It was well documented during the Covid crisis that low-skilled workers were the most affected by the financial challenges introduced by the lockdown measures. What’s more, the recovery from the pandemic has also seen the low-skilled benefit the least.

As we face a fresh challenge from the invasion of Ukraine and the energy crisis this has exacerbated, research from Chicago Booth provides a timely reminder that there is both a moral and a practical reason for supporting those low-skilled workers.

Bearing the brunt

“This paper shows a link between the heterogeneous impact of aggregate fluctuations and their size,” the author explains. “I find that the unequal incidence of aggregate fluctuations in the labor market increases the aggregate marginal propensity to consume, providing a measurement for a key moment in a new class of heterogeneous agent models.”

In other words, to make recessions shallower and shorter, policymakers should work to support vulnerable populations by expanding unemployment benefits, improving access to credit, and providing stimulus checks, all with the aim of stabilizing the income of low-income workers.

The paper highlights how recessions seldom affect workers, or indeed companies, equally. The author reminds us that in the past 11 recessions, while GDP fell by around 2% and unemployment rose by the same figure, this doesn’t tell the whole picture. After honing in on the changes in spending on goods and services as a result of lost income, the study found that recessions hit especially hard who tend to spend a large share of their income on things (as opposed to saving it).

Propensity to consume

This is something referred to as the “marginal propensity to consume” (MPC), and when people with a high marginal propensity to consume suffer a fall in their income, this can have an outsized impact on the economy as a whole, thus making the recession worse than it otherwise would be.

The study suggests that people with a high MPC tend to be younger and without a college education. Their income is usually lower than $25,000 a year and they’re more likely to be single than married. What’s more, men were also more likely to have a higher MPC than women, but this was less to do with their income than their spending habits.

This is worrying news for the current energy crisis, as the study also found that those people with a higher MPC were also most at risk of losing their jobs during a recession. When this happened, the ripple effect throughout the economy was significant.

“Someone loses income, and then doesn’t go out to dinner,” the researcher explains. “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.”

The cycle is then exacerbated as a lot of the businesses that high MPC people might frequent are themselves also high MPC entities, and so the process can quickly spiral out of control.

“Uncovering the linkages between labor market inequality and the consumption multiplier has potentially important implications for macroeconomic stabilization policy,” the author explains. “Indeed, policies can be made more effective in part by explicitly targeting this covariance between earnings heterogeneity and worker MPCs.”

Cutting down

The research found that workers with high MPC typically spend around 50 cents less for every dollar they lose in income. The multiplier effect then sends ripples throughout the economy such that overall consumption falls by 20% compared to a scenario where all workers were just as likely to lose their jobs during the recession as each other.

The findings are important, not least as the U.K. government has been adopting a tax-cutting policy toward the richest in society in the hope that economic fruits would trickle down to the rest of the economy. The proposals were met with disbelief by the financial markets, with the value of the pound crashing and the Bank of England forced to intervene to prop up pension providers.

The Chicago research suggests that a much better approach would be one of “trickle up” rather than “trickle down”. Instead of hoping the wealthiest will innovate the way to economic growth, a better stance would be to ensure that the spending doesn’t fall out of the bottom of the market should lower-skilled jobs be threatened by the recession.

What’s more, this is especially important in economies where inequality is high, as the researchers also found that high levels of inequality mean that the risks of this cycle of harm become much more dispersed.

“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,” they conclude.

Will policymakers heed this warning and ensure that low-skilled workers are supported in the current recession? I won’t hold my breath but we’ll see.