Simulating the Impact of Economic Shocks on Employment and Wages in Multisector Labor Markets

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Simulating the Impact of Economic Shocks on
Employment and Wages in Multi-sector Labor Markets

• James Albrecht
• Catalina Gutierrez
• Pierella Paci
• Beom Park

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Background

• Our knowledge about the potential impact of the
  crisis on employment and earnings, is limited.
• From past crises we have seen that response in
  DCs can take very different forms
• Unemployment is just one effect, and not always
  the most prominent one
• Relocation of labor across sectors, including
  backward migration to agriculture, and adjustment
  in earnings are often more important.
• Using employment elasticities to predict the
  effect of crises can be misleading or mask other
  important issues, when adjustments are not
  through overall employment changes.

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Main objective

• Construct a model that better reflects the
  characteristics of labor markets in DC
• Several segments with different rules for
  earnings determination for identical workers, and
  differences in marginal productivity.
• Agricultural sector is a large employer, with
  movement out of it, implying costs and requiring
  internal migration
• Large self-employment, informal sector and share
  of low earners
• Mobility between segments may be limited
• Unemployment is many times a luxury state that
  only the better off can afford
• This means we need to depart from unified
  competitive settings

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Modeling Strategy Combine several building blocks

• Albrecht, Navarro and Vroman (2008)
• Search model with informal sector with
  informality being a results of optimizing choice
  for low skill workers
• Satchi and Temple and (2006),
• Search model with rural-urban migration,
  bargained and efficiency wages
• Fields (1975)
• Rural-urban migration with informal sector and
  informality being a result of exclusion due to
  fixed non comp. wages

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The model Worker flows and LM structure

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

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

High Productivity jobs
Low Productivity Jobs
Unemployment
URBAN
Costly migration
Agriculture
Workers are paid average product of labor
RURAL
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5. The Model The structure of segmentation
Both good and bad
Only good jobs
Only bad jobs
skills
Y
Y
yr
Case 1 yrgtY
Case 1 yrltY
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Simulating the financial crisis

• An decrease in TFP in good jobs sector A1
• An increase in good sector turbulence ?
• Should there be other feedbacks to informal and
  agriculture ? Lower y0, lower A0, An increase in
  bad sector turbulence d?
• Simulations
• I. -10 in A1, 10 ?
• II. -10 in A1, 10 ? -5 y0, 5 d
• III. -10 in A1, 10 ? -10 y0, 10 d
• Alternative bargaining power as a measure of
  rigidity (ß1/2 and ß1/3)

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Conclusions

• Formal sector employment is more likely to
  contract if the informal sector can buffer the
  shock and the workers have more bargaining power
  (firms cant pass the lower profitability in the
  form of lower wages)
• Adjustment in formal wages is more likely if
  workers have a reduced bargaining power and if
  the informal sector cant buffer the shock.
• The stronger the effect on informal sector
  earnings, the more likely backward migration will
  take place
• Allowing for backward migration to agriculture
  makes unemployment effects rather small.
  Unemployment effects can be large if there is no
  backward migration.

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Conclusions (cont.)

• Small changes can have big impacts on the
  allocation of labor.
• Effects are not linear, elasticity is not kte.
• What matters for the allocation of labor are
  relative returns in each sector.
• For overall poverty and welfare, returns within
  sectors will be a key determinant.
• To simulate economic shocks such as the financial
  crisis it is important to understand which
  sectors will be affected and the likely magnitude
  of the effects.

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Extra slides
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The Model the environment

• Skills differ yF(ya,b)
• Good sector The maximum productivity of a worker
  of skill y is A1y
• Bad sector income y0.
• Agricultural sector workers receive average
  income of labor yaAa (la) ?-1.
• unemployed receive a flow income b lt y0.
• Shocks to bad jobs arrive at a rate d and are
  destroyed.
• Shocks to good jobs arrive at a rate ? and affect
  the productivity of the worker, reducing it to
  yy
• Bad sector employment opportunities arrive at a
  rate a,
• Good Sector opportunities will arrive at a rate
  that depends on the number of vacancies relative
  to the number of workers searching m(v/u) .

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The Model Agents decisions

• Firms decide whether to open a vacancy and hire a
  worker when it meets one
• Unemployed workers decided whether to accept or
  not employment opportunities as they arrive.
• They will accept a bad jobs if N0 gt U(y).
• They will accept a good jobs if N1 gt U(y)
• Once an unemployed and a (good sector) firm meet
  they bargain on a wage.
• When a shock to good job arrives workers and
  firms decide whether to destroy the job or not.
• ? will be a hiring standard Rf(y) (firm) and
  reservation productivity R(y) (worker) below
  which it is not worth to keep the job, and it
  will depend on the worker type. Wages are
  re-negotiated.

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4. The Model agents decisions (cont.)

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

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Solution

• To solve the model we find the value of being in
  each state, and rules that guarantee that agents
  take maximizing decisions
• The steady state solution of these values (i.e.
  the equilibrium) has to satisfy
• Workers and firms are maximizing at the bargained
  wage
• It is not profitable to create new jobs (The
  value of opening a new vacancy is zero or job
  creation condition)
• The inflow out-of and in-to each state equates
  (steady state conditions)
• There is no migration (benefit of migrating net
  of migration cost is zero for the marginal
  migrant with skills yr)