Aggregate labor earnings fell more in the period from 2007 to 2009 than during any other post-war recession. Although the behavior of such aggregate statistics is well documented, far less is known about how the labor earnings risk facing individual workers varies over the business cycle. The distribution of earnings changes--which reflects changes in people's employment status, wages, hours worked, and bonuses--provides a measure of the earnings risk facing workers. It is widely recognized that earnings risk matters for workers' well-being and affects their families' spending, saving, and borrowing decisions. This note reports some results from research conducted with Fatih Guvenen from the University of Minnesota and Jae Song from the U.S. Social Security Administration (SSA) that focuses on two specific aspects of how the earnings of individual workers are affected by economic downturns:

How does the distribution of changes in individuals' earnings shift in recessions? Do recessions affect workers with relatively low earnings differently than those with high earnings?

Little is known about these questions because answering them requires a very large dataset of individuals' earnings observed repeatedly over time. We use a unique dataset from the SSA, which contains (uncapped) earnings histories for millions of individuals (but no personally-identifying information). Our analysis focuses on a random sample of 10 percent of all workers in every year from 1978 to 2010. Since we lack separate data on hourly wages and hours worked, we focus on the experiences of male workers aged 25 to 60, who tend to have the most stable attachment to the labor market, although many of these workers are subject to unemployment spells. Even with these restrictions on the sample, we are still able to analyze a massive amount of data. For example, in 2010, we see the earnings of more than 5 million workers and can measure how each of their earnings compared with prior years.

Distributions of Earnings Changes in Economic Expansions and Recessions

What happens to the distribution of individuals' earnings changes in recessions? The answer to this question turns out to be central for understanding several important phenomena in macroeconomics and finance.1

The first chart compares the distribution across workers of earnings changes between 2008 and 2009 (the red bars) with the distribution during the expansion years of 2005 to 2006 (the blue bars). During the recent recession, the distribution of year-to-year earnings changes shifted substantially to the left compared with the distribution during the latter part of the previous expansion, indicating many more workers than usual saw their earnings fall in 2009 and many fewer saw their earnings rise.

Chart 1: Recent Recession vs. Expansion: Distribution of Earnings Changes

While the distribution shifted to the left, just as importantly--and much less well-known--the shape of the distribution changed as well. In particular, the fraction of workers falling into the left tail of the distribution increased significantly. Contrary to past research, this increase in the incidence of highly adverse earnings changes was not simply a reflection of an increase in earnings variance (so-called "countercyclical variance" emphasized in a number of previous studies).2 In particular, we find that those large declines in earnings for some workers were not balanced in the distribution by large increases experience by many other workers. As shown by the left-most bars, the fraction of workers experiencing large drops in earnings rose significantly, while the share experiencing large increases--the right-most bars--fell. Earnings risk becomes much more concentrated on the downside, ramping up workers' exposure to substantial income losses. In other words, the distribution of earnings changes became much more skewed to the left (downside) during the recent recession. These new data, therefore, show even more pernicious circumstances for many workers than would have resulted from the countercyclical variance argument emphasized in much of the past research.

Next, we ask how this change in skew during the recent recession compares to changes during previous recessions. The second chart compares workers' experience in the most recent recession to those from the 2001 recession, illustrated by the orange bars. This chart shows that the changes during the recent recession--that is, the shift to the left and the increasing weight in the lower tail--were greater than they were in the milder 2001 recession.

Chart 2: Recent Recession vs. 2001 Recession: Distribution of Earnings Changes

Average Earnings Changes across the Earnings Distribution in Recent Recessions

Next we explore whether workers with different levels of pre-recession earnings tend to experience very different changes in earnings during recessions. The third chart plots average earnings changes during recessions against pre-recession earnings. The horizontal axis ranks workers by their pre-recession earnings, from the bottom one percentile of the earnings distribution on the left to the top one percentile on the right. The four lines show the change in average earnings at each percentile during each of the past four recessions.

Chart 3: Change in Average Earnings During Recent Recessions

We draw a few conclusions from these data. First, across the earnings distribution, there were larger drops in average earnings from 1980-1983 and 2008-2010 than occurred around the other two relatively milder recessions. (That is, over the most of the earnings range, the green and red lines lie noticeably below the purple and blue ones.) Second, workers in the bottom half of the earnings distribution experienced significantly larger decreases in average earnings than those in the upper half. (That is, the lines are upward-sloping across the earnings distribution, especially the two relatively severe recessions.) This concentration of drops in earnings among the lowest earners may have exacerbated the disruption to household balance sheets in this recession since low earning workers are less likely to have significant stocks of savings to draw upon.

Interestingly, this relatively good fortune of high-income workers did not extend to the very top of the earnings distribution. Rather, average earnings of the workers who entered the recent recession in the top one percent dropped by 23 percent during the recession, while earnings for workers between the 90th and the 99th percentiles of the distribution fell by only 9 percent, on average. A similar pattern of large earnings drops at the top of the earnings distribution was also evident in the 2001-2002 recession (but not the other two recessions). The large earnings loss for the top one percent was not observed during the first two recessions at all. In fact, this phenomenon appears to be more recent. This sharp plunge in earnings at the top of the distribution is likely due to reductions in incentive-based compensation such as bonuses and stock options, which became more prevalent since the mid-1980s.

Overall, our empirical findings have important implications for thinking about the considerable economic risks facing families and the consequences for overall household financial conditions over the business cycle. We think that developing a more complete characterization of the forces affecting the earnings of individual workers could be important for better understanding the macroeconomic dynamics at play during the recent recession and allow a more complete understanding of the effects recessions have on households' spending, saving, and borrowing behavior.

Please cite as:

Ozkan, Serdar (2014). "How Does Earnings Risk for Americans Change During Recessions?" FEDS Notes. Washington: Board of Governors of the Federal Reserve System, January 31, 2014. https://doi.org/10.17016/2380-7172.0008