Labor Costs and Employment

Young businesses account for an important share of job creation. Still, many small firms do not hire any employees at all. For example, in the US and in 2014, 82% of all firms had zero employees. Moreover, the share of non-employers has steadily increased over the last three decades, while the rate at which non-employers become employers has slowed down. Understanding the factors underlying these trends is an important step toward an effective employment policy.

What makes a firm decide to hire, in particular to hire its first employee? Economic theory predicts that, as the cost of hiring an employee declines, the propensity to hire increases. The question is then: by how much?

A recently published paper tackles this question by examining the effect of a change in legislation in Belgium: Beginning on January 1, 2016, the first employee of a new employer became permanently exempt from Social Security Contributions (SSC). This exemption reduced the labor cost of the first employee by 13%.

The authors show that potential employers quickly responded to the reduction in labor costs. Using the methodology of Regression Discontinuity in Time (RDiT), they find that the number of new employers increased by 31% immediately following the reform. This corresponds to a -2.39 estimate of the elasticity of the decision to hire a first employee with respect to the labor cost, although with a large 95% confidence interval, namely [-3.45,-1.25].

The panel below illustrates the result. The vertical axis measures the flow of new employers, by quarter. The full red vertical line indicates the implementation of the policy (January 1, 2016). The black dashed line indicates the announcement of the policy (October 10, 2015). The dashed red line fits a local polynomial to the data.