Outline

1
Outline

• Some key definitions
• institutions, markets and wedges
• labor market states
• A simple static framework and the wedge
• Why institutions?
• Learning from reforms difference-in-differences.
  Pressures coming from globalisation.

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
2
Key definitions

• An institution is a system of laws, norms or
  conventions resulting from a collective choice,
  and providing constraints or incentives which
  alter individual choices over labor and pay.
• A labor market is a market where labor services
  (specified in a vacant job) are sold for a
  remuneration called wage
• Institutions create a wedge between the value of
  the marginal job for the firm (fl) and the wage
  (w)

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
3
Labour Market States

• Employed, L (OECD-ILO convention)
• People in working age who, during the reference
  week (or day), have made for at least one hour
• paid work (also paid in nature) or
• self-employed work
• Paid work includes
• People who are not temporally working but who
  have formally a paid work (e.g. they have a
  salary, maternity leave, etc.)

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
4
Labor Market States (cont.)

• Unemployed, U
• People in working age who, during the reference
  week (or day), were
• without either paid or self-employed work,
• willing to work and
• looking for a job.
• Inactive O
• People in working age neither employed nor
  unemployed

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
5
Normalization rules

• Labour Force (LF) L U
• Working Age Population (N) LUO
• Unemployment rate (U/LF)
• Employment rate (L/N)
• Activity rate (or labor force participation rate)
  (LF/N)

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
6
Problem with OECD-ILO definitions

• Porous participation borders potential labor
  force excluded
• Relaxing job search requirement, less inactive
  (about 15 less inactive in the EU countries)
• Some discouraged workers (without work and
  willing, but not searching) are undistinguishable
  from the unemployed in terms of labor market
  transitions (Box 1.3)

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
7
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
8
A framework (generalities)

• Labor supply derived from labor-leisure (plus
  home production) choice
• Aggregation assuming that workers do not choose
  hours, just participation
• Heterogeneity in reservation wages
• (Derived) labor demand with markups
• Institutions implement a wedge between labor
  supply and demand

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
9
Labor/Leisure choice

• Preferences indifference curves are negatively
  sloped in c and l (negative MRS), do not
  interesect (no incoherence) and convex (MRS
  declining with l)
• Constraints (assuming away non-labor income)
• Hourly wage (w) as slope of the budget constraint
• Maximum amount of hours (l0) to be allocated to
  labor/leisure l0

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
10
Slope of individual labor supply

• Depends on relative magnitude of
  income/substitution effects.
• With leisure as normal good, income effect
  negatively affects labor supply
• Substitution effects always positive on hours
  worked
• Generally substitution effects dominates for
  low-wage earners while income effect for high
  wage earners
• Income effect irrelevant at participation margins

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
11
Total effect of a wage rise
Money Income
C
192
Observed Change
N2
B
128
N3
N1
64
U2
U1
A
Hours of Leisure
0
8
16
5
16
8
11
Hours of Work
0
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
12
The Income Effect
Money Income
Income effect
192
B
128
N3
N1
64
U2
U1
A
Hours of Leisure
0
9
16
8
16
7
8
Hours of Work
0
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
13
The Substitution Effect
Money Income
C
192
Substituiton efffect
N2
128
N1
64
U2
A
Hours of Leisure
0
5
8
16
16
11
Hours of Work
8
0
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
14
The (static) reservation wage

• It is the lowest wage at which a jobseeker is
  willing to work (slope of IC at l0 and non-labor
  income level)
• At that level elasticity of individual labor
  supply is always positive (substitution effect
  dominates)
• Reservation wage is increasing in non-wage income
  and discriminates employment from non-employment

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
15
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
16
From individual to aggregate labor supply

• Adding up hours worked by each individual
• Heterogeneity in non-wage income (or
  preferences), hence in reservation wages, wr
• If individuals can only offer fixed number of
  hours of work, then aggregate labour supply
  follows distribution of wr (N F(wr) where N is
  working age population) and is always increasing
  in wages

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
17
Participation rateAggregate labour supply
1
.8
.6
.4
.2
0
-5
0
5
error
cum_ger
cum_dnk
cum_bel
cum_lux
cum_fra
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
18
(Derived) labor demand and equilibrium

• From profit maximisation of individual firms
• The optimal employment level equals the value of
  the marginal product of labour (fl) to the wage
  (w) f (l) w
• As flt 0, labour demand is decreasing in wages

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
19
Why Institutions?

• Three arguments for their existence
• Efficiency a competitive LM does not exist
• Equity as no lump-sum transfer is available,
  redistribution is distortionary
• Policy failure heterogeneity and powerful
  minority interest groups inertia of institutions

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
20
Institutions and wedges
L1S (w)
w
w
U
LS (w)
L0S (w)
Wedge
Wedge
Ld (w)
Ld (w)
L
L
L
L
Price-Based Institutions and the Wedge
Quantity-Based Institutions and the Wedge
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
21
Increasing employment bias of LM institutions?

• In the 1950s and 1960s US enviously looking at
  European institutions. In the 1980s and 1990s
  the other way round.
• Interactions between shocks and institutions
  (e.g., shocks create U, EPL or UBs make it
  longlasting)
• Under stronger competitive pressures, LM
  institutions may have higher costs in terms of
  foregone employment

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
22
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
23
Effects of increased product market competition
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
24
Stronger pressures for institutional reforms

• fRDB inventory of labor market and social policy
  reforms
• Classified by area (e.g. EPL, UBs, RET, MIG, WT),
  direction (increasing / reducing the wedge) and
  scope (structural / marginal)

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
25
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
26
Acceleration of reforms
100
NEB
EPL
90
80
70
60
N of Reforms
50
40
30
20
10
0
1996-2000
1996-2000
1986-1990
1986-1990
1991-1995
1991-1995
2001-2005
2001-2005
Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.
27
Remainder of the course

• Institutions by institution
• Outline of each lecture
• description of the institution (measurement)
• theory (does it implement the wedge? how?
  effects on employment and wages)
• evidence (possibly difference-in-differences)
• policy issues

Source Tito Boeri and Jan van Ours (2008), The
Economics of Imperfect Labor Markets, Princeton
University Press.