The Best Way to Prepare for a Recession? Help Vulnerable Workers

In a recession, the most vulnerable workers typically bear the brunt of layoffs and pay cuts—and their subsequent belt-tightening can magnify the effects of an economic downturn. That’s especially true when income inequality is rising, according to Chicago Booth’s Christina Patterson, whose research suggests that policy makers should bolster these populations ahead of recessions by improving access to credit, expanding unemployment benefits, and considering stimulus checks, as well as enacting other policies to stabilize the finances of young and low-income workers.

Recessions, defined as a fall in GDP over two successive quarters, do not affect all workers or companies equally. In the 11 recessions in the US between 1945 and 2011, GDP fell by an average of 2 percent, and unemployment rose by an average of about 2 percent, according to the research. To study how the impacts can vary, Patterson homed in on a period that included two of those recessions. She used a variety of US government data generally covering workers in 23 states between 1995 and 2011, measuring how much spending on goods and services tended to fall for each dollar of lost income.

Workers who spend a larger share of each extra dollar in their paycheck have a higher marginal propensity to consume, or MPC—and when those with higher MPCs cut back, that can worsen a recession. Patterson finds that those with the highest MPCs were younger than 35, didn’t have college educations, made less than $25,000 a year, or were Black. Single men and women had higher MPCs than married workers. And men had higher MPCs than women did, as they tended to spend more than they saved.

Patterson explored the extent to which workers whose consumption was sensitive to their income (that is, those with high MPCs) also worked in jobs that were likely to be cut during recessions. When these workers slowed their spending, there were ripple effects, she finds. “The initial shock of a person losing a job can amplify,” Patterson says. “Someone loses income, and then doesn’t go out to dinner. That person makes groceries stretch further, and doesn’t get a haircut. The hairdresser in turn has less income, so doesn’t buy a dishwasher.” When the people in this chain—serving dinner, selling groceries and dishwashers, and cutting hair—also have high MPCs, more ripples form.

On average, in recessions, workers with high MPCs spend about 50 cents less for every lost dollar of income, Patterson’s analysis indicates. When shocks disproportionately hit workers whose spending is more sensitive, the effect is large enough to decrease overall US consumption by 20 percent relative to a benchmark in which all workers were equally likely to lose their jobs in recessions, the study finds.

Shocks aren’t limited to specific industries and tend to impact certain jobs within a company. This means, Patterson says, that it wouldn’t necessarily be safer for workers who spend more and save less to leave jobs in industries viewed as less stable—such as hospitality or construction—for jobs in government or higher education. Those sectors still tend to cut administrative assistants and janitorial staff with less tenure.

Her findings support those of other research—including by University of Chicago Harris School of Public Policy’s Peter Ganong and Booth’s Pascal Noel—that argues policy makers should target relief policies toward people who have the most variable incomes and whose shopping patterns are most sensitive to shocks. And by measuring the connections between MPCs and recessions, her work could help governments better target their relief efforts. Germany, for example, offers more generous unemployment benefits to older workers, but Patterson’s findings indicate that the extra funds might be more effective if directed to younger workers with fewer financial resources.

Additionally, “these results may suggest another reason for policy makers to be alarmed by rising inequality in the economy,” Patterson writes. “As wealth becomes more unequally distributed, MPCs in the population may become more dispersed, with a wider swath of consumption being greatly affected by aggregate shocks.”

If more workers are potentially vulnerable to macroeconomic shocks, recessions could be deeper and more prolonged. But governments could prepare for and respond to such shocks and direct support to workers who need it—well before the next recession.