Cyclical Quality Adjustment in the Labor Market

1. IntroductionThe U.S. unemployment rate fell to very low levels during the 1990s. Even more impressively, the unemployment rate for minorities and less educated individuals fell disproportionately. Convergence of relative unemployment rates in expansions and divergence in recessions has been a feature of the U.S. economy over the last 30 years. There are many possible reasons for this feature. For example, if the costs of hiring and firing less-skilled labor are low, one would expect these individuals to have very procyclical employment. In this paper, I explore an alternative model: when there is an excess supply of labor, high-skilled people take jobs that would normally be occupied by less-skilled people. In expansions, the process reverses, with less-skilled workers getting access to jobs that they would normally not attain. I refer to this process as cyclical quality adjustment.Reder (1955, p. 834) was one of the first to discuss how hiring standards adjust to business cycle conditions:Quality variations in labor markets arise through upgrading and downgrading of members of the labor force relative to the jobs they are to fill. When applicants become scarce, employers tend to lower the minimum standards upon which they insist as a condition for hiring a worker to fill a particular job-and vice versa when applicants become plentiful.Since then, many papers have developed this idea theoretically and many economic commentators appear to share this view of the labor market. For example, the Economic Report of the President states that "A strong labor market is particularly important to less advantaged groups in the labor market, such as workers with less education, younger workers, racial and ethnic minorities, and immigrants.... When employers find it hard to fill vacancies, they are more willing to hire and train workers whom they might pass over when they have fewer openings and an abundance of applicants." (Council of Economic Advisors 1999, p. 103). Likewise, the expansion during the 1990s spawned many newspaper articles about the improvement in the types of jobs available to less-skilled applicants. However, there is little systematic empirical work about changes in job assignment in the United States over the business cycle. The empirical work in this paper seeks to redress this situation.Cyclical assignment changes are important for many reasons. As mentioned earlier, job upgrading is a potential explanation for the greater cyclical variation of employment experienced by less-skilled workers. It is well known that the unemployment rates of less-skilled individuals and minorities are more countercyclical relative to more skilled individuals (Clark and Summers 1981; Kydland 1984; Keane and Prasad 1993; Hoynes 1999). The standard explanation for this effect is that low-ability workers are more likely to be laid off in downturns because training and hiring costs are lower for these workers. No commensurate attention has been paid to the issue of how the decision of who to hire changes over the business cycle. However, assignment models present a natural explanation for the greater procyclicality of employment of the less skilled. Both the adjustment cost hypothesis and the upgrading hypothesis imply that less-skilled workers will have more procyclical employment. Empirically, they are distinguishable because the upgrading explanation implies that jobs obtained by comparable workers should vary systematically over the cycle. The adjustment cost hypothesis relates to the composition of those whose jobs are terminated.Second, these mechanisms suggest a reason why wages are particularly procyclical for job changers. Recent studies using panel data have indicated that the wages of job starters are much more procyclical than the wages of workers who do not change jobs. ' Researchers have suggested various explanations for this result. Beaudry and DiNardo (1991) and MacLeod and Malcomson (1993) present contracting models in which the wages of job starters depend on the state of the labor market when they join the firm. …