This award funds research on the business cycle dynamics of the relationship between employer size and job growth. The business cycle dynamics of firms of different sizes and productivities are important for fundamental issues in macroeconomics. For example, how real wages respond to aggregate shocks, whether hiring frictions or credit frictions have a larger impact on firm growth, and whether or not small businesses are indeed 'the engine of job creation' are all issues that depend on these dynamic effects of the business cycle. The PI and his team have already documented that employment in larger firms is more cyclical than employment in small firms (both in the U.S. and in other developed countries). They have developed a model that explains this observation that depends on turnover frictions. The funds awarded here will be used to expand this model to include a number of additional important determinants of firm size. The team will then test the model using restricted use business longitudinal microdata available through the Census Bureau. The empirical analysis will also provide additional robustness checks of the original empirical finding, will verify whether high paying firms (and not just larger firms) have more cyclical employment, and will also use business cycle indicators as a way to improve estimates of the entry of new firms.

This project brings insights from labor economics to bear on important questions in macroeconomics. The broader impacts are substantial, especially because public policy on small business often starts with the assumption that these businesses are the engine of job creation. Finally, a number of graduate students will be trained in the methods necessary to work with sensitive microdata at a secure data facility.

Project Report

Small firms are the engine of job creation. This much-paraded claim finds only partial empirical support in US data. It appears to be true at times of high unemployment, presumably when job creation is most needed. But it definitely fails in tight labor markets. The lead to the creation of new jobs in strong expansion is always taken by large employers, which tend to be more productive and to pay more. The project documents this fact, provides a new hypothesis to explain it, and investigates additional predictions of this hypothesis to further validate it against alternatives. In the labor market, where finding jobs and workers takes time, employed workers keep searching to quit to better jobs, and firms try to poach employees from other firms. This competition for employed workers is the engine of wage growth: if firms mostly hire from unemployment, they can keep doing it at depressed wages, as an unemployed worker's bargaining stance is poor. When aggregate productivity or demand are low, and unemployment high, for example following the financial crisis of 2008, firms can hire easily and do not compete much for each other's employees. As a result, small firms, which on average tend to bleed workers to larger competitors, can grow unconstrained, and generate most new jobs. As the aggregate expansion takes hold and unemployment declines, large firms, finding it increasingly difficult to hire the unemployed, turn to poaching workers from other firms. Job to job quits and wages rise, small firms stall, despite a booming economy, because they cannot keep up with attrition and quits of their employees to better competitors. Workers upgrade to more productive jobs. The project formalized and investigated theoretically, quantitatively, and empirically this hypothesis. Special attention was paid to the Great Recession and to its aftermath. The pace of job-to-job reallocation slowed down in an unprecedented fashion. Large firms stopped poaching, so small firms, the traditional point of re-entry into employment for many displaced workers, also stopped hiring. The constant movement up the job ladder came to a grinding halt. A large share of the greatly reduced flow of new hires were actually recalls of previous employees. Finding a new job became extremely difficult,, and upgrading from it even harder. The project points at the impact of the financial crisis on large firms as the ultimate cause. As large firms stopped hiring and poaching employees, they made less room for the unemployed at the bottom of the job ladder, where small firms lie. This explanation diverges from the conventional wisdom that the credit crunch hit directly and disproportionately small firms.

National Science Foundation (NSF)
Division of Social and Economic Sciences (SES)
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Nancy A. Lutz
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Yale University
New Haven
United States
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