Helping the less fortunate means recessions are shallower
It has been well documented during the Covid crisis that low-skilled workers were most affected by the financial challenges introduced by containment measures. Moreover, the post-pandemic recovery has also benefited low-skilled people the least.
As we face a new challenge from the invasion of Ukraine and the energy crisis it has exacerbated, Chicago Booth’s research is a timely reminder that there is both a moral and a practical reason to support these low-skilled workers.
carry the weight
“This article shows a link between the heterogeneous impact of aggregate fluctuations and their magnitude,” explains the author. “I find that the unequal incidence of aggregate labor market fluctuations increases the aggregate marginal propensity to consume, providing a measure for a key moment in a new class of heterogeneous agent models.”
In other words, to make recessions shallower and shorter, policymakers should work to support vulnerable populations by expanding unemployment benefits, improving access to credit, and providing stimulus checks, all with the aim of stabilizing the incomes of low-income workers.
The paper highlights how recessions rarely affect workers, or even businesses, in the same way. The author reminds us that during the last 11 recessions, when GDP fell by around 2% and unemployment rose by the same figure, that does not tell the whole story. After looking at changes in spending on goods and services due to lost income, the study found that recessions hit particularly hard those who tend to spend a large portion of their income on things ( instead of saving them).
Propensity to consume
This is called the “marginal propensity to consume” (MPC), and when people with a high marginal propensity to consume experience a drop in income, it can have an outsized impact on the whole of society. economy, thus making the recession worse than it otherwise would be.
The study suggests that people with a high GPA tend to be younger and without a college education. Their income is generally less than $25,000 per year and they are more likely to be single than married. Additionally, men were also more likely to have a higher CPM than women, but this was less related to their income than to their spending habits.
This is worrying news for the current energy crisis, as the study also found that people with higher MPCs were also most at risk of losing their jobs during a recession. When this happened, the ripple effect throughout the economy was significant.
“Someone loses income and then doesn’t go out to dinner,” says the researcher. “This person goes shopping further and does not get a haircut. The hairdresser in turn has less income, so does not buy a dishwasher.”
The cycle is then exacerbated because many companies that high MPC people might patronize are also high MPC entities themselves, and so the process can quickly spiral out of control.
“Discovering the links between labor market inequality and the consumption multiplier has potentially important implications for macroeconomic stabilization policy,” explains the author. “Indeed, policies can be made more effective in part by explicitly targeting this covariance between income heterogeneity and worker MPCs.”
Research has found that workers with high CPMs typically spend about 50 cents less for every dollar they lose in income. The multiplier effect then sends ripples throughout the economy, such that overall consumption falls by 20% compared to a scenario where all workers were just as likely to lose their jobs during the recession as others.
The results are significant, not least because the British government adopted a policy of cutting taxes on the wealthiest in society in the hope that the economic fruits would trickle down to the rest of the economy. The proposals were greeted with disbelief by financial markets, with the value of the pound plummeting and the Bank of England forced to step in to support pension providers.
The Chicago research suggests that a much better approach would be ‘trickle down’ rather than ‘trickle down’. Instead of hoping that the richest will innovate on the path to economic growth, a better position would be to ensure that spending does not fall from the bottom of the market if low-skilled jobs are threatened by the recession.
Moreover, this is particularly important in economies with high inequality, as the researchers also found that high levels of inequality mean that the risks of this damage cycle become much more dispersed.
“As wealth becomes more unequally distributed, MPCs in the population may become more dispersed, with more consumption strongly affected by aggregate shocks,” they conclude.
Will policymakers heed this warning and ensure that low-skilled workers are supported in the current downturn? I won’t hold my breath, but we’ll see.