Why Do Earnings Fall with Job Displacement?

Abstract

Displaced workers experience reduced earnings for many years. While this empirical phenomenon is well established, the theory of displacement-induced earnings loss is scattered. Policy discussion often interprets displacement-induced losses through the lens of specific human capital theory but there are other credible theories with different causal mechanisms and different interpretations. This paper reviews theories of costly job displacement and discusses their consistency with the available empirical evidence for the United States. We find that specific human capital theory and matching theory have considerable but far from conclusive empirical support. We suggest avenues for better discriminating among theories. *The authors' affiliations are, respectively, Congressional Budget Office, Washington, DC.

The Firm's Role in Displaced Workers' Earnings Losses

“…Displaced workers with higher tenure suffer larger long-run earnings losses (32 percent) than those in our overall sample (22 percent), consistent with past empirical findings (Couch and Placzek, 2010;Lachowska et al, 2018) and theoretical explanations summarized by Carrington and Fallick (2017). However, losses due to forfeited firm effects are also substantially larger.…”

“…For robustness, we impose more stringent post-layoff attachment requirements on the displaced sample and compare baselines estimates of overall earnings loss estimates (25% attachment) from equation (2) to samples with positive earnings in 50%, 75%, and 90% of postdisplacement quarters (Figure B.3). Earnings losses become smaller with higher post-displacement attachment requirements, consistent with the idea that more highly-attached workers are less likely to suffer subsequent unemployment spells which may dampen earnings (Carrington and Fallick, 2017).…”

Job-to-Job Flows and the Consequences of Job Separations

“…On the use of firm distress as an indicator of displacement, see Flaaen, Shapiro, and Sorkin (2019); and von Wachter, Handwerker, and Hildreth (2009). 2 See Carrington and Fallick (2017) for a recent assessment of the sources of loss.…”

Short-Time Compensation: An Alternative to Layoffs during COVID-19

“…Other benefits include reducing the costs that accompany job loss, reducing hiring and firing costs, and allowing firms to retain skilled workers. There exists overwhelming evidence that permanent job losses result in large earnings and health costs (Jacobson, Lalonde, and Sullivan, 1993;Sullivan and von Wachter, 2009;Carrington and Fallick, 2017) and that these costs are more pronounced during recessions (Davis and von Wachter, 2011). Because STC programs reduce layoffs, they help some workers avoid the consequences of permanent job losses.…”