FRBSF Weekly Letter
96-07; February 16, 1996
Yes, according to public perception and a number of articles in newspapers
and business magazines. They report that workers increasingly feel that
their jobs are at risk. They cite cost-cutting pressures, increased use
of temporary or contingent workers, and the need for greater flexibility
in response to a more competitive and dynamic economic environment as
factors that have frayed the ties that bind workers to firms. Even during
the past year, when economic growth has been relatively strong throughout
the U.S., wage growth reportedly has been held down by workers' concerns
about job security.
In contrast to the popular view, a recent study that attracted media
attention (Farber 1995) reports that job security has remained relatively
constant since the 1970s. Farber bases this conclusion on the finding
that average job duration the typical length of time that a job lasts
has changed very little. Such results, however, provide limited insight
into job security per se. In particular, they are not centered around
a reasonable definition of job security that properly distinguishes between
employer-initiated and worker-initiated separations.
This Weekly Letter presents an analysis of job security based on such
a definition. The evidence suggests that the popular view of declining
job security may be closer to the truth than results regarding stable
job durations suggest.
In order to decide whether job security has changed, it is important
to identify the bases for job security. Most U.S. employees are not union
members, and therefore their employment conditions are not specified by
written contracts. Instead, employment conditions for the bulk of U.S.
employees are determined by what economists call "implicit contracts"
unwritten and generally unspoken agreements between firms and workers.
Because these agreements are not explicitly binding, they must be "self-enforcing"
in order to be sustained. In other words, implicit contracts must possess
features such as mutual gains for involved parties, or "reputation
costs" for parties that breach agreements that minimize violations.
An example of mutual gains arises from the turnover costs related to
screening, training, and job search activities, that firms and workers
encounter as part of the job-matching process. These costs become more
significant when workers accumulate skills that are largely confined to
specific firms or when a worker's productivity and satisfaction in a given
firm or job is revealed only over time. Under these circumstances, the
employment relationship constitutes a shared investment between workers
and firms, so it is advantageous to both to agree implicitly on wage profiles
that minimize separations through sharing of the costs and benefits of
the investment. This in turn generates increasing wages and decreasing
turnover with seniority.
An example involving "reputation costs" was first posed by
Lazear (1979) and it is based on rising wages as a means of eliciting
worker effort and loyalty. Wages below productivity early in a worker's
tenure, followed by wages that exceed productivity later, constitute a
conditional performance bond that encourages workers to work hard and
stay at the firm. Under these circumstances, however, firms have an incentive
to fire highly paid senior workers. They are prevented from doing so by
"reputation costs": firms that prematurely fire senior workers
will be forced to pay higher wages to attract new workers, as potential
recruits learn of the firm's bad faith and require higher wages to insure
against future violations of the implicit employment agreement.
These features of implicit contracts may adequately ensure that firms
retain workers under normal economic conditions, thereby producing job
security. However, during periods of economic change, the degree of self-enforcement
in implicit contracts may be reduced. For example, changing technology
may reduce the value of firm-specific or industry-specific skills, thereby
inducing firms to discharge senior workers who have made substantial investments
in such specialized skills. Also, the reputation costs that enforce Lazear-type
implicit contracts may be reduced by economic dislocation, thereby providing
firms with the incentive to dismiss senior workers; Idson and Valletta
(1996) find evidence consistent with this behavior.
Farber (1995) argues that despite popular perception of declining job
security, job stability in the U.S. has remained essentially constant
from 1973-1993. He examined data on the duration of jobs and found that
although job durations declined over the period for some groups of low-wage
males, they increased for females, so that on average they remained approximately
constant.
Debate over these results continues. But even if they are correct, results
on changes in job stability have limited implications for changes in job
security. Suppose that due to sharp shifts in product demand patterns
across industries, firms engage in widespread permanent dismissals of
workers who believed their jobs were protected against such shifts. By
itself, this increase in dismissals will reduce measured job durations.
Suppose also, however, that workers who in the past might have quit to
search for new jobs observe this signal of labor market weakness and decide
to retain their current jobs. Then quit rates fall below what they otherwise
would have been, offsetting the increase in dismissals and possibly leading
to stable job durations. In this case, even though job durations appear
to be stable, job security has declined. This example suggests that data
on job durations should not be used to draw inferences about job security.
An alternative view of job security is required. A working definition
of job security should describe how safe workers' jobs are with respect
to changes in the economic environment, within or outside the firm. Thus,
the real issue regarding changing job security is whether variation in
factors external to firms, or firms' responsiveness to those factors,
have changed so that employees sense that they are increasingly vulnerable
to being permanently dismissed by their employers. Either change changing
variation in outside conditions, or greater responsiveness by firms could
be interpreted as decreased "job security." Greater responsiveness
by firms, however, is more interesting, because it indicates that firms'
behavior has changed.
In providing a more informative analysis of changing job security as
defined here, this study uses data that distinguish between firings by
firms and quits by employees. Specifically, I use unemployment data from
the Current Population Survey (CPS), which is administered each month
to 60,000 households and is the primary source of current U.S. labor market
data. The responses of unemployed individuals permit separate identification
of those unemployed due to permanent dismissals, temporary or indefinite
layoffs (both of which imply an expectation of being recalled to the firm),
voluntary quits, and re-entrance or new entrance into the labor market.
Data from the March CPS's for the years 1968-1993 reveal several interesting
patterns in the share of unemployment attributable to different causes.
Figure 1 (this file requires
Adobe Acrobat) shows the share of unemployment attributable to permanent
dismissals each year. The light line shows the unadjusted series, which
exhibits sharp changes over the business cycle i.e., the amount of unemployment
attributable to permanent dismissals changes disproportionately with the
unemployment rate. The solid line shows the series after the cyclical
and random components are removed. This line reveals a substantial upward
time trend over the period. In other words, conditional on the unemployment
rate, the share of unemployment attributable to permanent dismissals increased
steadily from 1968-1993; this increase is statistically significant.
Although this result may arise because unemployment durations for dismissed
workers have increased, similar analyses of layoff unemployment reveal
that the increased dismissal share has been accompanied by a decrease
in the layoff share of unemployment. This is shown in Figure
2 (this file requires Adobe Acrobat), which is identical
to Figure 1 (this file requires Adobe
Acrobat), except with layoffs replacing permanent dismissals. This
figure shows a downward trend in the layoff share of unemployment, albeit
one that is less pronounced than that for permanent dismissals. A similar
analysis reveals no significant time trend in the share of unemployment
attributable to quits. Instead, the increasing share of permanent dismissal
unemployment is balanced by decreasing shares of layoff and labor market
entrant unemployment. Although these results are not entirely consistent
with the story in which increasing permanent dismissals are matched by
decreasing quits, they indicate that in making their employment adjustment
decisions, employers are increasingly substituting permanent dismissals
for layoffs.
Further analysis of the data reveals an interesting difference between
the pre-1980 and post-1980 periods. In particular, the responsiveness
of the dismissal share to the unemployment rate i.e., the cyclical variation
in the dismissal share is substantially larger in the later period than
in the earlier period. This suggests that in making their permanent dismissal
decisions, employers have become more responsive to macroeconomic conditions
over time. In conjunction with the upward trend in the share of unemployment
attributable to permanent dismissals, these results suggest an expanding
role of permanent dismissals in firms' employment adjustment process,
particularly during the period 1980-1993.
Although a recent study finds that average U.S. job duration has been
largely constant over the past 20 years, such results provide little insight
into changes in job security. In particular, results on job durations
ignore the distinction between employer-and worker-initiated separations
and the economic bases for long-term attachments between workers and firms.
The analysis in this Weekly Letter indicates that despite stable job durations,
the share of unemployment attributable to permanent dismissals and the
cyclical responsiveness of permanent dismissals have increased. This in
turn suggests the increased importance of permanent dismissals in firms'
employment adjustment process. Perceptions of decreased job security may
relate to these trends, particularly if the burden of increased dismissals
is falling disproportionately on classes of workers who had significant
job security in the past.
A more complete analysis of the incidence of permanent dismissals across
different categories of workers, and how it depends on outside economic
conditions, remains to be performed. Popular perceptions of declining
job security may arise from increased variation in relevant economic variables
(due for example to accelerated technological change or defense cuts),
or from increased employer responses to those variables. The increased
cyclical responsiveness of the dismissal share suggests the latter explanation.
Additional work along these lines may help to resolve the apparent conflict
between general perceptions of decreased job security and research findings
of stable job durations.
Robert G. Valletta
Economist
Farber, Henry. 1995. "Are Lifetime Jobs Disappearing? Job Duration
in the United States: 1973-1993." NBER Working Paper No. 5014.
Idson, Todd L., and Robert G. Valletta. 1996. "Seniority, Sectoral
Decline, and Employee Retention: An Analysis of Layoff Unemployment Spells."
Journal of Labor Economics (forthcoming October).
Lazear, Edward P. 1979. "Why Is There Mandatory Retirement?"
Journal of Political Economy 87 (December) pp. 1261-1284.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
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