VoxEU Column Labour Markets Macroeconomic policy

Firms’ deleveraging and the persistence of unemployment

Three years after the beginning of the Great Recession, the US unemployment rate remains at 9%, double its pre-crisis level. This column suggests the credit crunch may be behind this high number. It argues this is not because lower debt impairs the hiring ability of firms, but because it places firms in a less favourable bargaining position, allowing workers to negotiate higher wages, and thus reducing employment.

The recent financial turmoil has been associated with a depressed state of the labour market. The unemployment rate in the US has risen from 5.5% to more than 10% and continues to remain close to 9% three years after the beginning of the recession (see Figure 1).

Figure 1. Unemployment rate

Note: percent, civilian unemployment rate. Source: BLS

Because the financial sector has been at the centre stage of the crisis, a popular view holds that the contraction of credit might have been an important driving force behind the unemployment hike. According to this view, firms are forced to cut investment and employment because they have difficulties in raising funds, a mechanism usually labelled the credit channel in the academic literature (see, eg, the seminal work of Bernanke and Gertler 1989 and Kiyotaki and Moore 1997).

Although there is some compelling evidence that the credit channel played an important role at the beginning of the crisis when the volume of credit contracted sharply and the liquidity dried up, this channel appears less important in explaining the sluggish recovery of the labour market after the initial drop in employment. As shown in Figure 2, the liquidity held by US nonfinancial businesses contracted in the first stage of the crisis, consistent with the view of a credit crunch. However, after the initial drop, the liquidity of nonfinancial businesses quickly rebounded, and yet the unemployment rate continued to rise. Figure 3 describes the same phenomena from a different angle by showing that after-tax corporate profits have already rebounded to their pre-recession level, which was already exceptionally high by historical standards.

Figure 2. Liquidity in the US nonfinancial business sector (percent of GDP)

Note: Liquidity = sum of foreign deposits, checkable deposits and currency, time and savings deposits. Source: US Flow of Funds.

Figure 3. After-tax profits in the US nonfinancial corporate business sector(percent+ GDP)

Source: BEA.

The contraction in credit has forced the business the sector to undertake a process of deleveraging (see Figure 4), analogous to the widely discussed one in the household sector. One puzzling (and still much debated) feature of the deleveraging process, common to both sectors, is its persistence. Initially, and following the credit contraction, it may seem plausible that such a process works via a dismissal of the firm’s assets, including its labour force. At some stage, though, with their liquidity rebuilt, firms should have accumulated enough resources to finance new investment and hiring.1 Why then does the dismal state of the labour market persist?

Figure 4. Debt in the US nonfinancial business sector(percent growth rates)

Note: Debt=credit market instruments. Source: US Flow of Funds

In recent work we argue that, even if firms have enough funds to accommodate their hiring plans, a credit contraction (and therefore a reduced ability of firms to borrow) can still generate a persistent cut in employment. This is not because lower debt impairs the hiring ability of firms, but because it places firms in a less favourable bargaining position, allowing workers to negotiate higher wages. Put differently, the availability of credit affects the `willingness', not (necessarily) the `ability' to hire.

To illustrate the mechanism we build a theoretical framework that shares the basic ingredients of the classic models studied in Pissarides (1987) and Mortensen and Pissarides (1994) where firms are created through the random matching of job vacancies and workers. We extend the basic structure of these models in two directions. First, we allow firms to issue debt under limited enforcement of financial contracts. Second, we introduce an additional source of business-cycle fluctuations which directly affects the firms’ ability to borrow. A negative realisation of this shock can be thought of as a deleverage shock. In this environment, where wages are determined through bargaining, lower debt increases the available net surplus attached to any new firm-worker match, thereby increasing the wage paid to newly hired workers, and discouraging hiring, everything else equal.

Central to our mechanism is the firm's capital structure as a bargaining tool in the wage determination process. Both anecdotal and statistical evidence points favourably to this channel. An illustrative example is provided by the case of the New York Metro Transit Authority. In 2004 the company realised an unexpected $1 billion surplus, largely from a real-estate boom. The Union, however, claimed rights to the surplus demanding a 24% pay raise over three years (see also Matsa 2010). Another example comes from Delta Airlines. The company weathered the 9/11 airline crisis but its excess of liquidity allegedly reduced the need to cut costs. This hurt the firm's bargaining position with workers and three years after 9/11 the firm faced severe financial challenges.2

The above examples suggest that firms may use financial leverage strategically in order to contrast the bargaining power of workers and that times of relatively low leverage may not be good times for bargaining and hiring from firms’ point of view. Although there are theoretical studies in the micro-corporate finance literature that investigate this mechanism (see Perotti and Spier 1993), its macroeconomic implications have not yet been explored. A key aggregate implication of our work is that the interaction between the capital structure of the firm and its hiring decisions could be an important factor behind the jobless recovery observed in the aftermath of the Great Contraction.


Atanassov, J, EH Kim (2009), "Labor and corporate governance: International evidence from restructuring decisions". Journal of Finance 64: 341-74.

Benmelech E, N Bergman and R Enriquez (forthcoming), "Negotiating with Labor under Financial Distress", Review of Corporate Finance Studies,.

Bernanke, B and M Gertler (1989), "Agency Costs, Net Worth, and Business Fluctuations". American Economic Review 79(1): 14-31.

Bronars SG and DR Deere (1991), "The Threat of Unionization: the Use of Debt and the Preservation of Shareholder Wealth", Quarterly Journal of Economics 119: 231-54.

Gorton and Schmid (2004), "Capital, Labor and the Firm: A Study of German Codetermination", Journal of the European Economic Association 2(5): 863-905.

Kiyotaki, N and JH Moore (1997), "Credit Cycles" Journal of Political Economy 105(2): 211-48.

Matsa DA (2010), "Capital Structure as Strategic Variable: Evidence from Collective Bargaining", Journal of Finance LXV(3), June.

Monacelli T, V Quadrini and A Trigari (2011), "Financial Markets and Unemployment", NBER Working Paper 17389.

Mortensen, DT and CA Pissarides (1994), "Job Creation and Job Destruction in the Theory of Unemployment", Review of Economic Studies 61(3): 397-415.

Pissarides, CA (1987), "Search, Wage Bargains and Cycles". Review of Economic Studies, 54(3): 473-83.

The Economist (2010) “Show us the money”, 10 July.


1 The view that following the peak of the recession firms have been persistently hoarding cash emerges also in the specialised press. See, eg, The Economist (2010).

2 The idea that debt allows employers to improve their bargaining position is also supported by several empirical studies in corporate finance. See Bronars and Deere (1991), Matsa (2010), Atanassov and Kim (2009), Gorton and Schmid (2004), Benmelech, Bergman and Enriquez (forthcoming).