Macroeconomics Part Two: Unemployment and Money Dr. Ali Moghaddasi Kelishomi Warwick Economics Summer School 2016 1
1. THE LONG RUN 2. Production, prices, and the distribution of income What determines the long- run level of income and its distribution? 3. Interest rates and investment What is the interest rate? What factors determine investment? 4. Consumption and the natural rate of interest What factors determine consumption and the real interest rate? 5. Capital accumulation and growth Why are some countries richer than others? 6. Wage setting and unemployment Why is there always unemployment in a market economy? 7. Money and inflation in the long run What determines the long run rate of inflation? 2
The labour market (Chapter 6) Why is there always unemployment in a market economy? It is important to understand unemployment because: Unemployment means that total production and income are lower than they could have been Unemployment causes poverty, inequality and social problems 3
The labour market: Introduction Plan: Data: stocks and flows in the labour market Theories of wage setting and unemployment - efficiency wages - search/matching frictions - labour unions and bargaining - minimum wages How do unemployment rates differ between countries and over time? 4
The labour market: Introduction Two types of unemployment: Focus here is on equilibrium unemployment: the natural rate of unemployment u n Cyclic unemployment: u u n will be analysed later 5
The labour market: Introduction Labour Force Surveys: N U L=N+U OLF u =U/L number employed: those who have a job number unemployed: those who do not have a job and are actively seeking work labour force = employed + unemployed outside the labour force: those who do not have and are not actively looking for work (retired, students, discouraged workers ) unemployment as a share of the labour force 6
The labour market: Stocks and flows 7
The labour market: Labour status, men 2008 8
The labour market: Labour status, men 9
The labour market: Labour status, women 2008 10
The labour market: Labour status, women 11
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The labour market: The chance to find a job What determines the chance to find a job for someone looking for work? This depends on how many people are looking for work but also on how many jobs become available. Suppose that a fraction s quit every month for exogenous reasons and these people also apply for a new job. Then the probability to find a new job within a month is: f = Ns U+Ns = s U N +s = s U L L N +s s u+s The approximation holds since L/N is close to one. 14
The labour market: The chance to find a job Numerical examples: L=100, N=96, U=4, s=0,01 f = U L s = 0,01 0,01 L N +s 4 100 +0.01 100 96 0.04+0.01 = 1 5 = 0,2 The chance to find a job within a month is 20 percent. L=100, N=91, U=9, s=0,01 f 0,01 0.09+0.01 = 1 10 = 0,1 The chance to find a job within a month is 10 percent. 15
The labour market: Short and long-term unemployment 16
The labour market: Theories of unemployment Why is there always unemployment in a market economy? Four different aspects/theories will be discussed: Efficiency wages (our baseline model of wages and unemployment) Search/matching frictions Labour unions and bargaining Minimum wages 17
The labour market: A model of wage setting and unemployment The firm decides about wages and employment Optimal to pay higher wages than the competitive wage in order to motivate and keep workers Higher workers effort and productivity means higher profit for the company The company weighs the cost against the benefit of setting a higher wage 18
The labour market: A model of wage setting and unemployment Higher wage More effort, two reasons: Gift exchange (Akerlof 1982): I treat you well and you treat me well AND Shirking We consider the efficiency wage model developed by Shapiro and Stiglitz (1984) Workers choose level of effort The company cannot monitor perfectly (costlessly) its workers (if a worker is exerting effort while working or he is shirking and so unproductive) If caught shirking he gets fired 19
The labour market: A model of wage setting and unemployment To discourage shirking the company would pay a higher wage to inflict a cost on those who shirk and lose their job! This would be an optimal for all other companies as well, so the incentive not to shirk fade away, BUT As average wage is higher now, labor demand falls and this results unemployment ( Equilibrium unemployment as a worker discipline device ) Monitoring, unemployment and wages are substitutes 20
The labour market: A model of wage setting and unemployment Model s assumption: Fixed supply of identical workers Workers put either 0 effort (e=0) or some fixed e>0 Shirkers (e=0) are detected with probability q per unit of time Workers utility: u = w e Unemployment benefit is b Utility of a non shirker and a shirker: u N = w e u S = θw + (1- θ)b 21
The labour market: A model of wage setting and unemployment Θ is the fraction of time that a shirker is employed The worker will not shirk if u N > u S So no shirking condition: w-e > θw + (1-θ)b w > b + e 1 θ Let f be the probability of finding a job, expected duration of a job = 1/q and expected duration of an unemployment spell = 1/f, thus: θ = 1/q 1 q +1/f or 1 1 θ = 1 + f q w > b + e 1 + f q we 22
The labour market: A model of wage setting and unemployment Efficiency wage, w e is high when: Unemployment benefits are high q is low f is high Equilibrium value of f: the inflow of workers into unemployment, sn, equals to outflow from unemployment, f(l-n) f = sn 1 u = s L N u Where s is the probability of losing a job. w > b + e + e/q(s 1 u u ) we w e falls with u (discipline device) and is not consistent with full employment 23
The labour market: A model of wage setting and unemployment 24
The labour market: A model of wage setting and unemployment Key results: Involuntary unemployment During a recession labour demand decreases and so the wage should decrease. However in the case of efficiency wages, the wage will not decrease enough to reach the competitive wage. This implies that involuntary unemployment will still arise 25
Evidence on Efficiency Wage Presence of substantial inter-industry wage differences Such wage differentials are consistent with efficiency wage theories since the monitoring problem (q in terms of the model above) is naturally more serious in some industries than others. But they are also consistent with lots of other models. Moreover, the exact extent of true inter-industry wage differentials is quite debatable. 26
Evidence on Efficiency Wage For example, these differentials may reflect compensating wages (since some jobs may be less pleasant than others) or premia for unobserved characteristics of workers, which differ systematically across industries because workers select into industries based on their abilities. 27
The labour market: Search frictions Workers and jobs are not homogenous. You need the right person for the job and he/she has to be willing to take it It takes time for an unemployed person to find a job and for a company to find someone to employ If the matching process works poorly, unemployment will be higher 28
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The labour market: Search frictions Factors that influence the search for employment: How intensively unemployed workers look for work How picky the unemployed are when they choose what jobs they will look for and accept How well the unemployed can compete for the jobs If the unemployed don t apply for or cannot compete for the available jobs, wages are not held back. The wage setting curve is higher up and equilibrium unemployment is higher. 30
The labour market: Search frictions Many factors affect the functioning of the labour market: Rules for receiving unemployment compensation (level, duration, demands for compensation) The ability of the educational system to equip the labour force with the skills that are in demand (degree of mismatch in the labour market) Labour market policy (employment office, employment training courses) 31
The labour market: Labour unions Workers form unions and threaten to go on strike if they don t get the wage they want The result can be higher wages and higher unemployment 32
The labour market: Labour unions 33
The labour market: Labour unions Coordination of wage negotiations is important: Negotiations on the company level: wages are held back by stiff competition between companies Negotiations on the sector level: strong unions that don t take macroeconomic effects into account Negotiations on the central level or strong coordination: the unions take account of the consequences for the macro economy 34
The labour market: Minimum wages In many countries there is a statutory minimum wage and most collective agreements include a floor for the wage High minimum wage can cause high unemployment, especially among low-skilled groups The problem becomes more difficult as recent technical developments seem to favour the highly educated (skillbiased technical change) 35
The labour market: Minimum wages 36
The labour market: Why does unemployment differ between countries? 37
The labour market: Why does unemployment differ between countries? 38
The labour market: Why does unemployment differ between countries? Theory The unemployment benefit system: benefit levels, duration benefits and requirements on those who get benefits (search and take relevant jobs) The wage negotiation system: strength of labour unions and degree of coordination, minimum wages Labour market policy The education system Employment protection and taxes 39
The labour market: Why does unemployment differ between countries? Empirical methods Many of these factors are hard to measure and compare across countries Macro studies of differences in unemployment between different countries ( cross-section ) Macro studies of changes over time in unemployment in different countries ( panel studies ) Micro studies using individual data, often studying the effects of specific changes in policy ( panel studies or repeated cross sections, difference in difference ) 40
The labour market: Why does unemployment differ between countries? Empirical results Countries with generous unemployment compensation tend to have higher unemployment Rise in unemployment when compensation became more generous (early 1970s) and decline when conditions became stricter (80-90s) Micro studies show an elasticity of about 0.5: increase in benefit by 10 per cent increases unemployment period (duration) about 5 per cent Benefit from 60 to 66 per cent of previous wage unemployment from 6 to 6.3 per cent of labour force 41
The labour market: Why does unemployment differ between countries? Empirical results Cross-country evidence: strong unions raise unemployment but coordination of wage bargaining reduces unemployment Employment protection and taxes seem less important for unemployment Labour market programs show mixed evidence: some programs work, some don t Much focus now on skill-biased technical change and globalisation 42
The labour market: Why has unemployment gone up over time in many countries? Persistence: High unemployment in itself seems to lead to continued high unemployment Theories: Loss of human capital during unemployment period When insiders bargain about wages they don t take into consideration the fact that there is high unemployment 43