Are low-paying companies less affected by the business cycle?

Lisa B. Kahn and Erika McEntarferanalyze the effects of the business cycle on employment at high- and low-paying firms. They find that low-paying firms are less cyclically sensitive, and as a result fare better in terms of employee retention and employment growth during economic downturns.

In NBER Working Paper No. 20698,Employment Cyclicality and Firm Quality, the authors use data from the Longitudinal Employer Household Dynamics program, a U.S. employer-employee matched database, for the period 1998 to 2011. They find that employment growth at low-paying firms varied less with the state unemployment rate than employment growth at higher-paying firms. This implies that the quality of jobs erodes in a downturn, as higher-paying firms shed a larger fraction of their workers than lower-paying firms.

Kahn and McEntarfer provide evidence that the cyclical pattern in growth rates is likely driven by a partial collapse of movement up the job ladder in economic downturns. This suggests that low-paying firms fare relatively better in a downturn because workers at these firms who are hoping to move on to better opportunities get stuck in place. The authors find that advancement on the job ladder is 20 percent slower for those working at the lowest-paying firms in a major bust, compared with a boom. They also estimate that the distribution of new job matches shifts towards these lower-paying firms in a downturn. The combination of a poor initial match and a reduced likelihood of upgrading implies that new job matchers are particularly hurt by recessions.

In normal times, low-paying firms experience a high rate of worker separation, and therefore also do a lot of replacement hiring. In bad times, separations decline substantially at these firms, which reduce hires proportionately. This keeps the growth rate relatively constant over the business cycle. The decline in separations exhibited in a recession apparently is a decline in voluntary separations by workers, since the largest effect is for separations to employment – workers leaving one firm for a job at another. For higher-paying firms, the impact on separations to employment is small, but they experience an increase in separations to non-employment, probably layoffs, and they significantly reduce hiring.

Kahn and McEntarfer’s data indicate that the reduced ability to move on to better matches caused by a recession has a greater impact on workers in low-quality firms compared with those in high-quality firms. Their results show that workers finding new jobs in recessions are more likely to go to low-paying firms, and more likely to stay there once hired, than workers hired during better economic times. The researchers conclude that these effects yield an estimated 2.6 percent reduction in average firm quality a year after matching for those who find a job in a recession compared with a boom. This corresponds to $75 per month lower average firm pay, and translates into roughly half of the advancement made by workers finding a job during a boom.

This article is published in collaboration with NBER. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Professor Lisa Kahn is a labor economist with interests in organizations and education at Yale University. Erika McEntarfer works at the U.S. Census Bureau Center for Economic Studies.

Image: A staircase looking like a snail is pictured in a Munich building ‘Haus der Bayrischen Wirtschaft’. REUTERS/Michaela Rehle