Employment and the cyclical cost of worker benefits

Abstract

Both aggregate and micro-level data show that the firm-paid quasi-fixed cost of an employee's benefits fluctuates with labor market conditions. It declines when employment growth deteriorates and increases when employment growth improves, a benefit-expenditure-level-to-employment-growth relationship. This paper develops an RBC model to study the impact of this cyclical quasi-fixed labor cost on firms' employment decisions. I find that the cost increases employment volatility and delays employment adjustments when productivity shocks are small. The model reflects the sluggish employment recoveries of the post-1990 period, but not before that. It also generates data-matching volatility for employment and other business cycle variables.