Published on Jobs and Development

The Fallout of Financial Crises on Labor Markets

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Nearly two years after the "Great Recession" officially ended in the United States according to the NBER, the labor markets in many countries remain stagnant. At the recent Latin American Economic Association Meetings (LACEA) in Peru (Nov. 1-3), several presentations attempted to shed light on the impact of shocks originating in credit markets on the labor market. Today’s blog highlights three working papers – all still works in progress – that suggest that all recessions are not created equal and that much more research is needed to understand better how labor markets function.

Pablo Ottonello, 2012

Financial crises bad for the labor market

Let's start with whether what triggers a recession matters for future jobless levels, a question being studied by Guillermo Calvo (Columbia University and NBER), Fabrizio Coricelli (Paris School of Economics-Université Paris 1 and CEPR), and Pablo Ottonello (Columbia University). In an interview with the JKP team and Vox LACEA, Ottonello tells us that their study shows that the nature of the trigger matters greatly. In advanced and emerging economies, recessions associated with shocks originating in credit markets tend to be followed by more sluggish adjustment in labor markets than during "normal" recessions (productivity-led). In advanced economies, financial crises are followed by jobless recoveries, whereas in emerging markets whether the recovery from financial crises is of a jobless or a wageless nature depends on the pattern of inflation during the recession episodes. This means that policy makers will need to either relax credit constraints or accept a trade-off between wages and inflation.

Less-educated workers hardest hit

Which segments of the work force are most vulnerable to being fired when a financial crisis hits? Jose Ignacio Lopez (HEC Paris) describes the main findings of his paper co-written with Virginial Olivella (Banque de France), which explores how a disruption to credit access can change both the firm's incentives to hire labor and the optimal mix between skilled and unskilled workers, a question that has so far been little studied. They do this by introducing a financial shock in a model that exhibits capital-skill complementarity. In this environment, a disruption to financial markets not only affects total overall hours worked but also the optimal mix between skilled and unskilled workers. In particular, the interaction between financial frictions and capital-skill complementarity enables the model to reproduce a fairly volatile and counter-cyclical ratio of skilled to unskilled hours worked. That is, the less educated workers are the first to go when credit is tight, meaning that they would benefit from greater protection by keeping trade flowing to the private sector and keeping financial conditions at the optimal level.

Watch the interview.

Getter a better fix on how jobs are filled

Finally, economists have long used matching theory to describe how jobs take form when there are unemployed workers and vacancies at firms. But in recent years, questions have been raised about the quantitative accuracy of the standard-calibrated, stochastic, search and matching model. While unemployment shows big fluctuations over the business cycle, this model — so far, focusing on the United States – predicts much smaller fluctuations in unemployment. To shed more light on this issue, Pedro Amaral (Federal Reserve Bank of Cleveland) investigated the accuracy of this model for a wide range of OECD countries. His paper establishes that for OECD countries, the model cannot deliver the volatility in unemployment and vacancies that is present in the data — that is, in the real world, unemployment and vacancies vary a lot more than the model suggest. In addition, his study shows that any adaptation of the model will need to take into account the fact that labor markets in countries like Portugal and Spain are quite different from others, such as those in the United States, and thus require different policy solutions.

Watch the interview.

This post was first published on the Jobs Knowledge Platform.


Claudia Sepúlveda

Lead Economist, Development Economics Vice Presidency, World Bank

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