Financial Crises and Firms’ Employment Behaviour: Lessons from the Swedish Banking Crisis
The banking crisis which hit the Swedish economy in the early 1990s provides an insightful case study both with high relevance to improve our understanding of the long-run consequences of the recent global financial crisis and to suggest effective resolution strategies. The purpose of this research project is to try and use the Swedish experience in combination with rich data to shed light on an important aspect of the latest economic downturn during the “Great Recession”: namely the mechanisms through which credit constraints affect firms’ employment decisions. The unusually rich matched employer-employee data containing information on the balance sheets and productivity of all firms in Sweden since the 1980s until today. Using these panel data we are able to answer several questions, many of which have not been possible in the previous literature: (i) To what extent does increased borrowing costs reduce firms’ demand for labor? (ii) Is the adverse impact of financial pressure on employment is mitigated by adjustments in wages and productivity (iii) What type of workers do firms lay off (e.g. high vs.low skilled)? (iv) To what extent do firms with high costs for capital substitute between capital and labor? (v) Did firms that were more severely affected by the banking crisis adjust in the long-run, e.g. by changing their way of production, the composition of the workforce, or their reliance on short-term loans, in a way that made them more resilient future economic crises?
Final report
1. Project aim and development
The banking crisis which hit the Swedish economy in the early 1990s provides an insightful case study both with high relevance to improve our understanding of the long-run consequences of the recent global financial crisis and to suggest effective resolution strategies. The purpose of this research project is to use the Swedish experience in combination with rich data to shed light on the mechanisms through which credit constraints affect firms’ employment decisions. The unusually rich matched employer-employee data containing information on the balance sheets and productivity of all firms in Sweden since the 1980s until today. Using these panel data we are able to answer several questions, many of which have not been possible in the previous literature: (i) To what extent does increased borrowing costs reduce firms’ demand for labor? (ii) Is the adverse impact of financial pressure on employment is mitigated by adjustments in wages and productivity (iii) What type of workers do firms lay off? (iv) To what extent do firms with high costs for capital substitute between capital and labor? (v) Did firms that were more severely affected by the banking crisis adjust in the long-run?
2. Brief about the implementation of the work
Grenet and Grönqvist have both worked with analyzing the data and writing the papers. The team members also had the help of a research assistant to do more of the mechanical data cleaning tasks. A PhD student from Uppsala University, Daniel Jahnson, also became involved in the project. Building on the results in the first two papers in this project, Jahnson also wrote an additional paper where he specifically examines small firms. This paper is his “job-market” paper and included in his doctoral thesis which is planned to be defended in early Fall 2024. During the work, Grönqvist and Jahnson visited Paris School of Economics to work with Grenet. Grenet also visited Uppsala at several occasions. Most other team meetings have been held online.
3. The three most important results of the project and a discussion about the conclusion of the project
a) The first paper examines how firms more exposed to this event adjusted employment in the long-run and the mechanisms involved. Our analysis draws on matched employer-employee data containing the financial statements for a large sample of firms. Our difference-in-differences estimates show that firms with a greater pre-crisis debt burden experienced more difficulties in accessing external capital during the crisis compared to firms with lower baseline debts. This is consistent with the most exposed firms becoming financially constrained. More exposed firms exhibit stronger downward employment adjustments than less exposed firms, and the reductions are mainly concentrated among low-skilled workers. Employment in more exposed firms started to recover four years after the crisis and had fully recuperated about a decade later. These firms also temporarily saw a larger drop in both productivity and investment. We do not find a significant effect on the wage bill, and the estimates are precise enough to rule out even moderate effect sizes.
b) The second paper shifts the focus from firms to the individual workers and examines the long-run labor market adjustments of workers who were differentially exposed to the banking crisis. Our difference-in-differences estimates suggest that the most exposed workers experienced larger and significant reductions in employment and earnings during the crisis compared to less exposed workers. Employment and earnings recovered slowly but did not fully recuperate until about one decade after the crisis. While the effects were similar for males and females, the losses were and larger for low skilled than high skilled workers. We also find that the most exposed workers were more likely to be enrolled in low quality labor market training programs and adult education even after the crisis, more likely to move to a different county, more likely to change industry and less likely to work in skill intensive industries. These findings may offer a partial explanation for why more exposed workers suffer from poor labor market prospects in the long-run.
c) The third paper examines short- and long-run effects of financial constraints on employment, specifically in small firms. Small firms are interesting to study as small and new firms are often more dependent on external capital. The analysis relies on a difference-in-difference-in-differences type of research design that compares small and large firms in sectors with high and low external financial dependence before, during and after the recession, using comprehensive firm-level register data that comprise the universe of firms. The results suggest that financial constraints significantly reduced employment growth of small firms during the recession and that the effect to a large extent was driven by a decline in firm entry. The decline in employment was persistent, without any signs of convergence to pre-crisis employment levels. The analysis further indicates that financial constraints of small firms accounted for about 5% of the aggregated employment decline during the recession.
4. Possibly new research questions
One key question which has arisen during the work with this project is how the crisis affected innovations. On the one hand, reduced access to external capital may hurt innovations. On the other hand, economic crisis may also lead to “creative destruction”, which promote innovation. We plan to pursue this in the continuing work. Another novel research question is to what extent the crisis affected the career paths of young individuals still enrolled in education. To what extent did these individuals adjust to the crisis in terms of avioding more exposed sectors. This is also a question that will be adressed in our contunied work.
5. How the team has disseminated the research and results and if collaboration has occurred
The results of this work has been presented at several seminars (e.g. in Uppsala, Paris School of Economics, the Society of Labor Economists (Toronto)). One of the papers is submitted for publication to the European Economic Review. The other paper is under preparation for submission to a top economic journal. We have also written one Swedish popular science report in Swedish on the first paper, which will be published in the IFAU report series (Winter 2023/2024). We will also send the paper for publication in Ekonomisk Debatt.
The banking crisis which hit the Swedish economy in the early 1990s provides an insightful case study both with high relevance to improve our understanding of the long-run consequences of the recent global financial crisis and to suggest effective resolution strategies. The purpose of this research project is to use the Swedish experience in combination with rich data to shed light on the mechanisms through which credit constraints affect firms’ employment decisions. The unusually rich matched employer-employee data containing information on the balance sheets and productivity of all firms in Sweden since the 1980s until today. Using these panel data we are able to answer several questions, many of which have not been possible in the previous literature: (i) To what extent does increased borrowing costs reduce firms’ demand for labor? (ii) Is the adverse impact of financial pressure on employment is mitigated by adjustments in wages and productivity (iii) What type of workers do firms lay off? (iv) To what extent do firms with high costs for capital substitute between capital and labor? (v) Did firms that were more severely affected by the banking crisis adjust in the long-run?
2. Brief about the implementation of the work
Grenet and Grönqvist have both worked with analyzing the data and writing the papers. The team members also had the help of a research assistant to do more of the mechanical data cleaning tasks. A PhD student from Uppsala University, Daniel Jahnson, also became involved in the project. Building on the results in the first two papers in this project, Jahnson also wrote an additional paper where he specifically examines small firms. This paper is his “job-market” paper and included in his doctoral thesis which is planned to be defended in early Fall 2024. During the work, Grönqvist and Jahnson visited Paris School of Economics to work with Grenet. Grenet also visited Uppsala at several occasions. Most other team meetings have been held online.
3. The three most important results of the project and a discussion about the conclusion of the project
a) The first paper examines how firms more exposed to this event adjusted employment in the long-run and the mechanisms involved. Our analysis draws on matched employer-employee data containing the financial statements for a large sample of firms. Our difference-in-differences estimates show that firms with a greater pre-crisis debt burden experienced more difficulties in accessing external capital during the crisis compared to firms with lower baseline debts. This is consistent with the most exposed firms becoming financially constrained. More exposed firms exhibit stronger downward employment adjustments than less exposed firms, and the reductions are mainly concentrated among low-skilled workers. Employment in more exposed firms started to recover four years after the crisis and had fully recuperated about a decade later. These firms also temporarily saw a larger drop in both productivity and investment. We do not find a significant effect on the wage bill, and the estimates are precise enough to rule out even moderate effect sizes.
b) The second paper shifts the focus from firms to the individual workers and examines the long-run labor market adjustments of workers who were differentially exposed to the banking crisis. Our difference-in-differences estimates suggest that the most exposed workers experienced larger and significant reductions in employment and earnings during the crisis compared to less exposed workers. Employment and earnings recovered slowly but did not fully recuperate until about one decade after the crisis. While the effects were similar for males and females, the losses were and larger for low skilled than high skilled workers. We also find that the most exposed workers were more likely to be enrolled in low quality labor market training programs and adult education even after the crisis, more likely to move to a different county, more likely to change industry and less likely to work in skill intensive industries. These findings may offer a partial explanation for why more exposed workers suffer from poor labor market prospects in the long-run.
c) The third paper examines short- and long-run effects of financial constraints on employment, specifically in small firms. Small firms are interesting to study as small and new firms are often more dependent on external capital. The analysis relies on a difference-in-difference-in-differences type of research design that compares small and large firms in sectors with high and low external financial dependence before, during and after the recession, using comprehensive firm-level register data that comprise the universe of firms. The results suggest that financial constraints significantly reduced employment growth of small firms during the recession and that the effect to a large extent was driven by a decline in firm entry. The decline in employment was persistent, without any signs of convergence to pre-crisis employment levels. The analysis further indicates that financial constraints of small firms accounted for about 5% of the aggregated employment decline during the recession.
4. Possibly new research questions
One key question which has arisen during the work with this project is how the crisis affected innovations. On the one hand, reduced access to external capital may hurt innovations. On the other hand, economic crisis may also lead to “creative destruction”, which promote innovation. We plan to pursue this in the continuing work. Another novel research question is to what extent the crisis affected the career paths of young individuals still enrolled in education. To what extent did these individuals adjust to the crisis in terms of avioding more exposed sectors. This is also a question that will be adressed in our contunied work.
5. How the team has disseminated the research and results and if collaboration has occurred
The results of this work has been presented at several seminars (e.g. in Uppsala, Paris School of Economics, the Society of Labor Economists (Toronto)). One of the papers is submitted for publication to the European Economic Review. The other paper is under preparation for submission to a top economic journal. We have also written one Swedish popular science report in Swedish on the first paper, which will be published in the IFAU report series (Winter 2023/2024). We will also send the paper for publication in Ekonomisk Debatt.