Grace Weishi Gu on Benefit Costs and Jobless Recoveries

by Reihan Salam

Robert Stein points us to a fascinating job market paper by Grace Weishi Gu on the relationship between benefit costs and employment growth. The following is drawn from her extended abstract:

During the early stages of a recession, employers decrease per worker hours and cut benefits in order to reduce labor costs while retaining workers. However, as the recession deepens, firms eventually have to lay off some employees. In the wake of a recovery, firms increase per worker hours and employee benefits, but to avoid extra benefit costs, they do not hire new workers. Moreover, firms are financially constrained from expanding their production and workforce. …

In particular, the dynamic benefit costs enable my model to deliver 2-to-7-quarter delays relative to NBER business cycle troughs for the employment recoveries following the 1990, 2001, and 2007 recessions, while generating no delay for the pre-1990 period. This falls in line with the data that has scarcely been matched in previous literature. Moreover, the benefit costs alone (with productivity shocks) can allow the model to explain up to 50 percent of employment volatility for the post-1990 period. In addition, the results are further strengthened when financial conditions are also incorporated. As recent empirical research suggests, these conditions have been playing an increasingly crucial role in business cycle fluctuations. [Emphasis added]

Gu’s analysis lends even greater urgency to the effort to constrain the cost of providing medical insurance, and it may also strengthen the case for decoupling medical insurance from employment.