Excessive Pessimism About Job Security Means That People Earn Less

People in Britain tend to greatly over-estimate the chances of losing their jobs, according to new research by Professor Alan Carruth and colleagues. Their study, which is published in the March 2007 issue of the Economic Journal, finds that such job insecurity leads to more moderate wage claims and lower wage growth. While this is
generally beneficial for the economy as a whole, it is not so good for the individuals concerned.

Can employees reliably predict the likelihood that they will lose their jobs and become unemployed? If so, do they moderate their wage claims in the hope that their jobs will be saved? These are the two key questions addressed by this research. The results are important for our understanding of the operation of the labour market, both for individuals and for the wider economy. For example, it has been suggested that high job insecurity in the mid-1990s may have resulted in lower wage growth and thus lower levels of unemployment in both the United States and Britain.

The first question – how well can employees predict if they are going to become unemployed? – can be answered by examining their expectations of becoming unemployed in the next 12 months, and then following them over time to see whether these expectations are realised. This study reveals that:

  • People are far too pessimistic in their fear of becoming unemployed – they tend to greatly over-estimate the chances of losing their jobs.
  • Nevertheless, people''s fear of unemployment is positively related to a range of factors – such as past personal experiences of unemployment; the unemployment experiences of a close friend; and characteristics of the current job that are typically associated with ''fragile'' employment and thus make it more likely they will lose their job.
  • The probability of someone becoming unemployed in the next 12-month period is significantly greater for employees who report higher levels of job insecurity.

Even taking account of other factors and characteristics that increase the chances of unemployment, individuals'' fear of job loss is still an important predictor of whether they subsequently will actually lose their jobs.

In this sense, employees seem to have ''private information'' about their job security. Misperception of risk is a known social phenomenon, for example in psychology research, so it is interesting that it also features in assessments of unemployment risk.

The second question – do people accept lower wages to try to keep their jobs? – can be addressed by examining the wage increases for employees who do remain in employment. Here the study finds that:

  • For men who think they will lose their job, wage increases over the next year are significantly lower than for men who are confident that they will keep their job. Employees who are most fearful of job loss receive wage increases that are 12 percentage points lower on average than of those of employees who have no fear of unemployment.
  • In contrast, for women, there is no evidence that their fear of unemployment is associated with lower wage growth.

The findings of this paper have two important implications. First, individuals'' subjective expectations should be regarded as reliable and valid indicators, which can provide useful additional information for researchers. Economists are often sceptical of subjective data, but these results are positive on their usefulness.

In this particular case, it is clear that, in effect, people have ''insider knowledge'' about the likelihood of losing their jobs and this information is not available in the objective data collected by government agencies. These subjective expectations of job loss could be used to provide a useful leading indicator of future unemployment patterns.

Second, there is evidence that a high level of job insecurity can lead to more moderate wage clams and consequently lower wage growth. For the individuals affected in this way, job insecurity results in poorer job outcomes, even if the outcome for the economy as a whole may be rather more beneficial.

''Job Insecurity and Wages'' by David Campbell, Alan Carruth, Andy Dickerson and Francis Green is published in the March 2007 issue of the Economic Journal.

The findings are derived from an analysis of data from the British Household Panel Survey, a representative survey of around 5,000 households and 10,000 individuals in the UK, and the 2001 Skills Survey, which surveyed around 4,500 individuals.