jobs in mass-layoff events  at larger firms, job displacement reduces the present value of future earnings by 12 percent in an  average year. The present value losses are high in all years, but they rise steeply with the  unemployment rate in the year of displacement. Present value losses for displacements that occur in recessions are nearly twice as large as for displacements in expansions. The entire  future path of earnings losses is much higher for displacements that occur in recessions. In short,  the present value earnings losses associated with job displacement are very large, and they are highly sensitive to labor market conditions at the time of displacement." Now, do tell me how on earth can we expect our pensions systems to be solvent in the future, following the Great Recession, given they were already insolvent prior to the crisis and given the effects of jobs losses on future earnings are so devastating?!

The authors "also document large cyclical movements in the incidence of job loss and job displacement and present evidence on how worker anxieties about job loss, wage cuts and job opportunities respond to contemporaneous economic conditions." Specifically they find that "…the available evidence indicates that cyclical fluctuations in worker perceptions and anxieties track actual labor market conditions rather closely, and that they respond quickly to deteriorations in the economic outlook. Gallup data, in particular, show a tremendous increase in worker anxieties about labor market prospects after the peak of the financial crisis in 2008 and 2009. They also show a recent return to the same high levels of anxiety. These data suggest that fears about job loss and other negative labor market outcomes are themselves a significant and costly aspect of economic downturns for a broad segment of the population. These findings also imply that workers are well aware of and concerned about the costly nature of job loss, especially in recessions."

Here's a chart to illustrate the empirical dynamics of earnings losses due to job loss.