ECONOMY IN THE LONG RUN. Chapter 6. Unemployment. October 23, Chapter 6: Unemployment. ECON204 (A01). Fall 2012

Transcription

1 ECONOMY IN THE LONG RUN Chapter 6 Unemployment October 23,

2 Topics in this Chapter Focus on the Long run unemployment rate Natural Rate of Unemployment contrast with cyclical behaviour of unemployment what it means what causes it understanding its behavior in the real world 2

3 Long Run Unemployment: Natural rate of unemployment The average rate of unemployment around which the economy fluctuates In a recession, the actual unemployment rate rises above the natural rate In a boom, the actual unemployment rate falls below the natural rate Changes over time as structural features of the labour market change. For example, Government employment policies Level of unionisation 3

4 Figure: The Unemployment Rate in Canada 4

5 Figure 6.1 The Unemployment Rate and the Natural Rate of Unemployment in Canada 5

6 A model of the Natural Rate of Unemployment (NRU) Let, U = number of unemployed workers E = number of employed workers L = the labour force = U + E, by definition U/L = unemployment rate Assumptions: a. L is exogenously fixed. b. s and f are exogenous where, s = fraction of employed workers that become separated from their jobs. s is called the rate of job separations 6 f = fraction of unemployed workers that find jobs. f is called the rate of job finding

7 The first assumption rules out people entering or exiting the labour force; i.e., no discouraged workers Transition between E and U: Each period s E lose their jobs and f U find jobs 7

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9 Substituting L = E + U into the first: s (L U) = f U s L s U = f U s L = (s + f) U Solving for U/L 9

10 Exercise Each month, 1% of employed workers lose their jobs (s = 0.01) 19% of unemployed workers find jobs (f = 0.19) The natural rate of unemployment: So, the Natural rate of unemployment is 5 percent 10

11 Two implications: a. Reducing NRU requires policies to lower s or raise f b. Any policy that affects s or f, affects NRU So far, we have assumed a non-zero level of unemployment. Put differently, we have assumed that the rate of job finding is not one. If it were, then NRU gets very close to zero. What we need to do is explain why U exists; in particular, why f is less than one. 11

12 Why is there Unemployment? If job finding were instantaneous (f = 1), then all spells of unemployment would be brief, and the natural rate would be near zero. There are two reasons why f < 1: job search wage rigidity Both can explain why U persists. Consider each in turn. 12

13 a. Job Search and Frictional Unemployment Frictional unemployment: caused by the time it takes workers to search for a job Occurs even when wages are flexible and there are enough jobs to go around Because, workers have different abilities, preferences jobs have different skill requirements geographic mobility of workers not instantaneous flow of information about vacancies and job candidates is imperfect 13

14 So, Firms looking for workers, workers looking for firms - job finding takes time, f < 1. As well, if matching is not perfect job separations occur, s > 0. Structural change in the economy also gives rise to s. Changes in the composition of demand among industries or regions For example, the more dynamic the economy, it is more likely to adopt new technologies and to undergo structural change, the more churning requiring job separation in the labour market; hence a higher natural rate of unemployment. These features of the economy give rise to frictional unemployment. Not necessarily bad; some amount is inevitable. 14

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16 Policies to reduce frictional unemployment a. Providing job and worker information - improve matching b. Re-training - improve job finding (e.g. after structural change) We need the government to provide these services. Why? Why don t we let individuals and firms pay directly for these services? The answer is that there may be externalities associated with these services. For example, search effort rewards both the firm and the worker. When making her search decision, the worker only considers her return, not the firms. So search effort is less than socially optimal. As well, there may be a concern that it puts an unfair burden on a disadvantaged group so it is explained on equity grounds. 16

17 c. Experience-rated employment insurance (firm pays part or all of the unemployment benefits of the workers it fires): A disincentive to lay-off, s falls. But, firms may hire less, f falls Policies that affect frictional unemployment: Unemployment insurance, designed to protect people from loss of income o It pays part of a worker s former wages for a limited time after losing his/her job. 17

18 Consequences o Lowers cost of search or reduces the opportunity cost of being unemployment, f falls o Lowers demand for employment security, s rises Studies o The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment. o There is ample evidence that search effort responds to incentives. For example, as the unemployment benefits get close to running out, the probability of finding a job raises substantially. Moreover, it allows workers more time to search may lead to better matches, would lead to greater productivity and higher income. 18

19 b. Real Wage Rigidity Classical labour market: real wage adjusts to clear the labour market. o All those willing to work at equilibrium wage instantly find a job. o No waiting, no unemployment. Labour market with real rigidities: labour market does not clear because the real wage does not adjust 19

20 Unemployment from real wage rigidity 20

21 Consequences Wait unemployment those that would like to work at the market wage cannot find a job. The real wage rigidity lowers the likelihood of finding a job; in other words, the rate of job finding f is lower. Reasons for real wage rigidity 1. Minimum wage laws 2. Labor unions 3. Efficiency wages 21

22 1. Minimum wage laws Equity policy - ensure that the low paid receive a fair wage There is considerable debate as to whether this is the best way of achieving this policy objective. First, it tends to lower employment for the less skilled (but ambiguous). Second, it is not necessarily targeted that well. Tax credits are generally preferred. Why? The minimum wage may exceed the equilibrium wage of unskilled workers, especially teenagers. Studies: a 10% increase in minimum wage reduces teen employment by 1-3% But, the minimum wage cannot explain the majority of the natural rate of unemployment, as most workers wages are well above the minimum wage. 22

23 2. Unions - Insider Outsider Problem Firm and unions bargain to determine wage Union exercise monopoly power to secure higher wages for their members. Firm chooses employment When the union wage exceeds the equilibrium wage, unemployment results. Insiders: Employed union workers whose interest is to keep wages high. Outsiders: Unemployed non-union workers who prefer equilibrium wages, so there would be enough jobs for them. What about unions that bargain for job security - does that lower? Possibly, but it will also cause firms to lower demand for labour. 23

24 3. Efficiency Wages Why might firms choose to pay above the market clearing wage? Higher wages increase worker productivity Simple arguments attracts higher quality job applicants Motivates workers to put more efforts reducing turnover, which is costly to firms improving health of workers (in developing countries) So, firms willingly pay above-equilibrium wages to raise productivity. Consequence Structural unemployment Arguments based upon imperfect information 24

25 1. Adverse selection: Firms cannot observe workers ability (not completely) To ensure high average quality labour force firms pay above market wage (otherwise all the high quality workers will leave, assuming that they have a greater chance of finding work elsewhere). 2. Moral hazard: Firms cannot observe worker s effort (not completely) High real wage raises the cost of a worker losing job 25

26 3A. A Simple Model of Efficiency Wages Firm cannot perfectly observe worker effort. Workers have two options: 1. Work hard, receive where, w a is the cost of effort 2. Shirk (don t work hard), get fired with some probability and receive b, the outside option To stop workers shirking, the after-effort wage equal or exceed b: >= b no shirking condition must Firm will always pay just enough, so b = 26

27 What determines b? A fired worker faces two outcomes: 1. Employed at w with probability where, u is the natural rate of unemployment 2. Unemployed at c.w with probability u where, c is the fraction of w from unemployment benefits, Expected outside option: In equilibrium, all firms pay the same wage, Which implies, 27

28 The higher the cost of effort, the higher the NRU. Firms must pay more to compensate for cost of shirking so they hire less. Higher benefits (larger c), higher u - higher benefits improve outside option (lessen the cost of being fired). 28

29 Labor Market Experience in Canada Econometric decomposition of unemployment: Incidence o The likelihood that an individual suffers an unemployment spell Duration o The average length of that spell Example: 5% unemployment could be a) with high duration and low incidence Long run structural unemployment b) short duration and high incidence Short run frictional unemployment 29

30 Data on the duration of unemployment can affect the view about the reason of unemployment Statistics Canada has estimated that about two-thirds of any increase in the unemployment is due to longer duration and one-third to higher incidence. Policy implication: If the goal is to lower the natural unemployment rate, policies should aim the long run unemployed, as they account for a larger amount of unemployment 30

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36 Over the last 50 years the natural rate of unemployment has been changing. Why? Economists hypothesize: 1. Demographics a. Baby booms after WWII, enter into labor force in the 1960s and the 1970s b. Increased women unemployed labor in the 1970s 2. Sectoral shifts a. Technological change b. Natural resource price shift 36

37 3. Productivity a. In the 1970s productivity slowdown increased the NRU b. Skilled biased technological change 4. Transition into and out of the Labor force When labor force is fixed, unemployment occurs due to separation But, if this assumption is relaxed then measurement of unemployment gets complicated. Some are unemployed because they don t look for job seriously Some individuals seriously look for jobs but after unsuccessful search give up searching discouraged workers. Not being in the labor force any more 37

38 Comparing Canadian labor market with other country labor markets 38