Download How Does an Economy Work?

The Labour Market & the
Macro-economy
The Macro-Economics of European Economies
MSc in Economic Policy Studies
John FitzGerald, February 2015
Course Outline
1. How does an economy work? JF 16-1-2015
2. The genesis of macroeconomics AM 23-1-2015
3. Modern macroeconomics AM 30-1-2015
4. Banks and financial markets AM 6-2-2015
5. The recent crisis AM 13-2-2015
6. The labour market JF 20-2-2015
7. Fiscal Policy and forecasting JF 6-3-2015
8. Trade JF 13-3-2015
9. The economics of global warming JF 20-3-2015
10. The future of the Irish economy AM and JF 27-3-2015
Outline of Lecture
• Theory
•
•
•
•
•
Demographic factors, exogenous in short run
Labour Supply
Labour Demand
Wage Determination, Market Clearing and Unemployment
Interaction with macro-economy
• Applied - examples covering a range of EU economies
• Human Capital and the labour market
• Labour Market Disequilibria in EU economies
Demography and the Labour Market
• Population
• Nt=Nt-1-Dt+Bt+Mt
• Where: N=population; D=deaths; B=births; M=immigration
• Education
• Affects participation, migration, employability and productivity
• Working age population
• Participation rates
• Affected by economic circumstances
• Migration
• Drivers of migration – economic differences and other factors
Demography and the economy
GDP
Pop

GDP per
capita

GDP
Emp


Emp
LForce

LForce


Pop1564

Pop1564
Pop

Productivity Employment Participation Dependency
Rate
Rate
Ratio (inverse)
The Role of Education
• Rising educational attainment – differs by country and by age
• Affects productivity which, in turn:
• Affects wage rates – in perfect competition labour paid the marginal product
• Affects participation because higher wages v costs of working
• Affects employability and numbers unemployed
EU15, Educational Attainment
100%
90%
80%
70%
60%
Tertiary
50%
High School
Lower Secondary
40%
30%
20%
10%
0%
1921-25
1931-35
1941-45
1951-55
Birth Cohort
1961-65
1971-75
1981-85
USA, Educational Attainment
100%
90%
80%
70%
60%
Tertiary
50%
High School
Lower Secondary
40%
30%
20%
10%
0%
1921-25
1931-35
1941-45
1951-55
Birth Cohort
1961-65
1971-75
1981-85
Labour supply
• L=f(W, N, M, UR, welfare, unions, T)
• Where: W=wage rate; UR= unemployment rate; T= other factors, e.g. culture
• Migration = f(UR, URw, W, Ww , T)
• Where subscript w signifies the rest of the world
• Sensitive to wage rates in Ireland – much less sensitive elsewhere
• Female labour supply= f(demographics, education, W, costs, culture)
• Fairly elastic – sensitive to wage rates
• Male labour supply= f(demographics, education, W, costs, culture)
• Fairly inelastic – what is inelastic?
• Shape of labour supply curve?
• How elastic – what is elastic?
Elastic Labour Supply
Wage Rates
W
S1L
W1
DL
L2
L
Employment
Inelastic Labour Supply
S1L
Wage Rates
W
W1
DL
L2
L
Employment
Totally Inelastic Labour Supply
Wage Rates
S1L
W
W1
DL
L2
L
Employment
Skilled v Unskilled
• Two kinds of labour: skilled (high education) & unskilled (low education)
• Are they substitutable?
• Unskilled labour may be less employable
• While the skilled labour market may clear the unskilled may not
• Focus on:
• Educational attainment of labour force
• Returns to education
• Migration – skilled or unskilled? Different effects
Labour Demand
• L=f(Q,W,Pk,Pm,T)
• Where L=employment; Q=output; W= wage rate; Pk=price of capital; Pm=price of
materials and other inputs; T=technical progress
• Firms choose the mix of inputs (labour etc.) so as to minimise the cost of producing a
given output Q
• Q=f(Qw,c,cw,T)
• Where c= unit cost of production; subscript w signifies the rest of the world
• World output is located based on the cost of production in different countries
• Hence wage rates affect employment through two channels
1. Substitution of capital and materials for labour and vice versa
2. Substitution of foreign for domestic output and vice versa
• Shape of Labour demand curve? How elastic?
Market Clearing: Wage Rates
• Market clearing? How can there be unemployment?
• Speed of adjustment
• Structural unemployment
• Hysteresis
• Bargaining
• Philips curve
• The tax wedge
• Minimum wages
• Efficiency wages
Speed of adjustment
• Employers may be slow to adjust employment
• Want to hold on to firm specific skills – e.g. Germany
• Costs of hiring and firing
• Labour laws – if hire may not be able to fire
• Employees slow to adjust reservation wage
•
•
•
•
Expectations
Don’t have requisite skills
Problems with nominal wage cuts v real wage cuts
Market wage < welfare etc.
• Result: market may remain out of equilibrium for a long time
Structural Unemployment
• Where skills of the unemployed don’t match needs of employers
• Where labour market laws may interfere with market clearing
• Reasons for laws may mean that some unemployment is acceptable?
• Hysteresis. A shock to the system shakes out labour that may not be
re-employed in a recovery – e.g. because of skills mismatch
• Move from a full employment equilibrium to an unemployment equilibrium
• Policy Options?
• Measures to increase demand?
• Measures to reduce / transform supply?
Bargaining
• One “model” of the labour market:
• Employees bargain in terms of after tax wages
• Employers take the wage and set employment
• Bargaining power of employees may be affected by
• Legislation
• Unions
• Insiders v Outsiders
Philips Curve
• Wage rates (or the level of wages) may be affected by unemployment
• With high unemployment employees anxious to hold jobs
• More willing to take a pay cut or not to look for an increase
• With high unemployment more competition for jobs
• May result in wage rates lower than would otherwise be the case
• With low unemployment labour is scarce and employers have to pay more
• If unemployment affects wage inflation
• At what level of unemployment is the effect on wage inflation zero?
• If higher unemployment – then real wage rates will tend to fall, leading to higher employment
and lower unemployment
• Similarly if unemployment below this level wages will tend to rise affect unemployment
• The non-accelerating wage rate of inflation (NAWRU) is the stable equilibrium
• Explains why market clears at a significant rate of unemployment
• What happens if infinite labour supply? No Philips curve
Wage Rates
• The tax wedge:
• Employers pay W*(1+te); Employees get W*(1-tp)
• Where te=employers taxes (rate) and tp=employees taxes (rate)
• The higher the tax wedge the bigger the difference between the 2 wage rates
• Who pays the taxes on labour – where is the incidence?
• Depends on the shape of the labour supply and demand curves
Tax incidence: affected by labour supply & demand
• Impose a tax on labour of W1-W3.
• Labour bargains in terms of after tax wages
• Labour supply moves from S1 to S2
• Labour demand downward sloping
• Employment falls from L2 to L1
• Wage rates rise from W1 to W2 – that share of the tax is paid by employer
• The part of the tax W2-W3 is paid by the employee
• The flatter – more elastic – labour supply the bigger the share of the tax is
paid by employers – increasing the employment effect
• Partnership in Ireland 1987 – trade off tax cuts for wage moderation
• This reflected the behaviour of the market with an elastic labour supply
• Other countries – labour supply less elastic because limited migration
Elastic Labour Supply
Wage Rates
W
S1L
W1
DL
L2
L
Employment
Elastic Labour Supply
Wage Rates
S2L
W
S1L
W3
W2
W1
DL
L1
L2
L
Employment
Replacement Rate or Minimum Wage
• Sets a floor on wage rates
• Does it lead to unemployment?
• Consider the distribution of wage rates
• If there are many at the bottom of the distribution ….
• If there are few at the bottom of the distribution ….
• Social considerations:
• Higher pay – welfare gain, less welfare payments; offset by lost employment?
• Protection of the weak e.g. immigrants
Unskilled Labour
Wage Rates
W
S1L
DL
S=W
L1
L3 L2
L
Employment
U
Efficiency Wage
• Employers do not know the productivity of a new hire
• Pay a premium to ensure that they get the best
• High pay may affect morale and productivity of workers
• Result: may pay more than market clearing wage rate
Labour Market and the Macro-Economy
• Demand for goods and, hence, labour determined in goods market
• Wage rate feeds back into prices, competitiveness etc.
• Employment, unemployment and wage rates affects public finances
• Tax revenue
• Welfare payments
• Cost of goods and services
Examples
• Education and skills
• How does education affect labour supply?
• Productivity, participation, employability
• Examples of Labour market adjustments
• Finland – Crisis 1990
• Germany – Unification 1990 and Labour market reforms 2004
• Ireland, Spain, Portugal – 25 years of labour market adjustment
• Migration: example of Ireland
• Labour market policies
Education – cohort of 1931-5
Education – cohort of 1951-5
Educational Attainment, birth cohort 1951-55
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Education – cohort of 1981-5
Returns to education: lower secondary
relative to upper secondary
Men
2000/1
Belgium
Chile
Denmark
Estonia
Germany
Ireland
Portugal
Spain
UK
USA
EU
Women
2011/2 2000/1 2011/2
93
92
83
84
64
65
87
79
90
82
89
91
81
87
74
82
82
80
64
70
68
69
81
80
69
74
74
67
69
69
65
64
66
62
82
78
78
77
Returns to education: tertiary relative to
upper secondary
Belgium
Chile
Denmark
Estonia
Germany
Ireland
Portugal
Spain
United Kingdom
United States
EU21 average
Men
2000/1
128
132
143
135
125
152
181
160
2011/2
129
271
138
137
171
169
173
136
151
182
165
Women
2000/1
133
124
141
161
143
176
169
153
2011/2
134
262
126
160
172
190
172
155
178
177
162
Human Capital Index, 2010, Population 20-64,
OECD average returns to education
130
125
120
115
110
105
100
95
90
85
80
Investment in Human Capital, 2010
Ratio 25-29 to 55-59
1.4
1.3
1.2
1.1
1
0.9
0.8
Unemployment rate by level of education, 2010
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Lower secondary
Upper secondary
Tertiary education
Unemployment Rate by level of education, 2010
25
% of labour force
20
15
10
5
0
Lower secondary
Upper secondary
Tertiary education
Contribution of Rising Educational Attainment to Growth, annual average
2.5
2
%
1.5
1
0.5
0
-0.5
Employment rate
Labour Force Participation
Productivity
EU 15, Labour Market, Lower Secondary Education
60000
55000
50000
thousands
45000
40000
35000
30000
25000
20000
1995
1996
1997
1998
1999
2000
2001
Labour supply
2002
2003
2004
2005
2006
Employment
2007
2008
2009
2010
EU15, High School
90000
80000
70000
thousands
60000
50000
40000
30000
20000
10000
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Labour supply
Employment
EU15, Tertiary Education
60000
55000
50000
Thousands
45000
40000
35000
30000
25000
20000
1995
1996
1997
1998
1999
2000
2001
2002
Labour supply
2003
2004
2005
2006
Employment
2007
2008
2009
2010
Examples of Labour Market Adjustment
• Finland – Crisis 1990
• Germany – Unification 1990 and Labour market reforms 2004
• Ireland, Spain, Portugal – 25 years of labour market adjustment
• Migration: example of Ireland
Finland – Unemployment Rate
Unemployment rate
20
18
16
14
12
10
8
6
4
2
0
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Finland – Unemployment Rate by Education
Chart Title
20
18
16
14
12
10
8
6
4
2
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Lower Secondary
Upper Secondary
Tertiary
Finnish wage rates relative to EU 15
RX_FIN*W_FIN/(W_EU15)
1.15
1.10
1.05
1.00
0.95
0.90
0.85
90
92
94
96
98
00
02
04
06
08
10
12
14
Germany – Unemployment Rate
Unemployment Rate
12
10
8
6
4
2
0
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Germany – Unemployment Rate by Education
Chart Title
25
20
15
10
5
0
1992
1994
1996
1998
Lower Secondary
2000
2002
Upper Secondary
2004
2006
Tertiary
2008
2010
German wage rates relative to EU15
RX_DEU*W_DEU/(W_EU15)
1.12
1.08
1.04
1.00
0.96
0.92
0.88
90
92
94
96
98
00
02
04
06
08
10
12
14
Labour market adjustment: Ireland, Spain Portugal
• Ireland – post 1980s crisis slow to fall
• Hysteresis post 1990 why?
• Today?
• Spain – pre-crisis – very high, though had been falling
• Labour market rigidities?
• Today?
• Portugal – appears fairly flexible – till the crisis
• Today?
Unemployment Rate
28
24
20
16
12
8
4
0
90
92
94
96
98
Spain
00
02
Ireland
04
06
08
Portugal
10
12
14
Ireland: unemployment rate by education
Chart Title
25
20
15
10
5
0
1992
1994
1996
1998
Lower Secondary
2000
2002
Upper Secondary
2004
2006
Tertiary
2008
2010
Spain: unemployment rate by education
Chart Title
30
25
20
15
10
5
0
1992
1994
1996
1998
Lower Secondary
2000
2002
Upper Secondary
2004
2006
Tertiary
2008
2010
Portugal: unemployment rate by education
Chart Title
14
12
10
8
6
4
2
0
1992
1994
1996
1998
Lower Secondary
2000
2002
Upper Secondary
2004
2006
Tertiary
2008
2010
Unemployment Rate by level of education, 2010
25
% of labour force
20
15
10
5
0
Lower secondary
Upper secondary
Tertiary education
Wage rates relative to EU15
1.3
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
90
92
94
96
98
Spain
00
02
Ireland
04
06
08
Portugal
10
12
14
Migration
• Driven by:
• Potential earnings differentials
• Employment opportunities
• Cultural factors
• Differences between labour markets – inflows and outflows
• Impact of migration on:
• Receiving labour markets
• Origin labour markets
Ireland v UK, Wage Rates
Wage Rates, Manufacturing: Ireland relative to UK
1.1
1
0.9
0.8
0.7
0.6
0.5
0.4
1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011
Ireland: Net emigration, % of population
Net emigration
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
1927
1937
1947
1957
1967
1977
1987
1997
2007
Unemployment: Implications for Policy?
• Largely a national responsibility
• However a European fiscal policy would have helped in the crisis
• How to make European labour markets work
• Europe v US
• Supply side measures
• Education and training
• Activation etc.
• Demand side measures
• Costs of employment
• Flexibility
AMECO Database
• Many annual variables for EU economies, US, Japan etc.
• Don’t assume that the data are always right!
• Where available, runs from 1960. Includes EU forecasts to 2016
• Be careful that 2014 onwards are EU forecasts!
• Two approaches to accessing it:
1.
Online: http://ec.europa.eu/economy_finance/ameco/user/serie/SelectSerie.cfm
2.
Excel File: AMECOTCD.xlsx – a limited number of variables, 1 variable per sheet
• House prices from BIS datatbase:
• Online: http://www.bis.org/statistics/pp_detailed.htm#selected
Other Data Used in this Lecture
• Eurostat Labour Force Survey
• OECD Economic Outlook
• CSO
Presentations
1. The origins and resolution of the current crisis in Estonia, Bulgaria,
and Greece (20th February)
• What were the origins? How is it resolving? Look at disequilibria in markets
2. The origins and resolution of the current crisis in Latvia, Portugal,
and Italy (20th February)
• What were the origins? How is it resolving? Look at disequilibria in markets
3. The crisis in Scandinavia (Finland, Sweden, Denmark) 1988-1995
(6th March)
• What were the origins? How was it resolved? Look at disequilibria in markets
Reading for this lecture
• Basic text:
• Blanchard etc. Probably more theory than you need, but provides the basics
• Chapters 7 and 9
• The rest of the reading discusses real economic situations.
• The objective is to evaluate whether labour markets are out of equilibrium
and if so why? How are they adjusting or how have they adjusted? What are
the problems?
• In addition to previous reading
• http://www.oecd.org/g20/topics/employment-and-social-policy/G20-labour-markets-outlook-key-challenges-andpolicy-responses.pdf
• On Spain http://www.oecd.org/els/emp/SpainLabourMarketReform-Report.pdf
• On labour market reforms http://www.oecd.org/site/sgemrh/46190166.pdf
Reading for this lecture
• As mentioned previously:
• FitzGerald, J., 2013 “Financial crisis, economic adjustment and a return to growth in the EU”, Revue de l’OFCE Debates and policies, No.127 pp. 277-302 http://www.ofce.sciences-po.fr/pdf/revue/127/revue-127.pdf
Look at one or two of these publications for the EU and its component economies
• IMF World Economic Outlook, October 2014. http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/text.pdf
• OECD Economic Outlook, November 2014, http://www.oecd.org/eco/outlook/General-assessment-of-themacroeconomic-situation.pdf
• National Institute Economic Review, November 2014, http://ner.sagepub.com/content/230/1.toc
• European Commission: European Economic Forecast, Winter 2014
http://ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee2_en.pdf
• See http://www.oecd.org/eco/surveys/ for surveys of individual countries. They don’t do Bulgaria and Latvia