The Labor Market Spillovers of Job Destruction

Should policymakers aim to directly preserve existing jobs during recessions? The answer depends on whether greater job loss exacerbates labor market frictions more than it facilitates productive labor reallocation. This paper provides new evidence on the former by examining the general equilibrium effects of job destruction—establishment-level employment contractions—on labor market conditions following recessionary shocks. To isolate these labor market spillovers from changes in local productivity, we combine administrative data on employment relationships with variation in the idiosyncratic layoff practices of large firms across local labor markets in the United States. Workers who lose their jobs when local job destruction rates are one percentage point higher than average experience a persistent $700 (1.2%) larger reduction in annual earnings, driven by lower employment in the short term and lower-paying positions in the medium term. These spillover effects account for one-third of the increased costs of job loss in recessions compared to expansions and imply that each marginal job loser imposes an annual cost of approximately $17,000 on other workers in the same labor market. To explore policy implications, we develop a general equilibrium search model featuring heterogeneous firm productivity, endogenous separations, and human capital depreciation in unemployment. To account for the magnitude and persistence of our spillover estimates, the model requires that an increase in job loss reduces the job-finding rate, limiting workers’ human capital growth and their reallocation to more productive firms.