Diverging unemployment trends Diverging unemployment trends across the two shores across the two shores of the Atlantic Oceanof the Atlantic Ocean

Francesco DaveriFrancesco Daveri

The labor market on the two shores of the Atlantic Ocean

UNEMPLOYMENTUNEMPLOYMENT

Part I: measurementPart I: measurementPart II: causesPart II: causes

Part I firstPart I first

Dictionary: employment

The International Labor Office (ILO) calls “employed” all persons above a specified age (typically 15) who during a specified brief period, either one week or one day, were in the following categories: - paid employment; - self employment

This definition includes:

• those having worked for at least an hour in the last week or day

• those with a paid job, even if they did not do paid work in the last week

• those who did at least one unpaid hour of work in a family-owned business in the last week

Actual definitions of employment still vary across industrialized countries; however, the remaining differences are in most cases not very significant

Dictionary: unemployment

The ILO calls “unemployed” those individuals above 15 who:

neither performed any gainful dependent activity in the reference period nor were self-employed

are looking for a paid job actively searched for a job in the last month are willing to immediately accept a job offer (in two weeks)

Also the individuals that are waiting for the start date of a new job are classified as “unemployed”

Dictionary: Labor Force

• The labor force is the total number of potential workers, inclusive of both the employed and the unemployed

• The labor-force participation rate is the percentage of the adult population that is in the labor force

• The labor force participation rate is a measure of the proportion of an economy's working-age population that is economically active

• It provides an indication of the relative size of the supply of labor available for the production of goods and services

Young (<15) and old (>64)20 mn

Non-participants (students, sick, housewives and “househusbands” not looking for a job) 15

Total Population 60 mn

Working-age population 40 mn

Labor force 25

Employed 22 mn Unemployed 3 mn

To better fix concepts: Italy’s population tree (with round numbers)

Checking the dictionary: labor force participation and unemployment rates in Italy

The labor force participation rate is calculated as the percentage of the working-age population that is potentially employable (Italy = 25/40 = 62,5%).

• The average number for the Eurozone (EZ) is 71,5% (Germany is at 77,8%; Spain is at 74%)

The unemployment rate is calculated as the percentage of the labor force that is unemployed (Italy = 3/25 = 12%)

• The EZ number is some 11%

Quick Quiz: the labor market in a fairy tale

(1) Count the employed and the unemployed

(2) Calculate the unemployment rate and the participation rate in the land of Snow White

The labor market in the land of Snow WhiteGiven that

1. Snow White doesn’t participate in labor market though in working age

2. Dopey (Cucciolo) is <15 and Doc and the other dwarfs within 15-64 age interval.

Hence:

Employed = 6 (Snow White doesn’t work; Dopey <15 so excluded; Doc<64 included)

Unemployed = 0 (Snow White doesn’t work BUT she is not looking for a job)

Unemployment rate = 0,0%

Labor force participation = 85,7% (=6/7)

Female labor force participation rate = 0,0% (but female unemployment is also 0!)

Three Transatlantic unemployment puzzles

1) Before the crisis: unemployment much lower in the US than in the EZ (mind the scale on the y-axis!)2) In 2008-09: steeper rise of unemployment in the US than in the EZ3) Since 2010: unemployment declines in the US, keeps growing in the EZ

UNEMPLOYMENTUNEMPLOYMENTPart I: measurementPart I: measurement

Part II: causesPart II: causes

we do Part II nextwe do Part II next(so as to solve the three puzzles)(so as to solve the three puzzles)

The LABOR market is a MARKETThe LABOR market is a MARKETSoSo

It works through It works through interaction of interaction of

Demand and SupplyDemand and Supply

Model of labor market under perfect competition (workers and firms take wage as given and adapt their decisions)

Rea

l Wag

e

Employment

Labor supply

Labor Demand

W0

L0

Why labor demand negatively sloped with respect to the real wage

Firms want to maximize profits by hiring people

Rule of thumb: hire as long as marginal benefit of hiring a worker higher than its marginal cost

Marginal benefit from hiring: MPL (marginal productivity of labor) Amount of extra output produced by one more worker Assume: decreasing returns to extra workers (think of workers lining

up in decreasing order of productivity for the firm)

Marginal cost: real wage

In perfectly competitive labor market, real wage (=money wage divided by price level) taken as given by firms

Rule of thumb for hiring decisions: if MPL>real wage (i.e. if additional worker adds more to output than to costs) then: hire

Otherwise: don’t hire

Labor demand curve: how many people companies hire for any real wageAs real wage falls, demand for labor increases and MPL decreases along the same LD (hence for given capital and technology)

Labor Demand=MPL

Employment

Rea

l Wag

e

W0

L0

W1

L1

What if capital is accumulated and/or better technology becomes available?

Labor Demand=MPL

Employment

Rea

l Wag

e

W0

L0L1

Answer: labor demand curve would shift to the right. For given wage W0, firms can afford hiring more people

New Labor Demand = MPL’

Summing up on labor demand

The demand for labor on the part of a firm may go up for two reasons

1) Lower real wages (shift along the curve) lower costs of hiring

2) Higher levels of capital and/or technology (shift of the curve) Higher benefits/needs from hiring

Labor supply

Labor supply (from households to firms) is positively sloped with respect to wages

As wage changes a Substitution effect occurs. Higher wage means price of leisure (lost income) is higher and so consume less leisure. Tends to supply more labor

There might also be an Income effect. Higher wage means people have more income and want to buy more of all goods, including leisure. This effect leads to lower labor supply

We assume that for most people the substitution effect prevails over the income effect.

So: we draw the labor supply curve as upward sloping

Labor supply curve: how many people willing to work households feel like supplying to companies for any real wageAs real wage rises, willingness to supply labor increases along same LS (hence for given unemployment subsidy or black economy wage)

Rea

l Wag

e

Employment

Labor supply

W0

L0

W1

L1

What if unemployment subsidy goes down?Answer: Labor supply curve shifts downwards and therefore labor supply goes up. Now, with lower unemployment subsidy, more people (L1- L0) induced to work at the same wage, because their outside opportunities have worsened

Rea

l Wag

e

Employment

New Labor supply

W0

L1

Same effect if wage in the black economy goes down

L0

Labor supply

Summing up on labor supply

The supply of labor on the part of a household may go up for two reasons

1) Higher real wages (shift along the curve) Higher benefits from working

2) Lower unemployment subsidies or black market wage (shift of the curve) Lower opportunity costs from working

Summing up onSumming up on

the competitive labor market modelthe competitive labor market model

Three main features of the competitive labor mkt model 1) equilibrium (W0,L0) is there where LD and LS cross; 2) If real wage set too high (WH>W0), LD<LS i.e. there is excess supply of labor. Real wage must fall to eliminate excess supply;

3) If real wage set too low (WL<W0), LD>LS i.e. there is excess demand for labor. Real wage must rise to eliminate excess demand

Rea

l Wag

e

Employment

Labor supply

Labor Demand

W0

L0

WH

WLIt looks as though the competitive model delivers NO equilibrium unemployment (so may be useless for our purpose …)

Unemployment in the competitive labor market

In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring full employment

But there may be frictions or other obstacles causing unemployment

Frictional (or search) unemployment

• It takes time to match workers with jobs. Meanwhile, people may stay unemployed

• Search unemployment is often seen as voluntary

Structural (or wait) unemployment

• It might be the case that the number of jobs available in some labor markets is insufficient to give a job to all the job seekers

• Structural unemployment is typically involuntary and may have different causes

We concentrate onWe concentrate on

Structural - or Wait - UnemploymentStructural - or Wait - Unemployment

(the bad one)(the bad one)

Why is there structural unemployment?

Three main reasons

1. Minimum wage legislation and unions

2. Efficiency wages

3. Employment Protection Legislation (EPL)

Minimum wage legislation and unionsWhen a minimum wage is set by law or a union above the level that would balance D-S of labor, unemployment shows up

Two groups of workers: the “lucky” (0LD) & the “unlucky” (LDLS)

WE

LE

Surplus of labor = Unemployment

Labordemand

Minimum wage

LD LS Quantity of Labor0

Wage

Laborsupply

Efficiency wages

Firms may freely choose to pay efficiency wages, i.e. wages higher than in competitive markets

Why? To reduce labor turnover To motivate workers to work harder To make workers well fed and healthier (more relevant in poorer countries)

Consequences? Same as above Wage floor, wait unemployment, two groups of workers Yet: this comes from company decisions, not from govt regulation or

bargaining, though

Employment protection legislation (EPL)

Goal: achieve labor market security by:• raising employment stability• giving higher chances to find a new job after a spell of unemployment• raising income security for labor market participants

EPL includes measures geared to protect jobs such as:•Severance pay requirements•Notice requirements•Government approval for layoffs

YET higher EPL has ambiguous effect on unemployment:•Reduces probability of being fired for those holding a job•Reduces probability of finding a job for those who haven’t one

Overall, EPL tends to reduce the risk of job loss, but it also has an adverse effect on exit rates from unemployment, thus prolonging the average unemployment spell• As such, EPL does not necessarily makes labor “more secure”, although it tends to make the existing jobs “more protected”

NOW at last READY to explain the three Transatlantic puzzles

Puzzle 1: US unemployment lower before the crisis. Why?

• Lower minimum wage, less unionization (Lower EPL also used to make unemployment less durable)

Puzzle 2: US unemployment quickly up during the crisis

• The other side of the coin: firms free to lay off upfront in the US and therefore labor demand falls a lot. Less so in Europe, where solidarity contracts and other contractual forms of EPL protect employment

Puzzle 3: US unemployment coming down, while it stays up in Europe

• Stronger growth in the US helps shift labor demand to the right.

• Higher EPL in Europe may have made European firms more reluctant to hire and increased persistence of unemployment