Wednesday, May 18, 2011

What Might Cause a Two-Track Recession?

Copyright, The New York Times Company

Census Bureau data on employment by pay level cast doubt on credit-crunch and demand-based theories of the recession. One theory is that a credit squeeze left businesses short on funds, and they responded by cutting payroll, their major expense. Indeed, the bank bailouts were rationalized on the grounds that a bailout would help employers maintain their payrolls.

If cutting payroll spending had been the primary motivation of employers, then they should have cut deepest among their most expensive employees. Firing one person making, say, $2,000 a week saves more than firing three people making $600 a week.

It is true that part-time employment, which is typically low-paying, increased significantly during the recession. However, last week I showed Census data suggesting that employment of people making more than $2,000 a week may have been greater in the 12 months after Lehman Brothers failed than it was before, even while employment of people making less than $2,000 a week fell several million.

Hiring more high-paid people is not a way to reduce payroll spending.
Moreover, payroll spending now exceeds what it was when the recession began, yet employment remains millions lower. Apparently, payroll spending is not enough to bring those jobs back.

Another theory of the recession is that it was caused by a lack of demand — fewer employees were needed because employers were selling less to their customers. The low-demand theory is a good description of a couple of industries, like manufacturing and home construction, but if it described the economy as a whole we would have seen all types of employment cut, not just employment of people making less than $2,000 a week.

Another set of theories say that high-paid employees are replacing low- and middle-income employees. This replacement might come from employers’ attempts to cut personnel during the recession, rather than payroll spending. For example, employers might have worried about health insurance and other employment regulation whose costs are proportional to the number of employees they have. In this view, the bank bailout did little to prevent layoffs.

Some of the replacement could come from families, as they react to some new incentives presented during the recession. Unemployment insurance reduces incentives for unemployed people to accept a new job, because, for up to 99 weeks, the insurance pays them for being unemployed.

Unemployment insurance benefits are capped, so the disincentive is much less for people making $2,000 or more a week than for people making less. Some homeowners with underwater mortgages may react by earning more, while others earn less as they recognize that all their extra earning ultimately ends up with their mortgage lender.

The chart below explores the replacement theories further.

For each of the 50 states and the District of Columbia, the chart compares the percentage change in the fraction of adults in the state who make $300-1,200 a week (the middle two-thirds of employees are paid in that range) to the percentage change in the fraction making $2,000 or more.

For example, the fraction of Arizona adults earning $300-1,200 was 10 percent lower from October 2008 to September 2009 than it was in the previous 12 months, and the fraction of Arizona adults earning more than $2,000 a week was 29 percent higher.

The low-demand and payroll-cutting theories say that the two should be positively correlated, because the states with the largest demand reductions (or the employers most motivated to cut payroll spending) would have cut employment across the board.

But the Census data suggest that they are negatively correlated (the correlation is also negative if the small or “outlier” states shown in the chart are excluded or downweighted according to population).

These patterns of employment by pay level reveal a number of insights that are not visible in the aggregate employment statistics: the credit crunch and lack of demand may have received too much of the blame for the recession’s job losses.


Anonymous said...

"If cutting payroll spending had been the primary motivation of employers, then they should have cut deepest among their most expensive employees. Firing one person making, say, $2,000 a week saves more than firing three people making $600 a week."

Simply valuing the employee by size of there salary fails to capture the value they bring to their employers and the idea of profit centers and cost centers. The sales dept should be bringing in more money than they cost in salary whereas the receptionist and the mail room boy aren't directly linked to revenue so they appear to be more expensive than someone in sales. Hence those who can generate business are getting back to work sooner.

I think you'll agree?

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