Inventories, Layoffs, and the Short-Run Demand for Labor

Abstract

This paper presents a theoretical and empirical analysis of the short-run employment, layoff, and inventory strategies of firms. On average, more than two-thirds of all layoffs in American manufacturing end in a rehire by the employer of origin (Martin Feldstein, 1975; David Lilien, 1980). These layoffs have recently accounted for about half of all ongoing employer-initiated spells of unemployment in that sector (see Table 1), and have led to a revised interpretation both of the involuntary nature of these separations (Costas Azariadis, 1975; Feldstein, 1976; Martin Baily, 1977) and of the durability of employment relationships. Evidently, a significant proportion of unemployed workers know that the conditions that generated their separations are temporary, and so they expect to be recalled within some reasonable time. The point of departure for this paper is in interpreting these findings as evidence of a privately and socially efficient stock of excess capacity held against contingent future demands; that is, as an inventory of a productive input. This view leads to empirically refutable hypotheses regarding both the role of temporary layoffs and the circumstances under which they will be important. In particular, both excess capacity (idle resources) and inventories are devices by which firms may economize on the costs of rapid adjustments when faced with unstable market conditions (George Stigler, 1939). In such an environment, the demands for layoffs and for other buffer stocks are jointly determined elements of long-run technology: the choice among alternative stocks will depend on relative profitabilities, and firms may choose to hold stocks of inputs as a substitute for inventory accumulation, especially if the costs of varying capacity or of storage are important. This reasoning implies that (i) the structure of short-run employment and layoff decisions will vary across firms and industries and, (ii) differences in these structures will be systematically related to the role of inventories in firms' dynamic strategies. Some perspective is warranted. At least since Charles Holt et al. (1960), economists have recognized the production smoothing role of inventories and the necessity of predicting future demand in making current decisions (David Belsley, 1969; Gerald Childs, 1967; Michael Ward, 1978). Similarly, one of the contributions of recent work on implicit labor contracts is in viewing the exchange of labor services as a bilateral and durable commitment. Both these lines of analysis are concerned with the methods firms use to respond to fluctuating demand, yet the underlying, interrelated nature of employment and inventory decisions has rarely been recognized (Roger Miller, 1968; M. Ishaq Nadiri and Sherwin Rosen, 1973; R. G. Crawford, 1979; Robert Hall, 1972). This paper aims to provide a framework for evaluating these decisions, and in so doing to explain some interesting features of observed labor markets. The notion of substitution between inventories of human and physical capital suggests a more disaggregated look at the data. Table 2 shows the importance of temporary layoffs in the distribution of unemployment among manufacturing industries. It reports layoff and total unemployment rates for twelve representative industries over the period 197376, and average layoff rates and recall frequencies for 1958-76. Among all (21) twodigit manufacturing industries the correlation between layoff and rehire rates is .6, and the table illustrates this. Evidently, industries with larger than normal layoff rates also tend to have larger rehire frequencies from firm-initiated spells of unemployment. This *University of Chicago. I am indebted to Gary Becker, Robert Cotterman, Sherwin Rosen, Jose Scheinkman, Michael Ward, Finis Welch, the managing editor, and an anonymous referee for discussions and comments at various stages. The usual disclaimer applies.

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