Chapter V: Growth and Employment

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Chapter V Growth and Employment

1. Accounting for Growth
2. Efficiency of Labor
3. Solow model and interpretation
4. The labor market
5. Real wages
6. Population and migration

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Labor market equilibrium

• According to the macro analogue of microeconomic
  analysis, equilibrium is established through the
  real wage bringing labor supply and demand in
  line
• This analogue is fallacious though, because
  labor markets are heavily regulated, which could
  entail market disequilibria
• As a benchmark, the labor market equilibrium
  concept is useful however

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Decomposing employment

• Lets look at some specific elements of the
  labor market
• Total hours worked per population can be
  decomposed as follows

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Trends in hours workedper capita
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Measuring unemployment

• Measuring unemployment is tricky and far from
  uniform throughout the world
• An unemployed person must be
• In employment age and capable to work
• Willing to work at the going wage, everywhere
• Willing to retrain where skills do not match
  demand
• Part-time and multiple jobs add to complexities
• Workers might be discouraged and leave the labor
  force
• Workers could become self-employed
• Unemployment is linked to labor participation

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Standardized unemployment rates
Source OECD
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Growth and unemploymentin the European Union
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Labor market movements
Source Thomas Rothe, IAB
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Definition ofnatural unemployment

• N is the size of the labor force, L is the number
  of employed, and U the number of unemployed
• The ratio of hiring is h, and the ratio of firing
  f
• In a dynamic equilibrium (steady state) the
  following must hold
• hU fL or hU f(N-U).
• And

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Example

• Consider the following example
• We assume that 2 percent of the employed lose
  their job every month (average job duration 4
  years)
• 20 percent of the unemployed find a new job
  (average duration of unemployment 5 months)
• Then the natural unemployment rate is 0.02
  / 0.02 0.20 0.0909 (or 9.1).

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NRU and economic policy

• You can reduce the NRU only by reducing f or
  increasing h
• But f and h are behavioral parameters of the
  private sector
• Economic policy can create incentives, but the
  incentive structure is highly complex
• We discuss two policies
• Employment protection regulation (EPL) to reduce
  f
• State employment and wage subsidization to
  increase h

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Example EPL

• Protection against dismissal (extreme f 0 ) can
  drive firms into bankruptcy (respectively Chapter
  11 in the United States)
• Moreover such costs are anticipated by firms and
  capitalized, i.e. wage levels are lower
• It could lead to a reduction of hiring new labor
  force, combined with overtime of existing staff
• It could also explain the high incidence of
  temporary work in some countries
• EPL does not necessarily entail a psychology of
  job security

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Unemployment insurance

• Insurance against unemployment is more effective
  in providing subjective job security
• It is effective to combat cyclical unemployment
• Where there is substantial structural
  unemployment, unemployment insurance adds to
  non-wage labor costs, and the scheme may become
  unsustainable over time
• Moreover, unemployment insurance could entail
  moral hazard

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State intervention

• Government can increase h by hiring people in
  the public sector
• It can also subsidize wages in the private sector
• In both instances the financing of government
  programs has to be skimmed off production
• I may entail negative incentives and distort
  wages
• Financing such measures through government
  borrowing is not sustainable over time

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Real wages

• Real wages equal marginal productivity in
  theory, but they also depend on the supply for
  labor function in market equilibrium
• In practice however total factor productivity is
  often apportioned independently from the labor
  supply function
• We shall look at two extreme cases
• The market for unskilled labor
• The market for highly skilled labor

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Unskilled labor A historical review
W/P real wage
F. Lassalle 1825-64
Hours worked
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Unskilled labor and the wage rate

• As long as the supply for labor function is
  flat, increases in the productivity of labor do
  not filter into the wage rate, but have a pure
  employment (quantity) effect
• Conversely, if the supply for labor is scarce,
  as for highly qualified and specialized labor,
  any productivity increase is fully reflected in
  the real wage

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Dual labor market

• In the Third World there is typically a dual
  labor market characterized by
• A limited supply of qualified workers, who are
  also often well organized
• A large number of unskilled workers less well
  organized
• Arbitrage between the two markets is virtually
  impossible
• It produces significant wage differentials

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Dual labor market and increase in productivity
(W/P)1
(W/P)2
Wage differenettial
L1
L2
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Productivity increase and trickling down

• Total factor productivity has increased
  tremendously in industrialized countries
• And less skilled labor was not left behind
• Productivity increase has trickled down to all
  wage categories, not just the most productive
• An important factor was broad compulsory
  education and participation in training
• Another factor was organizing labor (and
  social policies)

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Dependency between skills and employment
Source OECD
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Organizing labor

• Obviously, the market mechanism creates
  inequality, which may lead to social tensions
• Almost all countries attempt to counter its
  effects
• The instrument is the standardized work contract
  and collective bargaining
• It attempts to allocate total factor productivity
  among various groups of skill in a fair manner
• All wage groups are tied together in fixed
  relativities, wages are negotiated collectively,
  and productivity increases distributed evenly

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Collective bargaining and labor union density
Source OECD
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Collective bargaining and sticky wages

• Collective bargaining introduces an element of
  stickiness in wage setting
• For most, wages are reasonably in line with
  productivity, for others they may be too high or
  too low
• If they are too high, this tends to create
  unemployment
• If they are too low, qualified people could
  migrate

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Minimum wages andunemployment
W/P
Unemployment
Stickyreal wage
Labor supply
Labor demand
L
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Efficiency wages

• The theory is based on the hypothesis that higher
  wages could also increase productivity
• It recognizes that a standard work contract can
  never be fully defined
• The wage becomes an instrument to incite
  workers to fully and efficiently comply with
  their duties that are specified in the contract
  only vaguely

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• Sam Goldwyn (movie producer) about one of his
  best agents

We are overpaying him, but hes worth it
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Higher wages are supposed ...

• ..to reduce transactions costs that could result
  from frequent turnover of personnel
• .. to keep in particular qualified personnel on
  board, and to counter problems of adverse
  selection of staff
• .. to increase the motivation and work effort of
  staff, and to contain the problem of moral
  hazard
• Efficiency wages will aggravate inequality
  between skilled and unskilled labor

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Dual labor market, efficiency wage, and
collective bargaining

• For a dual labor market with less qualified
  workers (or outsiders) and more qualified
  workers (insider) and
• Wages being lumped together through standard work
  contracts for collective bargaining and
• Qualified staff (or insiders) enjoying
  efficiency wages, but less skilled staff (or
  outsiders) not then
• A wage increase will produce unemployment

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Dual labor market,and collective bargaining
(W/P)1
(W/P)2
L1
L2
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Relative wage stickiness

• Not absolute wage stickiness will produce
  unemployment, but relative wage stickiness
• The model also explains the coexistence of
  unemployment and over-employment (overtime
  work) at the same time
• It also elucidates, in collective bargaining,
  the lack of employers resistance against real
  wage increases
• Collective bargaining will also affect different
  groups differently women, the young, the old

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France minimum wagesand unemployment by groups
Source Ministry of Education, France
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Rise in real wage dispersion

• Industrialized countries will experience a rise
  in real wage dispersion
• Its main causes are
• Increased arbitrage in labor markets in a
  globalizing world, especially for services
• A skill biased technical change of the production
  function, which favors highly trained work force
• Globalization will also induce migration

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Lester Thurow (1993)

• If capital is borrowable, raw materials are
  buyable and technology is copyable, what are you
  left with if you want to run a high-wage economy?
  Only skills there isnt anything else.

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Reading
Abel, Bernanke and Croushore,Chapter 3.4 and 3.5
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Readings

• Reading 5-4 Labour painsThe Economist,
  September 21st 2000 (a bit dated by now, but
  still interesting)
• Reading 5-5 The dark side of globalisation, The
  Economist, May 29th, 2008

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Discussion 5Understanding the global labor
market

• What characterizes the global market for labor?
• Should firms only look at wages when making
  investment decisions at an international scale?
• How will globalization impinge on the labor
  market of the 21st century?

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