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Macroeconomics of the labour market
Leszek Wincenciak, Ph. D.
October 28th, 2009
Structure of the course
• Advanced labour market economics
• 6 classes:
– Introduction and review of stylized facts on contemporary labour market
– Natural rate of unemployment and NAIRU
– Modern theories of unemployment:
• Efficiency wages models
• Wage bargaining and unions
• Search and matching theory
Structure of the course
• Final exam covers labour macroeconomics as well as advanced macroeconomics (2 sets of questions)
• Problem set – sample problems
• Office hours: Wednesday, 13.15-14.45, room 410
• E-mail: [email protected]
• Slides available at: http://www.development.wne.uw.edu.pl/index.php/Courses/AdvancedMacroeconomicsLabour
Literature
Recommended textbooks:
Layard R., Nickell S., Jackman R., Unemployment. Macroeconomic Performance and the Labour Market, London 1991
Romer D., Advanced Macroeconomics, (chapter ‘Unemployment’), various editions.
Articles – listed on MADE website
Today’s lectureShort revision of basic labour market categories: static vs dynamic
analysisAssessing labour market performance: key indicators
Labour market performance: review of key results
Short revision of simple neoclassical model of labour market:
labour as factor of production, labour supply,
labour demand, wages, unemployment
Imperfections on the labour market
Labour market institutions
Imperfect flexibility of wages and its sources
Heterogeneity of the labour force and its results
Basic macroeconomic relations: Phillips curve and Okun law
Part I: Basic labour market definitions
Static versus dynamic analysis
Overview of the labour market
Working age
population
Labour force
(those who
want to work)
Economically
inactive
population
Employment:
employees
and self-
employed
Unemployed
How to assess labour market situation?• Good and efficient labour market?• Traditional approach: low unemployment rate• Recent trends: stress on employment rate• Other goals:
– Lower economic unemployment, particularly in case of groups threatened with unemployed more than others and long-term unemployed (risk of social exclusion),
– Labour market flexibility, allowing for fast and smooth adjustment of employers and employees to fast changes ongoing in contemporary open economy (technological shocks and international competition),
– High-quality work (highly productive work, safe working conditions, respect for basic employees’ rights),
– Accumulation of human capital resources, providing incentives for investments in own qualifications,
– Counteracting segmentation of the labour market and discrimination
Labour market performance: basic measures
• Participation rate
• Employment rate
• Unemployment rate
LF
Uu
POP
LFa
POP
Ee
Examples of labour market performance measures
Measure USA
September 2009
Poland
II q. 2009
Participation rate 65.2% 54.7%
Employment rate 58.8% 50.4%
Unemployment
rate
9.8% 7.9%
Labour market flows – dynamicapproach
Part II: Some stylized facts on labour market performance
Unemployment fluctuates over time
There is a lot of persistence inunemployment
)051.0(
877.00080.0
)039.0(
934.00041.0
1
1
tt
tt
UU
UU (UK, 1900-1989)
(US, 1890-1990)
In the very long run unemploymentshows no trend
Take the time series representation for unemployment:
where is the long run unemployment (6.21% for the UK). We can derive the transition speed as follows:
1
0110
1UUU tt
01
1
1
2
10
010101102
0101
]1[
][
UU
UUU
UU
tt
t
U
We thus find that:
where is the unemployment rate in some base year.
• Experiment: Suppose that the unemployment rate is currentlyand the long-run unemployment rate is . How many
periods (T) does it take, for example, before half of the difference is eliminated? We can use T (the „half life”) as the indicator for the adjustment speed in the system:
Which for the UK is about 10.2 years!
t
t UUUU 10 ][
U
0U U
][ 0 UU
1
1
010
ln
2ln
2
1
][2
1][
T
UUUUUU
T
T
T
Unemployment is countercyclical
Unemployment varies greatly amongcountries
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
1980 1985 1990 1995 2000 2006
France
Germany
Ireland
Italy
Japan
Poland
United Kingdom
United States
European Union 15
Europe
Unemployment duration
02468
10121416182022242628
1970 1975 1980 1985 1990 1995 2000 2005
Mexico
Norway
Poland
Spain
Switzerland
United States
Europe
Long term unemployment(over 1 year as % of the unemployed)
0
10
20
30
40
50
60
1970 1975 1980 1985 1990 1995 2000 2005
France
Germany
Japan
Poland
United Kingdom
United States
Europe
Structural unemployment
Unemployment varies greatly amongdifferent groups of workers
Sex Men Women
Age 15 to 24 25 to 64 Total 15 to 24 25 to 64 Total
Country
Australia 10.9 3.6 4.8 9.8 3.9 5.0
Canada 12.9 5.4 6.5 10.3 5.2 6.0
Czech Republic 16.6 4.8 5.8 18.6 8.0 8.8
Finland 19.3 5.8 7.4 18.4 6.6 8.0
France 22.4 7.6 9.0 25.8 9.3 10.7
Germany 14.2 9.9 10.3 12.6 10.0 10.2
Hungary 18.6 6.2 7.2 19.8 6.9 7.8
Italy 19.1 4.3 5.4 25.3 7.4 8.8
Japan 8.8 4.0 4.3 7.2 3.6 3.8
Korea 11.7 3.6 3.8 9.0 2.3 2.9
Mexico 5.4 2.4 3.0 7.4 2.5 3.5
New Zealand 9.3 2.3 3.5 10.0 2.8 4.1
Norway 8.6 2.7 3.5 8.7 2.5 3.4
Poland 28.3 11.1 13.0 31.6 12.9 14.9
Portugal 14.5 6.0 6.5 18.4 8.5 9.0
Spain 15.0 5.3 6.3 21.6 10.2 11.6
Sweden 21.1 5.1 6.9 21.5 5.1 7.1
Switzerland 7.9 2.7 3.4 7.5 4.3 4.7
Turkey 18.2 8.2 9.7 19.8 7.6 10.3
United Kingdom 15.8 4.1 5.7 11.8 3.6 4.9
United States 11.2 3.5 4.6 9.7 3.8 4.6
European Union 15 15.8 6.2 7.2 16.4 7.8 8.7
G7 countries 12.9 4.9 5.8 11.3 5.3 6.0
North America 9.6 3.4 4.4 9.2 3.7 4.6
OECD countries 12.6 5.0 5.9 12.3 5.6 6.4
Key concepts of neoclassical labour market theory
Labour as a factor of production
• Factor of production (service)
• Service similar to other – demand, supply, price (wage)
• Specifics of labour – derived demand from final goods’ demand
• Different perspectives of analysis: household, industry, country
• Limited supply of factor (population, education lags etc)
Labour supply
• Labour-force member behaviour: do I want to work? How much? What job? Where?
• Decision on work is a decision on spending of time. Time is an asset we have. It is one of scarce resources
• We divide our time between leisure and work
• In the simplest model we do not take into account education (increased earnings in future) or differences between household work and hired employment (both are treated as employment)
Labour supply
• The simplest model formulates the following problem:
– how to divide 16 hours we have everyday (suppose that 8 hours we spend sleeping, eating etc) between work and leisure?
• When we rest, we don’t work, therefore instead of thinking about factors determining labour supply, we may re-formulate our problem into a question on factors determining demand for leisure– standard demand model
Labour supply
• To simplify, we may say that demand for a given good depends on:
– Price of that good
– Level of income, wealth
– Preferences
– Prices of complementary goods and substitutes
• What is a price of an hour of leisure?
– A wage for one hour of work (concept of alternative cost)
Labour supply: conclusions from demand theory
• Income effect: increase of income leads to growth of demand, therefore with constant wages and preferences, growth of wealth leads to a reduction of labour supply
• Substitution effect: increase of a price of good, with constant income, leads to fall of demand, therefore increase of wage leads to fall of demand for leisure and increase of labour supply
Which effect prevails?
• When income effect is stronger – growth of wage leads to a fall of labour supply (fall is smaller than in the case of non-wage income growth, since substitution effect works as well)
• When substitution effect is stronger – labour supply curve has positive slope and when income effect is stronger – labour supply curve has negative slope
• We may expect that for lower levels of wages, substitution effect is stronger and for higher level of income – income effect is stronger
Labour supply curve
SPłacarealnaw/p
Oferowanaliczba godzin pracy
Real
wage
Number of hours of work
offered
„For less than 10 000 $ I don’t even get up from bed”, reservation wage
• Linda Evangelista and her reservation wage
• Persons not belonging to labour force price additional hour of leisure for some value X; if market wage is lower than X they do not enter labour market at all
• Role of costs of traveling to work
• Social benefits system
Choice of employment by firm – labour demand
• A firm employs worker only if revenue it gets from his/her work is at least as high as his/her wage
• If this revenue (VMPL – value of marginal product o labor) is higher than wage, it is profitable to increase employment
• If employment cost (wage) is higer than VMPL (value of marginal product o labour), it is rational to decrease employment
• Equilibrium demand is determined by the value of a marginalproduct – MPL curve
Mariginal product of labour and realwage
MPL
Zatrudnienie
Płacarealnaw/p
Real
wage
Employment
Labour market equilibrium
Popyt
Zatrudnienie
Płacarealnaw/p
Podaż
L
w/p
Real
wage
Supply
of
labor
Demand
for
labor
Employment
Are wages flexible and clear the market?• Labour market is in equilibrium when labour supply equals labour
demand at given level of wage – unemployment in this view istotaly voluntary
• Is unemployment always voluntary? If at any given level of wages, there exists an excess demand or excess supply of labour, unemployment is involuntary – why then do not wages fall?
• Efficiency wages – shirking (moral hazard problem), costlymonitoring of workers’ effort or efficiency effects of higher wages
• Labour unions negotiate higher wages for union members – insidershave more bargaining power
• Labour force heterogeneity and structural mismatch – jobs and workers are different and need time and scarce resources to be matched together
• Institutional context – minimum wage, layoffs rules, severancepayments, costs of hirings and firings – insiders and outsidersapproach, labour market segmentation, labour market sclerosis and hysteresis
Employment protection and labour market flows – simple cross-country correlations
OECD EMPLOYMENT OUTLOOK 2004
Labour market and macroeconomics: basic relations
Macroeconomics and labour market –classical interdependences
Demand
Production Prices
Employment
Unenployment≈
Okun’s lawPhillips
curve
Phillips curve• In the paper written in 1958 and titled „The Relationship between Unemployment
and the Rate of Change of Money Wages in the United Kingdom 1861–1957”, Phillips describes an inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries, so Phillips postulated explicit link between inflation and unemployment: when inflation was high, unemployment was low, and vice-versa.
• Many economists in the advanced industrial countries believed that his results showed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governments could control unemployment and inflation within a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemployment – there would be a trade-off between inflation and unemployment. For example, monetary policy and/or fiscal policy (i.e., deficit spending) could be used to stimulate the economy, raising GDP and lowering the unemployment rate. Moving along the Phillips curve, this would lead to a higher inflation rate, the cost of enjoying lower unemployment rates.
Phillips curve
π
0
u u*
Long run Phillips curve
Short run Phillips curve
Phillips curve – USA, 1960s
Phillips curve – USA, 1974-1990
Phillips curve – Poland, 1992-2005, yearly data
Okun's law• Named after economist Arthur Okun who proposed the relationship
in 1962 – describes a relationship between the change in the rate of unemployment and the difference between actual and potential realGDP
• In the United States during the period since 1965, Okun's law can be stated as saying that for every one percentage point by which theactual unemployment rate exceeds the "natural" rate of unemployment, real GDP is reduced by 2% to 3%
• That is for every 1% excess of the unemployment rate, a 2% to 3% reduction in GDP is predicted
• The difference between actual and potential GDP is called the GDP gap
• Okun's law is more accurately called "Okun's rule of thumb" because, like Moore's law in semiconductors, it is primarily an empiricalobservation rather than a result derived from theory. Okun's law isapproximate because factors other than employment (such as productivity) affect output. The relationship varies depending on thecountry and time period under consideration
Okun's law• The relationship has been tested by regressing change in the
unemployment rate on GDP or GNP growth. Martin Prachowny estimatedabout a 3% decrease in output for every 1% increase in the unemploymentrate (Prachowny 1993). The magnitude of the decrease seems to be declining over time in the US. According to Andrew Abel and Ben Bernanke, estimates based on data from more recent years give about a 2% decreasein output for every 1% increase in unemployment (Abel, Bernanke, 2005).
• There are several reasons why relationship between changes in GDP and unemploment might be different than predicted:– As unemployment increases, unemployed persons may drop out of the labor force
(discouraged worker effect), after which they are no longer counted in unemploymentstatistics
– employed workers may work for shorter hours
– labour productivity may decrease, perhaps because employers retain more workers thanthey need (costs of firing, labour hoarding)
• One implication of Okun's law is that an increase in labour productivitytogether with an increase in the size of the labor force means that realoutput grows without unemployment rates falling (the phenomenon of "jobless growth”)
Okun's law: quarterly GNP growth and change in the unemployment
rate
Data period: 1947q2 - 2002q4
(d GNP/GNP) = 0.856 - 1.827x(dU)
Adj R2 = 0.504
Okun's law: yearly GNP growth and change in the unemployment rate
Data period: 1970 - 2008
(d GNP/GNP) = 2.988 – 1.735 x (dU)
Adj R2 = 0.704
What links Phillips curve and Okunlaw?
• Concept of natural rate of unemployment
....Next lecture
