3. Potential Determinants of Differences in the Level of Unemployment across Countries. Degree of Competition in Product Markets

Transcription

1 3. Potential Determinants of Differences in the Level of Unemployment across Countries Unemployment Insurance Minimum Wage Unions Degree of Competition in Product Markets Employment Protection Legislation Working Hours Tax Wedge 1

2 3.1. Unemployment Insurance Why is unemployment insurance (UI) typically mandatory? The risk of unemployment is not the kind of risk that insurance companies typically cover. The risk of unemployment depends heavily on the business cycle. I.e., it s a collective risk that in contrast to most risks which insurance companies cover cannot be diversified away. Consequently, pooling individual risks in a collective insurance brings few advantages. In the end, one simply builds up the savings needed to cover one s own risk. Invidual risks of unemployment vary systematically and not randomly. Low-wage earners carry a markedly higher risk of unemployment than higher-wage earners. In Switzerland, for example, the top 50% of wage-earners pay 72 percent of all insurance premiums but receive only 43 percent of total paid-out benefits, whereas the bottom 50% pay 28 percent of all contributions but receive 57 percent of paid-out benefits. In short, lowwage earners receive double as much in benefits as they pay in. Systematic differences in risk lead to adverse selection if insurance coverage is voluntary. Voluntary insurance coverage in which a systematic redistribution of income occurs is unsustainable. The reason is as follows. A uniform insurance premium based on average risk would be unattractive for those with below-average risks and thus draw only those with above-average risks (adverse selec- 2

3 tion). Adverse selection would in turn necessitate a premium increase which would scare off even more lower risks. In the extreme, this could dovetail into a vicious circle in which in the end insurance coverage would be so prohibitively expensive that no one would buy it. Problem of moral hazard or insufficient coverage People could refuse coverage with the expectation that political pressure would force the government to bail them out if unemployment should arise. This occurred in Switzerland in the wake of the first oil price crises in the mid-1970s and moved the government to introduced mandatory unemployment insurance in April Positive External Effects Unemployment benefits strengthen aggregate consumer demand thereby helping to support recovery in economic downturns. 3

4 What parameters characterize an UI system? Financing - form: experience rating or uniform premium - size of premium Benefits - passive benefits (paid-out claims) - active labor market policies (ALMP) 4

5 Effect of these parameters on equilibrium unemployment ALMP (cf. Chapter 4) They raise P UE and thus lower U*. passive benefits They raise the reservation wage (w*) and thus lower P UE and increase U* (moral-hazard effect). They could also lower unemployment to a degree by giving the unemployed time to find a job better suited to their skills and abilities thereby lessening the chance of repeat unemployment and hence lowering P EU. 5

6 Problem of uniform unemployment insurance premiums They make workers and firms more willing to dissolve employment relationships since they do not bear the full costs of their actions, which increases P EU and hence U* (moral-hazard effect). They result in a subsidy of firms and workers that enter into unstable employment relationships by firms and workers that enter stable ones. Cross subsidies of this kind foster the growth of firms with unstable employment relationships at the cost of firms with stable ones thereby raising the overall level of unemployment. This is known as the allocation or structural effect. P EU and U* rise here too. Unlike the moral-hazard effect, the allocation effect can arise without direct efforts of workers and firms. 6

7 Effect of job instability on the reservation wage 7

8 Source: OECD EMPLOYMENT OUTLOOK. (2006). 8

9 Source: OECD EMPLOYMENT OUTLOOK. (2006). 9

10 Source: NICKELL, S. L. NUNZIATA, W. OCHEL (2005), Unemployment in the OECD since the 1960s. What Do We Know?, Economic Journal, 115, S

11 Source: GRUBB, D. (2001), Eligibility Criteria for Unemployment Benefits, in: OECD (Hrsg.), Labour Market Policies and the Public Employment Service, Paris, S

12 Source: GRUBB, D. (2001), Eligibility Criteria for Unemployment Benefits, in: OECD (Hrsg.), Labour Market Policies and the Public Employment Service, Paris, S

13 Source: GRUBB, D. (2001), Eligibility Criteria for Unemployment Benefits, in: OECD (Hrsg.), Labour Market Policies and the Public Employment Service, Paris, S

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16 3.2. Minimum Wage If a firm s demand for labor has no effect on the wage it pays, as is the case of perfect competition, then a minimum wage above the going or market wage will decrease employment. If a firm s demand for labor affects the wage it must pay (monopsony case) then a minimum wage can within limits have a positive effect on employment. 16

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19 Source: RAGACS, CH. (2003), Mindestlöhne und Beschäftigung: Ein Überblick über die neure emprische Literatur, Working Paper No. 25, Wirtschaftsuniversität Wien. 19

20 Source: OECD (1998), OECD Employment Outlook, Paris, Kapitel 2. 20

21 3.3. Unions The effect of unions on wages is similar to that of a minimum wage. I.e., wages negotiated by unions and firms that lie above the going wage can have a positive, negative or no effect on the level of employment. 21

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23 Table 3.7. OECD summary indicators for bargaining centralisation a and co-ordination b since 1970 c Centralisation Co-ordination Australia Austria Belgium (4) (4.5) Canada Czech Republic Denmark (4) (4) Finland France Germany Hungary Ireland 4 (2.5) 4 4 (2.5) 4 Italy Japan Korea Netherlands New Zealand Norway (4.5) (4.5) (4.5) (4.5) (4.5) (4.5) Poland Portugal Slovak Republic Spain 5 (3.5) 3 5 (3.5) 3 Sweden Switzerland United Kingdom (3) 1 1 United States OECD unweighted average Coefficient of variation Data not available. a) Centralisation: 1= Company and plant level predominant. 2= Combination of industry and company/plant level, with an important share of employees covered by company bargains. 3= Industry-level predominant. 4= Predominantly industrial bargaining, but also recurrent central-level agreements. 5= Central-level agreements of overriding importance. b) Co-ordination: 1= fragmented company/plant bargaining, little or no co-ordination by upper-level associations. 2= fragmented industry and company-level bargaining, with little or no pattern-setting. 3= industry-level bargaining with irregular pattern-setting and moderate co-ordination among major bargaining actors. 4= a) informal co-ordination of industry and firm-level bargaining by (multiple) peak associations b) co-ordinated bargaining by peak confederations, including government-sponsored negotiations (tripartite agreements, social pacts), or government imposition of wage schedules. c) regular pattern-setting coupled with high union concentration and/or bargaining co-ordination by large firms. d) government wage arbitration. 5= a) informal co-ordination of industry-level bargaining by an encompassing union confederation. b) co-ordinated bargaining by peak confederations or government imposition of a wage schedule/freeze, with a peace obligation. c) No scores for were attributed to the central and eastern European OECD countries (formerly central command economies). Figures in brackets are period averages in cases where at least two years differ from the period s modal value. Source: OECD (2004), OECD Employment Outlook, Chapter 3, Paris. 23

24 Source: OECD (2004), OECD Employment Outlook, Paris, Kapitel 3. 24

25 Source: OECD (2004), OECD Employment Outlook, Paris, Kapitel 3. 25

26 The above charts and tables indicate the following: Union density is decreasing in most OECD-member countries. Exceptions are Belgium, Denmark, Finland and Sweden, where unions run the unemployment insurance system. The degree of union coverage, on the other hand, has remained virtually unchanged. Wage negotiations are increasingly conducted in a decentralized fashion. The degree of coordination is decreasing. 26

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29 3.4 Competition in Product Markets For a monopolist, product price is not a given but rather a function of the quantity sold: increasing sales necessitates lowering prices. A profit-maximizing monopolist takes this into account with the consequence that he produces less and employs fewer workers (E M ) than in the case of perfect competition (E*), where he can sell as much as he wants at a fixed price. Moreover, the worker employed by a monopolist receives just his marginal revenue product (MRP) instead of the value of his marginal product (VMP) in equilibrium. This suggests that a decrease in competition in product markets lowers production and employment. European product markets are less competitive than US ones. More competition increases consumers ability to substitute thereby increasing the elasticity of demand and in turn employment. In the Battle-of-the-Markups model, increased competition could also increase the sensitivity of the income demands of unions and firms to rising unemployment, i.e., the parameters α 1 and β 1, lowering equilibrium unemployment. If a lack of competition has led to overmanning then more competition could increase unemployment temporarily. 29

30 Graphical explanation Product Market Labor Market Source: BORJAS (1996), S Source: BORJAS (1996), S

31 Source: OECD EMPLOYMENT OUTLOOK. (2002). 31

32 Source: OECD EMPLOYMENT OUTLOOK. (2006). 32

33 Table 7.A1.1 Baseline unemployment rate equations, = 1 = 1 = 1 = 4 = 1 = 6 Baseline with ARR split into two components with EPL split into two components with tax wedge derived from national accounts with separate labour and consumption tax rates with standard macroeconomic shocks with labour demand shock Average replacement rate (ARR) [6.28]*** [6.79]*** [4.22]*** [4.16]*** [4.14] *** [3.35] *** Tax wedge [9.75]*** [10.96]*** [11.14]*** [4.49]*** [7.73] *** [6.40] *** Union density [1.57] [1.89]* [1.64] [0.56] [0.49] [1.48] [2.33] ** EPL [0.98] [0.55] [0.08] [0.02] [-1.52] [-1.22] PMR [2.98]*** [3.29]*** [3.52]*** [2.17]** [2.17]** [2.25] ** [3.28] *** High corporatism [3.57]*** [2.88]*** [3.94]*** [4.80]*** [4.89]*** [-2.90] ** [-3.26] *** Output gap [14.00]*** [14.21]*** [13.99]*** [11.89]*** [11.60]*** RR 1st year 0.09 [7.37]*** Benefit duration 2.64 [2.03]** (RR 1st)*(duration) 0.09 [2.69]*** EPL regular 1.28 [2.49]** EPL temporary (EPL regular)*(epl temporary) [2.16]** [1.21] Labour tax rate 0.25 [4.82]*** Consumption tax rate 0.21 [1.92]* Macroeconomic shocks Productivity shock [-3.34] *** [-2.33] ** Terms of trade shock [6.45] *** [6.09] *** Interest rate shock [2.72] *** [2.44] ** Labour demand shock [3.91] *** Country dummies yes yes yes yes yes yes yes Time dummies yes yes yes yes yes yes yes Observations R-squared

34 3.5 Employment Protection Legislation (EPL) Pro EPL tends to bind workers to their employers. This provides the firms with an incentive to invest more in the skills of their employees since the increase in job tenure raises a firm s chances of recouping its investment. More highly skilled workers are less likely to become unemployed. Counter EPL secures jobs for the employed, but not for the unemployed. For the latter EPL serves more as a barrier to employment. EPL raises the employment costs of a firm by making employment adjustments for a firm more expensive and by raising the chances of undermanning or overmanning. On the other hand, EPL makes firms more hesitant to both hire and fire so that the effect of EPL on the level of employment is unclear. 34

35 Source: ADDISON, J. T., P. TEIXEIRA (2001): The Economics of Employment Protection, IZA Discussion Paper No Bonn: IZA 35

36 Source: OECD EMPLOYMENT OUTLOOK. (2006). 36

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38 3.6. Working Hours The following identity suggests that a reduction in working hours would increase employment and thus lower unemployment U*. volume of work jobs = GDP GDP jobs volume of work 1 1 = GDP labor productivity working hours The success of such a policy is questionable for a number of reasons: A reduction in working hours tends to raise labor costs since it lowers the total supply of labor. Moreover, it fails to realize that certain labor costs are fixed. It implicitly assumes that it costs firms the same to employ one person for 40 hours per week or 40 persons for 1 hour a week each. The latter case is in fact more expensive. Both factors entice firms to substitute labor for other factors of production thereby raising labor productivity and decreasing employment. 38

39 Even if reducing working hours would create more jobs, that does not necessarily mean that unemployment would decrease commensurately. Underemployment, of course, would not decrease at all but simply be re-distributed. - A reduction in working hours without a commensurate increase in the hourly wage lowers a worker s income. Workers unwilling to accept a pay cut will attempt to find additional work after a reduction in hours thereby increasing the total demand for jobs. - Furthermore, a reduction in working hours could entice non-active persons who want to work less to enter the labor market, further raising the demand for jobs. 39

40 3.7 Tax Wedge Non-Wage Labor Costs These costs are only of added interest if their assessment ceilings are so low that they take on the character of fixed costs of employment meaning that they vary more with the number employed than with the number of hours worked. In this case it is cheaper to hire one person fulltime than two persons part-time. An example of a low ceiling is the one for UI in the USA. There only the first $7,000 paid in wages to each employee during a calendar year are subject to UI taxes. Taxes Relevant for employment is only the question of incidence, i.e., which side carries the burden of the tax: the employer or the employee, which in turn depends on the elasticity of supply and demand in the labor market. Since capital is usually more mobile than labor, the latter generally carries the tax. An exception is the case of a minimum wage, which obviates shifting the tax burden on to labor. 40

41 The Effect of Imposing a 1 Unit Tax on the Employer 41

42 The Effect of Imposing a 1 Unit Tax on Employees Conclusion: The impact on the net wage, labor costs and employment is the same in both cases. 42

43 The tax burden is shifted onto labor if labor suppy is completely inelastic as it is here. 43

44 Tax Wedge Real gross wage from the viewpoint of the employer w f w 1 tf p f Real net wage from the viewpoint of the employee w e w p c 1 t e 1 t c Tax wedge 1 tf 1 tc 1 wf p w t p e e f c where: p c = consumer price index p f = producer price index t f = employer tax rate t e = employee tax rate = value-added tax rate t c 44

45 Figure 3.7. Evolution of tax wedges for different earnings levels and family types Panel A. Couple (100% and 0% of APW a ) with two children, b , percentage Unweighted average 40 TUR POL SWE FRA BEL FIN GRC DEU NLD ITA 30 Unweighted average NOR CZE AUT DNK ESP HUN JPN CAN PRT 20 AUS CHE NZL GBR MEX USA KOR 10 LUX IRL , c percentage Panel B. Single low earner (40% of APW a ) with two children, d b 2003, percentage Unweighted average Unweighted average NOR DNK AUT -8 BEL LUX ISL NZL CAN AUS IRL GBR TUR GRC POL ESP SWE JPN FRA HUN DEU KOR ITA FIN PRT MEX NLD CHE CZE , percentage Source: OECD EMPLOYMENT OUTLOOK. (2006). 45

46 Figure 3.7. Evolution of tax wedges for different earnings levels and family types (cont. ) Panel C. Dual low-earner couple (both earning 40% of APW a ) with two children, d , percentage Unweighted average ISL b KOR NZL AUS Unweighted average JPN NOR PRT AUT CHE CAN MEX LUX DNK ESP DEU FIN CZE NLD Panel D. Single moderately low earner (67% of APW a ) with two children, d b GBR , percentage IRL HUN GRC BEL ITA POL FRA TUR SWE , percentage Unweighted average Unweighted average JPN CZE HUN PRT AUT NLD NOR DNK KOR CHE MEX GRC DEU ESP FIN TUR POL SWE BEL FRA ITA 5 0 ISL AUS LUX NZL USA CAN IRL GBR , e percentage a) Average production worker income. b) Some of the apparent changes in the tax wedge are due to changes in methodology for Australia, Austria, the Czech Republic, Finland, Germany, Hungary, Italy, Japan, Mexico and the Netherlands. c) 1994 for France, 1995 for Hungary and Korea. d) Negative tax wedges reflect tax credits and child benefits in excess of any tax paid. e) 1996 for Korea. Source: OECD EMPLOYMENT OUTLOOK. (2006). 46

47 Figure 3.8. Evolution of value-added taxes, , percentage Unweighted average 25 NOR ISL DNK SWE 20 Unweighted average PRT TUR BEL POL FIN IRL ITA AUS FRA NLD GRC GBR 15 MEX DEU ESP LUX NZL 10 CHE CAN 5 JPN , percentage Source: OECD EMPLOYMENT OUTLOOK. (2006). 47

48 Graphical Explanation of the Effect of a Tax Wedge 48

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