Simulating the Impact Simulating the Impact of Economic Shocks on of Economic Shocks on Employment and Wages Employment and Wages

in Multi-sector Labor in Multi-sector Labor MarketsMarkets

James AlbrechtJames AlbrechtCatalina GutierrezCatalina Gutierrez

Pierella PaciPierella PaciBeom ParkBeom Park

BackgroundBackground

Our knowledge about the potential impact of the Our knowledge about the potential impact of the crisis on employment and earnings, is limited.crisis on employment and earnings, is limited.

From past crises we have seen that response in From past crises we have seen that response in DC’s can take very different formsDC’s can take very different forms

Unemployment is just one effect, and not always Unemployment is just one effect, and not always the most prominent onethe most prominent one

Relocation of labor across sectors, including Relocation of labor across sectors, including backward migration to agriculture, and backward migration to agriculture, and adjustment in earnings are often more important.adjustment in earnings are often more important.

Using employment elasticities to predict the Using employment elasticities to predict the effect of crises can be misleading or mask other effect of crises can be misleading or mask other important issues, when adjustments are not important issues, when adjustments are not through overall employment changes.through overall employment changes.

Main objectiveMain objective Construct a model that better reflects the Construct a model that better reflects the

characteristics of labor markets in DCcharacteristics of labor markets in DC– Several segments with different rules for Several segments with different rules for

earnings determination for identical workers, earnings determination for identical workers, and differences in marginal productivity.and differences in marginal productivity.

– Agricultural sector is a large employer, with Agricultural sector is a large employer, with movement out of it, implying costs and movement out of it, implying costs and requiring internal migrationrequiring internal migration

– Large self-employment, informal sector and Large self-employment, informal sector and share of low earnersshare of low earners

– Mobility between segments may be limitedMobility between segments may be limited– Unemployment is many times a luxury state Unemployment is many times a luxury state

that only the better off can affordthat only the better off can afford This means we need to depart from unified This means we need to depart from unified

competitive settingscompetitive settings

Modeling Strategy: Modeling Strategy: Combine several building Combine several building blocksblocks Albrecht, Navarro and Vroman (2008)Albrecht, Navarro and Vroman (2008)

– Search model with informal sector with Search model with informal sector with informality being a results of optimizing informality being a results of optimizing choice for low skill workerschoice for low skill workers

Satchi and Temple and (2006), Satchi and Temple and (2006), – Search model with rural-urban Search model with rural-urban

migration, bargained and efficiency migration, bargained and efficiency wageswages

Fields (1975)Fields (1975)– Rural-urban migration with informal Rural-urban migration with informal

sector and informality being a result of sector and informality being a result of exclusion due to fixed non comp. wagesexclusion due to fixed non comp. wages

The modelThe model: : Worker flows and Worker flows and LM structureLM structure

Unemployment

Costly migration

•Wages are bargained •Positive returns to skills•There are wage floors•Government pays fixed wage

High Productivity jobs Low Productivity Jobs

Agriculture

•Workers receive •fixed earnings (no returns to skills)

Workers are paid average product of labor

URBAN

RURAL

5. The Model:5. The Model: The structure of The structure of segmentationsegmentation

Y* Y**

yrCase 1: yr>Y*Case 1: yr<Y*

Only good jobsBoth good and

bad

Only bad jobs

skills

Simulating the financial Simulating the financial crisiscrisis An decrease in TFP in good jobs sector An decrease in TFP in good jobs sector AA11 An increase in good sector turbulence An increase in good sector turbulence λλ Should there be other feedbacks to informal and Should there be other feedbacks to informal and

agriculture ? Lower agriculture ? Lower yy00, lower , lower AA0, 0, An increase in An increase in bad sector turbulence bad sector turbulence δδ??

Simulations:Simulations:– I. -10% in I. -10% in AA11, , +10% +10% λλ

– II.II. -10% in -10% in AA11, , +10% +10% λλ & -5%& -5% y y00, +5% , +5% δδ

– III. III. -10% in -10% in AA11, , +10% +10% λλ & -10%& -10% y y00, +10% , +10% δδ– Alternative bargaining power as a measure of rigidity Alternative bargaining power as a measure of rigidity

((ββ=1/2 and =1/2 and ββ=1/3)=1/3)

  Good Jobs Sector Bad Jobs Sector Agriculture Total Economy

Bargaining parameter =1/2

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Benchmark 2,415   1,252   1,072   1,225  I. Crisis hits only the good jobs sector

2,847 17.9 1,252 0.0 1,072 0.0 1,200 -2.0II. Crisis hits good jobs sector more than bad jobs sector 2,466 2.1 626 -5.0 1,015 -5.3 1,178 -3.8III. Crisis hits good jobs sector and bad jobs sector equally 2,146 -11.1 1,127 -10.0 960 -10.4 1,147 -6.3     Good Jobs Sector Bad Jobs Sector Agriculture Total Economy

Bargaining parameter 1/3

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Average Earnings ($C)

Change in Earnings (%)

Benchmark 2,415   1,252   1,072   1,225  

I. Crisis hits only the good jobs sector 2,300 -4.8 1,252 0.0 1,072 0.0 1,170 -4.5

II. Crisis hits good jobs sector more than bad jobs sector

1,999 -17.2 626 -5.0 1,015 -5.3 1,142 -6.7

III. Crisis hits good jobs sector and bad jobs sector equally

1,765 -26.9 1,127 -10.0 960 -10.4 1,109 -9.5

ConclusionsConclusions

Formal sector employment is more likely to Formal sector employment is more likely to contract if the informal sector can buffer the shock contract if the informal sector can buffer the shock and the workers have more bargaining power (firms and the workers have more bargaining power (firms can’t pass the lower profitability in the form of can’t pass the lower profitability in the form of lower wages)lower wages)

Adjustment in formal wages is more likely if Adjustment in formal wages is more likely if workers have a reduced bargaining power and if workers have a reduced bargaining power and if the informal sector can’t buffer the shock.the informal sector can’t buffer the shock.

The stronger the effect on informal sector earnings, The stronger the effect on informal sector earnings, the more likely backward migration will take placethe more likely backward migration will take place

Allowing for backward migration to agriculture Allowing for backward migration to agriculture makes unemployment effects rather small. makes unemployment effects rather small. Unemployment effects can be large if there is no Unemployment effects can be large if there is no backward migration.backward migration.

Conclusions (cont.)Conclusions (cont.)

Small changes can have big impacts on Small changes can have big impacts on the allocation of labor.the allocation of labor.

Effects are not linear, elasticity is not kte.Effects are not linear, elasticity is not kte. What matters for the allocation of labor What matters for the allocation of labor

are relative returns in each sector.are relative returns in each sector. For overall poverty and welfare, returns For overall poverty and welfare, returns

within sectors will be a key determinant.within sectors will be a key determinant. To simulate economic shocks such as the To simulate economic shocks such as the

financial crisis it is important to financial crisis it is important to understand which sectors will be affected understand which sectors will be affected and the likely magnitude of the effects. and the likely magnitude of the effects.

Extra slidesExtra slides

The ModelThe Model : the environment : the environment

SkillsSkills differ differ y~F(y:a,b)y~F(y:a,b) Good sectorGood sector The maximum productivity of a The maximum productivity of a

worker of skill worker of skill y y is is AA11yy Bad sector:Bad sector: income income yy00. . Agricultural sector:Agricultural sector: workers receive average workers receive average

income of labor income of labor yyaa=A=Aaa (l(laa) ) γγ-1-1.. unemployedunemployed receive a flow income receive a flow income bb < < yy00.. Shocks to bad jobsShocks to bad jobs arrive at a rate arrive at a rate δδ and are and are

destroyed.destroyed. Shocks to good jobsShocks to good jobs arrive at a rate arrive at a rate λλ and affect and affect

the productivity of the worker, reducing it to the productivity of the worker, reducing it to y’≤yy’≤y ‘‘BBad sectorad sector’ employment opportunities arrive at a ’ employment opportunities arrive at a

rate rate αα,, ‘‘Good SectorGood Sector’ opportunities will arrive at a rate ’ opportunities will arrive at a rate

that depends on the number of vacancies relative that depends on the number of vacancies relative to the number of workers searching to the number of workers searching m(v/u)m(v/u) . .

The Model : Agents The Model : Agents decisionsdecisions

Firms decide whether to open a vacancy and hire a Firms decide whether to open a vacancy and hire a worker when it meets oneworker when it meets one

Unemployed workers decided whether to accept or Unemployed workers decided whether to accept or not employment opportunities as they arrive. not employment opportunities as they arrive. – They will accept a bad jobs if They will accept a bad jobs if NN00 > > U(y)U(y). . – They will accept a good jobs if They will accept a good jobs if NN11 > > U(y)U(y)

Once an unemployed and a (good sector) firm meet Once an unemployed and a (good sector) firm meet they bargain on a wage. they bargain on a wage.

When a shock to good job arrives workers and firms When a shock to good job arrives workers and firms decide whether to destroy the job or not. decide whether to destroy the job or not. will be a hiring standard will be a hiring standard RRff(y)(y) (firm) and reservation (firm) and reservation

productivity productivity R(y)R(y) (worker) below which it is not worth to (worker) below which it is not worth to keep the job, and it will depend on the worker type. Wages keep the job, and it will depend on the worker type. Wages are re-negotiated.are re-negotiated.

1

1 1( ', ) arg max ( ', ) ( ) ( ', )w y y V J y y U y N y y

4. The Model : 4. The Model : agent’s agent’s decisions (cont.)decisions (cont.)

A worker will migrate if the value of agricultural A worker will migrate if the value of agricultural employment employment NNaa(y)(y) is lower than the expected value is lower than the expected value of being unemployed and searching for a job of being unemployed and searching for a job U(y) U(y) net of migration costs net of migration costs ((M)M)

SolutionSolution To solve the model we find the value of To solve the model we find the value of

being in each state, and rules that being in each state, and rules that guarantee that agents take maximizing guarantee that agents take maximizing decisionsdecisions

The steady state solution of these values The steady state solution of these values (i.e. the equilibrium) has to satisfy:(i.e. the equilibrium) has to satisfy:– Workers and firms are maximizing at the Workers and firms are maximizing at the

bargained wagebargained wage– It is not profitable to create new jobs (The value It is not profitable to create new jobs (The value

of opening a new vacancy is zero or job of opening a new vacancy is zero or job creation condition)creation condition)

– The inflow out-of and in-to each state equates The inflow out-of and in-to each state equates (steady state conditions)(steady state conditions)

– There is no migration (benefit of migrating net There is no migration (benefit of migrating net of migration cost is zero for the marginal of migration cost is zero for the marginal migrant with skills yr)migrant with skills yr)