POLICY BRIEF | MAY, 2020 Softening the pandemic’s blow to workers By Jack Blundell, Nicholas Bloom, Luigi Pistaferri, and Brian Bell KEY TAKEAWAYS The COVID-19 pandemic is turning into a global recession — threatening the biggest drop in economic activity since the n Recessions typically hit younger workers in smaller Great Depression. The latest forecasts put U.S. and European firms the hardest. GDP both down by about 10 percent in the second quarter of 2020, or 40 percent on an annualized basis. n Policymakers should rapidly work to restore a sensible GDP is an important measure, but the primary way workers feel an economic unemployment benefit level shock is in their paycheck. This policy brief draws on our ongoing work on the so that workers have the impact of aggregate shocks on individual workers to analyze the likely effects incentive to look for new jobs of the current crisis on earnings and, most importantly, to identify groups of where available. workers that are most exposed to risk. We then discuss a number of policies, which we argue would help cushion the shock for the worst-affected workers. n To cushion the impact on the Our analysis is based on more than 3 million earnings observations drawn young, policymakers should from more than 400,000 workers in the United Kingdom between 1975 and focus not only on helping 2016. We estimate a set of “exposure parameters,” which are essentially young workers find jobs but estimates of how earnings of different types of workers are impacted by also helping them find the changes in GDP. These figures are similar to those estimated in the U.S. “right” jobs. (Guvenen et al. 2017), so our conclusions are broadly applicable to the U.S. context as well. n Coming out of the crisis, government should explore We assume a plausible year-on-year real GDP decline of 10 percent caused by how it can raise more taxes the pandemic and predict how the crisis will affect workers. We stress that this from older, richer workers. is a period of immense uncertainty and one in which unprecedented policy While not without issue, a responses make forecasting difficult. well-designed wealth tax could However, we argue that in terms of understanding which types of workers be an appropriate response to are more likely to bear the brunt of the aggregate fluctuations induced by the the COVID-19 shock. COVID-19 pandemic, it is instructive to investigate past fluctuations in GDP. On aggregate, feeding a 10 percent decline in real GDP through our GDP sensitivity estimates, we estimate a fall in real weekly earnings of about 3 percent. For a worker at $50,000 per year, this corresponds to a drop of $1,500. John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 1 POLICY BRIEF | MAY, 2020 This would be a significant shock to household incomes. Workers at smaller firms already tend to earn lower However, as will be shown below, this is very unevenly wages. This suggests that the “large firm wage premium” spread across different workers and can translate to a (Bloom et al. 2018) — the earnings advantage accrued by nearly 6 percent drop in income for those just entering working at a larger employer — could grow even larger. the workforce. The firm size effect dominates the age effect, so that even older workers at the smallest firms will see large earnings losses. Taken together, this evidence suggests that a Big impact for young workers in small firms younger worker in a small firm will see earnings fall by about 5.7 percent compared with 1.2 percent for an older Figure 1 plots the estimated changes in weekly earnings worker in a large firm. For a young worker at a small firm by age group and firm size. There is a clear age profile on $30,000, the effect is $1,710 whereas an older worker in earnings responses to GDP changes. The earnings in a large firm earning $60,000 would see a loss of $720. of workers under 35 are the most affected. For these younger workers, an average 10 percent drop in real GDP corresponds with a 3.2 percent fall in real weekly earnings. The gender gap might look different For those between 45 and 55, the fall is 2.5 percent. this time Younger workers typically see higher wage growth Men and women tend to work in different industries than older workers, but this is very much dependent and occupations, work different hours, and are found at on economic conditions. Even more concerning for different types of employers. Therefore, it is not surprising the youngest workers is the substantial literature that aggregate shocks have different effects by gender. demonstrating a lifetime penalty from entering the labor market in a recession (Kahn 2010). Figure 2 demonstrates that, historically, female earnings have been less impacted by fluctuations in GDP, in part We also find that the earnings effect is largest for since they are more likely to work in sectors that are those employed in smaller companies and it declines typically less exposed to GDP fluctuations, such as the substantially with firm size. The pattern is striking but public sector or the food preparation sector. perhaps unsurprising, given that larger firms are likely to have greater access to the liquidity required to smooth For men, on aggregate a 10 percent drop in real GDP over temporary shocks. corresponds to a 3.9 percent fall in weekly earnings Figure 1. Size of employer (# employees) <100 100-500 500-1999 2000+ Expected change in earnings (%) 0 -1 -2 -3 -4 -5 Age 25-34 35-44 45-55 -6 -7 Notes: % fall in real weekly earnings based on worker exposure regressions. Assumes 10% fall in real GDP. Source: Office for National Statistics. (2017). New Earnings Survey Panel Dataset, 1975-2016: Secure Acess. [data collection]. 7th Edition. UK Data Service. SN: 6706, http://doi.org/10.5255/UKDA-SN-6706-7. John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 2 POLICY BRIEF | MAY, 2020 compared with a 1.8 percent drop for women. Here, at small firms could see earnings losses of 6 percent to however, we might expect to see a difference between 7 percent, with older women at large firms seeing little previous patterns and those stemming from the or no change in their earnings. While our sensitivity current crisis. As emphasized in a recent paper by Alon estimates are based on U.K. data, similar work for the et al. (2020), some of the most immediately affected U.S. finds similar qualitative patterns and, if anything, industries — such as hospitality and travel — contain larger magnitudes (Guvenen et al. 2017). a high proportion of female workers. This stands in We should note that our data omit self-employed sharp contrast with previous downturns, where male- workers, who could be particularly badly hit — for dominated industries such as finance, construction, many have already seen their earnings fall to zero. and manufacturing have borne the brunt of the decline Moreover, while earnings are important, we do not in output. There is also a long-standing literature discuss unemployment effects here. Recent data on suggesting that mothers have systematically higher unemployment insurance claims suggest there has been child care responsibilities than fathers, which can in a massive spike in unemployment, meaning many people part explain gender differences in the labor market have lost their paychecks and reliable sources of income. (Petrongolo 2019). With the majority of children now taken out of school, it is possible that this asymmetry Finally, a large amount of literature in economics has could amplify the impact of the crisis on female workers. documented that firms occasionally shield workers from significant wage losses in downturns in exchange for higher profits in better times (e.g. Guiso et al 2005). This Adding it all up is a key prediction from a family of “implicit contract” models in which risk-neutral firms employ risk-averse Combining the differences by sex with the firm-size and workers. But with a shock as large as the COVID-19 age results above, this suggests that young male workers recession this is unlikely to be possible. When firms are Figure 2. facing the risk of bankruptcy, they may be forced to pass Sex the economic costs onto their employees. Female Male 0 What can policymakers do? Expected change in earnings (%) -1 Based on previous patterns, we should expect earnings losses to be concentrated among young workers at -2 smaller firms. But what can policymakers do to soften the blow? -3 Restore a sensible unemployment benefit level -4 When workers and firms separate, the firm-specific Notes: % fall in real weekly earnings based on worker exposure regressions. skills and experience that workers have accumulated, Assumes 10% fall in real GDP. and which make them more productive at their firm, are Source: Office for National Statistics. (2017). New Earnings Survey lost. Equally, finding “good matches” with a given firm Panel Dataset, 1975-2016: Secure Acess. [data collection]. 7th Edition. UK Data Service. SN: 6706, http://doi. takes time, implying that involuntary separations induce org/10.5255/UKDA-SN-6706-7. John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 3 POLICY BRIEF | MAY, 2020 costly job searches and potentially poor matches with On the one hand, the expansion of unemployment subsequent firms. benefits under the CARES Act is welcome and is required to soften the income shock caused by the crisis. On the Through these mechanisms, the separation of firms and other hand, benefit levels have been pushed above what workers in response to a temporary shock can lead to many workers earn on the job, which works against both inefficient labor market outcomes and a longer-term the policy goals given above. Businesses may have low stagnation in the economy. For these reasons, preserving incentives to preserve jobs if workers have access to high worker-firm links is valuable not only for individual unemployment insurance benefits. workers and firms but also for the economy at large. Equally, workers may have low incentives to search for Nonetheless, it is clear that some worker mobility is a job in a booming sector if they earn more by staying at required in the current economic context. There is home. We recommend that policymakers take a second strong demand for labor in such sectors as agriculture, look at the generosity of benefit levels in the CARES Act e-commerce, and parts of retail (e.g., grocery stores, — maintaining the relaxation of job search requirements etc.), and it makes sense for workers in the most and the inclusion of gig workers and the self-employed affected industries to move into these jobs, even if only while ensuring that workers have incentives to maintain temporarily. There are many cases of firms taking steps employment relationships where possible and to accept to promote this temporary rapid re-allocation. new work where available. The Payroll Protection For example, the Hilton hotel chain, having furloughed Program, offering small businesses a forgivable loan to tens of thousands of hospitality workers, has invested in assist with cash flow during the crisis, goes some way an expedited recruitment path with Amazon, CVS, and toward achieving this goal. However, the conditions grocery stores. This means that workers are directed on loan forgiveness mean that it is not a good fit for all through a dedicated website toward job openings and businesses. For some businesses, the program is riskier in some cases able to avoid background checks and than allowing their employees to take advantage of the other paperwork. The expectation is that these workers expanded unemployment benefits. will return to their previous roles when the demand for hospitality services resumes. Supporting younger workers in job search Following this example from the private sector, government policy may be designed to strike a balance A wide literature in labor economics has shown that how between preserving worker-firm relationships and good your first employer is may have surprisingly strong allowing some re-allocation of labor toward essential effects on long-term career prospects. As discussed in a activities and expanding sectors. recent paper by Arellano-Bover (2020), the search for jobs later in life depends on the quality of first employers, To achieve this, many European countries have opted and opportunities for the development of useful skills to subsidize the wage bill of firms directly while their vary substantially across firms. Therefore, if we hope workers are furloughed, whereas the U.S. has instead to cushion the impact of the crisis on the young, it is primarily opted for changes to the generosity of imperative that policymakers focus not only on helping unemployment benefits. This has created a classical young workers find jobs but also helping them find the example of what economists call the trade-off between “right” jobs. providing “insurance” to workers hit by an unavoidable shock and avoiding “moral hazard” distortions induced The Workforce Innovation and Opportunity Act of 2014 by more generous benefits. coordinates federally funded state employment and training programs, with a particular focus on the most John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 4 POLICY BRIEF | MAY, 2020 vulnerable workers. Academic research has questioned policies has been particularly scrutinized, and there exist the long-term effectiveness of some aspects of the additional concerns about the methodology used to U.S. education and training programs, particularly for estimate the revenue that can be raised through wealth younger workers (Schochet et al. 2008). taxes (Fagereng et al. 2016). Never has the need for these programs been greater, The proposal by Saez and Zucman sets out a relatively and the U.S. could potentially learn something from the narrow tax base covering only the wealthiest individuals, European experience. The German vocational training with a high tax rate. The disadvantage of this approach program model, mixing company-based and in-school is that it could potentially be highly distortive — the training, is broadly considered a standout success. A wealthy can move around their money to avoid such comparison of this and other less-successful programs taxes — with large economic costs, and wealth taxes may demonstrates that successful training schemes require disincentivize entrepreneurial effort and innovation. cooperation between government, the business However, given the severity of the crisis we would community, and social partners. recommend exploring a wealth tax, possibly with a low rate and a wider base. Politically, the introduction of The German example shows the effectiveness of an such a policy is constrained by low-interest rates — it integrated system, in which employment agencies is hard to see people accepting a tax that would shrink become involved with job matching several months their savings. before an apprentice finishes a vocational program. Coming out of the current crisis, younger workers Data from the Survey of Income and Program Participation will be key to re-establishing economic growth and shows that U.S. households headed by 55- to 64-year- we recommend that where they have been shown to olds hold three times as much wealth as those headed by be successful, policymakers should expand existing 35- to 44-year-olds, and 20 times as much as households employment and training services. headed by those younger than 35. Since an individual’s wealth grows over the life course in this fashion, a wealth tax would have the advantage of being targeted toward Raising taxes from older, richer workers individuals who are older and possibly with a history of higher earnings, which may have protected them from the While the health risks from COVID-19 are greater for older worst aspects of the current crisis. workers, the analysis above suggests that the economic impact is likely to be greater for the young. The financial Raising more tax revenue from wealth will not be easy, commitments included in the CARES Act (as well as likely but in the wake of the current crisis it could well be additional spending to counter the health and economic necessary if we are to ensure fiscal sustainability in an crises) will put public finances under immense strain over equitable fashion. While ambitious, a well-designed tax the coming years. Policymakers must consider carefully could be appropriate for the COVID-19 shock and raise a how best to implement the inevitable tax raises that will substantial amount of revenue, at least for the short run. follow — trying in particular to avoid that the burden of Whether a wealth tax, in light of the distortions discussed high taxes fall on the so-called millennials and Gen Z, above, is viable in the longer term is an important topic compounding the negative effect of the initial shock on for policy and future economic research. living standards. This will require a radical rethinking of the way taxes are raised. The recent wealth tax proposals of Saez and Zucman (2019) have been controversial. The practicality of these John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 5 POLICY BRIEF | MAY, 2020 Avoiding disaster Petrongolo, B. (2019). “The gender gap in employment and wages.” Nature Human Behaviour, 3 (4), 316-318. Before COVID-19 struck, there was already a crisis of Saez, E., and Zucman, G. (2019). “Progressive wealth taxation.” Brookings economic inequality. We fear the recession caused by the Papers on Economic Activity. pandemic will drive an even larger gulf between rich and Schochet, P. Z., Burghardt, J., and McConnell, S. (2008). “Does job corps poor. But this is not inevitable. work? Impact findings from the national job corps study.” American Our three policy recommendations could soften the Economic Review, 98 (5), 1864-1886. severe shocks hitting workers and lead to a stronger economy coming out of the crisis. The first is a more careful consideration of the insurance/incentive trade-off Jack Blundell is a PhD candidate in involving the generosity of unemployment benefits. Stanford’s Department of Economics. His research focuses on The second is a call for an expansion of support for labor and public economics. younger workers making their first steps into the labor market at this inopportune time. Nicholas Bloom is a SIEPR senior The third proposes that government explores new fellow and the Eberle Professor in approaches to taxation once the economy is growing Stanford’s Department of again. We argue that these policies could help mitigate Economics. His research focuses on the inequality-increasing effects of the shock and limit its management practices and catastrophic damage on aggregate growth uncertainty. Luigi Pistaferri is the Ralph Landau References Senior Fellow at SIEPR and a professor in Stanford’s Department Alon, T. M., Doepke, M., Olmstead-Rumsey, J., and Tertilt, M. (2020). The of Economics. His research focuses Impact of COVID-19 on Gender Equality (No. w26947). National Bureau of Economic Research. on consumption, saving, portfolio allocation and labor. Arellano-Bover, J. (2020). The Effect of Labor Market Conditions at Entry on Workers’ Long-Term Skills (No. 12929). IZA. Brian Bell is a professor of Bloom, N., Guvenen, F., Smith, B. S., Song, J., and von Wachter, T. (2018, economics at King’s Business May). “The disappearing large-firm wage premium.” AEA Papers and School. His research focuses on Proceedings, 108, 317-322. wages and inequality. Fagereng, A., Guiso, L., Malacrino, D., and Pistaferri, L. (2016). “Heterogeneity in returns to wealth and the measurement of wealth inequality.” American Economic Review, 106 (5), 651-655. Guiso, L., Pistaferri, L., and Schivardi, F. (2005). “Insurance within the The Stanford Institute for Economic Policy Firm.” Journal of Political Economy, 113, 1054-1087. Research (SIEPR) catalyzes and promotes evidence- Guvenen, F., Schulhofer-Wohl, S., Song, J., and Yogo, M. (2017). “Worker based knowledge about pressing economic betas: Five facts about systematic earnings risk.” American Economic issues, leading to better-informed policy solutions Review, 107 (5), 398-403. for generations to come. We are a nonpartisan Kahn, L. B. (2010). “The long-term labor market consequences of research institute, and SIEPR Policy Briefs reflect graduating from college in a bad economy.” Labour Economics, 17 (2), the views and ideas of the author only. 303-316. John A. and Cynthia Fry Gunn Building siepr.stanford.edu 366 Galvez Street, Stanford, CA 94305-6015 @siepr facebook.com/SIEPR/ 6