Chapter V: Growth and Employment

1. Chapter V: Growth and Employment Accounting for Growth Efficiency of Labor Solow model and interpretation The labor market Real wages Population and migration

2. 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

3. Decomposing employment • Let’s look at some specific elements of the labor market • Total hours worked per population can be decomposed as follows:

4. Trends in hours workedper capita

5. 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”

6. Growth and unemploymentin the European Union

7. Labor market movements Source: Thomas Rothe, IAB

8. Definition of“natural 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 h×U = f×L or h×U = f×(N-U). • And

9. 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 “naturalunemployment rate” is [0.02] / [0.02 + 0.20] = 0.0909 (or 9.1%).

10. 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

11. 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

12. 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”

13. 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

14. 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

15. Marx’s “Industrial reserve army” Subsistence level Labor demand H* Unskilled labor: A historical review W/P = real wage F. Lassalle 1825-64 Hours worked

16. 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

17. “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

18. As productivity increases, the wage differential becomes larger Ls Lsconstant “Dual” labor market and increase in productivity (W/P)1 (W/P)2 Wage differenettial L1 L2

19. 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)

20. Dependency between skills and employment Source: OECD

21. 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

22. Collective bargaining and labor union density Source: OECD

23. 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

24. “Minimum” wages andunemployment W/P Unemployment “Sticky”real wage Labor supply Labor demand L

25. “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

26. Sam Goldwyn (movie producer) about one of his best agents: “We are overpaying him, but he’s worth it”

27. 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

28. “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

29. Wage increase is“validated” throughhigher productivity Linked by contract Employment increase Unemployment “Dual” labor market,and collective bargaining (W/P)1 (W/P)2 L1 L2

30. “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

31. 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

32. 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 isn’t anything else.”

33. Reading Abel, Bernanke and Croushore,Chapter 3.4 and 3.5

34. Readings Reading 5-4 “Labour pains”The 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

35. Discussion 5:Understanding 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?