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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

APRIL 2006
NUMBER 225a

Chicago Fed Letter
Assessing the impact of job loss on workers and firms
by Kristin F. Butcher, senior economist, and Kevin F. Hallock, associate professor, Cornell University

Many economists agree that the United States’ openness to competition and technological
change raises our living standards, but sometimes results in job losses. This article summarizes
“Job Loss: Causes, Consequences, and Policy Responses,” a conference which was
cosponsored by the Federal Reserve Bank of Chicago and the Joyce Foundation.

According to the U.S. Bureau of Labor
Statistics, between January 2001 and
December 2003, 5.3 million workers
were displaced from jobs that they had
held for three or more years. These workers are of particular
1. Policy papers associated with the conference
interest for at least
four reasons. First,
Henry S. Farber (Princeton), “What do we know about job loss in the
they may have lost
United States?: Evidence from the Displaced Workers Survey, 1984–2004.”
their jobs through
Lisa M. Lynch (Tufts), “Job loss: Bridging the research and policy
no fault of their own.
discussion.”
Second, their long
Lori G. Kletzer (University of California, Santa Cruz), “Globalization
association with their
and job loss, from manufacturing to services.”
employers implies
Louis S. Jacobson (CNA), Robert LaLonde (University of Chicago),
that they were good
and Daniel Sullivan (Federal Reserve Bank of Chicago), “Is retraining
employees. Third,
displaced workers a good investment?”
research has demonSteven Redfield (STRIVE), “Understanding and addressing the
strated that they are
challenges of job loss for low-wage workers.”
unlikely to get new
Randall W. Eberts (W. E. Upjohn Institute), “After the doors close:
Assisting laid-off workers to find jobs.”
jobs that are similar
to their old jobs—
John A. Challenger (Challenger, Gray, and Christmas), “Return on
investment of high-quality outplacement programs.”
particularly if they
lost their old jobs
Kenneth D. Schwartz (Duvin, Cahn, and Hutton), “A lawyer’s
perspective on planning a reduction in force.”
because of technologPeter Cappelli (University of Pennsylvania), “Public policy and
ical change or interdownsizing decisions.”
national trade. Fourth,
NOTE: These papers are available in the Chicago Fed’s Economic Perspectives, Second
research has also
Quarter, 2005, “Job loss: Causes, consequences, and policy responses,” Vol. 29, No. 2.
shown that, on average, these workers
are likely to suffer long-term earnings
losses due to their job loss. These losses
are larger in cases where workers had
built up skills specific to a particular
job and where they are unlikely to be
reemployed in a similar job.

Industries and firms often have idiosyncrasies that are tied to creating their
product. It is important that their workers learn specific skills for the production environment that may be unique to
the firm or the industry. However, for
workers, this entails risks. If the firm does
not adequately compensate them for
learning these job-specific skills, then
they are at risk if technology changes
and that job disappears. It is difficult to
predict which skills will be enduringly
useful and which will turn out, from
the worker’s perspective, to have been
a bad investment. To the extent that it
is beneficial to the economy overall to
have workers who are willing to invest
in job-, firm-, or industry-specific skills,
there may be a desire to insure workers against the possibility their skills
may become obsolete.
In recent years, rates of job displacement
have been relatively high—as high as in
earlier periods when the unemployment
rate was much higher. This suggests that
the pace of change in the economy may
have increased the risk that workers’
skills will become obsolete. It is also
possible that a higher fraction of unemployed workers are those who have
been displaced, who often take longer
to find new jobs. This may help explain
the relatively high fraction of long-term
unemployment in recent years.

The rate of job displacement may also
have implications for macroeconomic
and monetary policy. From the perspective of monetary policy, the implications
of displacement are complicated, because an increase in job displacement
may have two offsetting effects. First,
the current unemployment rate may
overstate the amount of slack in labor
resource utilization if a higher proportion of the unemployed are likely to
take a long time to find a new job.
Second, if a higher fraction of the unemployed lack the skills necessary for
current vacancies, shortages may arise
that would put upward pressure on labor costs. However, if job displacement
is relatively common, workers may be
reluctant to press for wage increases,
restraining labor costs.

Sweetman (Queen’s University) explores
whether workers with “multiple skills”
suffer, on average, smaller earnings
losses than other workers after a displacement occurs. Kuhn and Sweetman
find that workers in jobs that require
multiple skills earn more than other
workers. Furthermore, workers who are
displaced from these jobs have higher
earnings in subsequent jobs. However,
part of these higher earnings appears
to be the result of the workers’ training.
After the researchers control for the
time it takes to train for the job, multiskilled individuals have lower earnings
than individuals who do not describe
themselves as multi-skilled, in both the
pre- and the post-displacement jobs.
However, earnings loss associated with
job loss is smaller for the multi-skilled.

This Chicago Fed Letter summarizes some
of the presentations at a two-day job loss
conference held at the Chicago Fed.
The first day of the job loss conference
focused on new research findings. The
second day featured an address by
Michael Moskow, president of the Federal Reserve Bank of Chicago,1 and
panel discussions on layoffs. A special
issue of the Chicago Fed’s Economic Perspectives presented papers by our keynote
speakers, Lisa Lynch of Tufts University
and Henry Farber of Princeton University, and the second-day panel participants.2 Titles and authors of these papers
are listed in figure 1. Here, we highlight
some of the research findings from the
first day’s presentations, which focus
on 1) the impact of job loss on workers;
2) the intersection of regulation and
job loss; and 3) the effects of job loss
on firms; we also briefly summarize
some of the conclusions from both
days’ discussions.

Kuhn and Sweetman point out that their
results cannot be interpreted as “causal,”
since it is possible that workers who are
more adaptable simply sort themselves
into jobs requiring multiple skills.

The impact of job loss on workers

It is important to understand what types
of individuals are likely to suffer most or
least in the event that they are displaced.
This is valuable from the perspective of
targeting policies after a layoff, but it
may also be important for workers as
they consider what types of skills to invest in early in their careers.
Research by Peter Kuhn (University of
California, Santa Barbara) and Arthur

Clearly, the effects of job loss may be different for workers with different characteristics. In particular, as the work force
ages, it is critical for policymakers to
understand how the effects of displacement differ for older and younger workers. Research presented by Todd Elder
(University of Illinois) documents that
job displacement does affect older workers differently. He finds that there has
been an increase in involuntary job loss
due to the elimination of positions for
workers over age 50 in the past two decades. He also finds that workers over
50 have longer spells of unemployment
and greater earnings losses than their
younger counterparts. However, younger
workers may suffer larger earnings losses
over their working lives, because they
will receive the lower post-displacement
wage over a longer period.
Elder’s findings are consistent with the
idea that the need for health insurance
makes older workers willing to accept
a full-time job with benefits, even if
the earnings are low. Thus, changes in
health insurance policies are likely to
affect the labor supply of workers over
the age of 50.

Finally, it is important to understand the
best policies for helping displaced workers to find new jobs. One possibility is to
retrain workers. However, little is known
about the value of providing training to
displaced workers. Many previous studies
of the value of government-subsidized
(post-high-school) training were conducted for young workers with few skills.
Displaced workers tend to be older,
since they have substantial work experience, with many, albeit perhaps outdated, skills. Research on retraining at
community colleges by Louis Jacobson
(CNA), Robert LaLonde (University of
Chicago), and Daniel Sullivan (FRB
Chicago) finds that, first, older displaced
workers use community colleges less
than younger displaced workers. Second,
the increase in per-period earnings for
each credit earned is similar for older
and younger workers. Third, because
younger workers have more of their working lives remaining, training them appears to be a better investment—though
even for older workers, the benefits of
training outweigh the costs. Finally, the
returns to some courses are much higher
than to others. Technical courses such
as nursing are more likely to be good
investments than nontechnical courses
such as history.
These presentations prompted a number of questions. For example, should
workers be encouraged to acquire multiple skills and at what age? Should it
only be after formal schooling? What,
if anything, should government do for
older workers? What are the implications
for pensions and health insurance?
Should we retrain more workers? Should
we have a system of vouchers or reemployment bonus accounts?3
Regulation and job loss

A paper by Stephen Woodbury (Michigan
State University) examines the impact
of experience-rating unemployment
insurance (UI) on the temporary layoff
behavior of firms.4 Currently, the UI
system is tailored to address short bouts
of unemployment, not permanent job
loss. However, we need a better understanding of how the UI system affects
temporary layoffs for a number of reasons. First, temporary layoffs are costly

for workers. In addition, if there were
fewer temporary layoffs, we might be
able to structure the UI system better
to meet the needs of displaced workers, for whom job loss is most costly in
terms of earnings loss.
Woodbury uses unique panel data from
the states of Missouri, Washington, and
Pennsylvania, with several special features. First, the unit of observation is
not the employee but the employer. Second, Woodbury uses UI administrative
data, allowing explicit observation of
the tax rates and incentives to lay off
for each employer. Finally, he has a
long panel to control for unobserved
employer effects. In the end, he finds
that increased experience rating significantly reduces layoffs.
International trade and outsourcing
receive a disproportionate share of the
attention surrounding job displacement.
The paper presented by Lori Kletzer
(University of California, Santa Cruz),
coauthored with Howard Rosen (Trade
Adjustment Assistance Coalition), provides an overview of the assistance the
government provides to workers who
have lost their jobs through trade.
Kletzer and Rosen find that the labor
market in the United States is very flexible and that most of the “burden of this
flexibility is borne by U.S. workers, their
families, and communities.” They also
suggest that there is increased anxiety
over trade liberalization and potential
growth of services outsourcing. They
say that the current system of assistance
to unemployed workers is “no longer
adequate.” Kletzer and Rosen point out
that trade adjustment assistance is the
area in which policymakers have been
more willing to reform and expand assistance to displaced workers.
This session also raised some interesting
policy issues. Clearly, when it comes to
displaced workers, labor market policy
and trade policy are closely linked. Many
asked whether it makes sense to make a
distinction between the case where one
loses a job because someone overseas
does something “better” than her company versus the case where someone in
another state in the U.S. does. There is

more public assistance available to workers who are displaced from manufacturing jobs due to trade than from other
industries, even though the causes and
the consequences may be similar.
However, it can be difficult to identify
which workers are “displaced” versus
those who simply lost their jobs for other
reasons. For example, the presentation
by Maia Guell (Universitat Pompeu
Fabra) and Jose E. Galdon-Sanchez
(Universidad Publica de Navarra) on
firing costs suggested that firms are sometimes reluctant to reveal their true reasons for dismissing workers to avoid
paying the costs associated with layoffs.
On the other hand, workers may have
an incentive to claim that they are in the
“displaced” group, if that group receives
more generous treatment.
The impact of layoffs on firms

In the final session of the day, Henry
S. Farber (Princeton) and Kevin F.
Hallock (Cornell) concentrated on the
very short-term (three-day) reaction of
stock prices to job loss announcements.
Hallock presented research documenting the short-term relationship between
job loss announcements and stock prices
using a very large sample of all job loss
announcements in all firms ever in the
Fortune 500 in any year between 1970
and 1999. While the effect of job loss
on workers is clearly negative, some
have suggested that business owners
profit handsomely from large layoffs
as stock prices increase in the wake of
such announcements. If large layoffs
are viewed by the market as evidence
that management is aggressive about
cutting costs and increasing profits, then
the chief executive officer and others
may benefit from decisions that hurt
workers. On the other hand, the market
may view layoffs as an indication that
the executives have information about
bad times ahead and the stock price
may fall. Farber and Hallock find that
the number of job loss announcements
follows the business cycle quite closely.
Second, the overall stock price reaction
to job loss announcements was most
negative early in the sample period and
has become less negative over time.
Third, “clean” announcements (that

is, separate from other announcements
that might also affect stock prices) have
larger negative effects than others. The
authors find no evidence that, on average, firm owners are profiting from large
increases in stock prices by laying off
workers. However, the stock price reactions vary, so some business owners gain
and some lose stock value after their
layoff decisions.
Conclusion

The general discussion at the job loss
conference highlighted the diversity
of points of view in the audience. Many
economists agree that changes like
technological progress and increased
competition, while imposing costs on
some, bring benefits for the majority,
and that those benefits are greater than
the costs. However, even if one accepts
that these changes generate benefits
that are so large that those who benefit
can compensate those who bear the costs,
it does not automatically follow that
such compensation actually happens.
Participants agreed that in the United
States a great deal rests on having a job.
In addition to salary, access to health
insurance is generally through one’s
employer. Thus, job loss may have effects beyond labor market outcomes.

Michael H. Moskow, President; Charles L. Evans,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; David
Marshall, Vice President, macroeconomic policy research;
Richard Porter, Vice President, payment studies;
Daniel Sullivan, Vice President, microeconomic policy
research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Kathryn Moran, and Han Y. Choi, Editors; Rita
Molloy and Julia Baker, Production Editors.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2006 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Helen.Koshy@chi.frb.org. Chicago Fed
Letter and other Bank publications are available
on the Bank’s website at www.chicagofed.org.
ISSN 0895-0164

The current UI system may not be optimally designed to meet the needs of
displaced workers. In addition, however,
they may need incentives to return to
the labor market, because the wages they
face on the subsequent job are typically substantially lower than on the job
they lost.
Trade adjustment assistance goes further toward addressing the particular
needs of those facing a permanent job
loss. However, it makes little sense to
make these programs available only to
workers displaced from manufacturing
jobs due to import competition. Workers who lose service sector jobs due to
changes in technology will face similar
reemployment challenges.

and vocational classes, such as nursing,
have a high return. There may be an
important role for programs that advise
displaced workers about which types
of training may be most worthwhile.
Currently, several states are piloting “reemployment bonus account” programs.
These programs would give unemployed
workers a sum of money that they could
use to obtain training. If they get a job
within some specified period, they would
get to keep any remaining money as a
bonus. This pilot program may be a creative way to encourage retraining. However, as with all such programs, rigorous
evaluation is needed to ensure that scarce
public resources are used effectively.

Training appears to yield benefits greater
than the costs for displaced workers who
voluntarily seek retraining through community colleges. In particular, technical

Peter Cappelli (University of Pennsylvania) pointed out a seeming conundrum of the U.S. labor market: At the
same time that many firms are contemplating a reduction in force, the same

1

The text of this speech is available at
www.chicagofed.org/news_and_
conferences/speeches/2004_11_19_
job_loss.cfm.

3

2

The articles in the Economic Perspectives,
Second Quarter, 2005, are available at
www.chicagofed.org/economic_research_
and_data/ index.cfm, under the link
labeled “Economic Perspectives.”

Reemployment bonus accounts were proposed in the first term of the Bush Administration. These would consist of a sum of
money that long-term unemployed workers
could use for training. If the worker found
a job within a specified period, he or she
could keep any unused funds, which would
constitute a “bonus” for reemployment.

firms are complaining about the difficulty of retaining qualified workers. The
unfettered flexibility that firms have to
lay off unneeded workers may have an
unintended consequence—if the risk
of layoff permeates the firm–employee
relationship, then the relationship will
be inherently unstable. This may lead to
increased costs for the firm, for example,
in training of new employees. Under
some circumstances, firms, workers, and
the economy might be better off if firms
gave up some of their flexibility to lay
off workers.
The United States enjoys a higher standard of living due, in part, to our willingness to embrace change. However, there
will be winners and losers associated with
these changes. Many participants agreed
that it is critical to have policies that help
compensate those who lose in this equation, since this will help ensure that we
continue to have a dynamic economy.
4

Firms pay a tax into the unemployment
insurance system. That tax rate is based on
their past layoff experience; thus, it is “experience rated.” However, there is a cap such
that once the top tax rate is reached, further
layoffs do not increase the tax a firm pays;
thus, the unemployment insurance tax is
said to be “incompletely” experience rated.