Download Notes Unemployment and Efficiency Wages

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In the simple market equilibrium model, there
can be no involuntary unemployment.
One of the most difficult tasks for economists
has been (and is) to explain how
unemployment can exist.
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The Great Depression – one quarter to a
third of all workers unemployed in the
industrialised countries.
In Sweden in 1933, 22% of trade-union
members were unemployed.
After 1933, unemployment fell almost
steadily and in the 1950s stabilised at
about 2% and remained near that level until
the early 1980s. It did not reach 4 % before
the depression of the 1990s.
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In other European countries unemployment
was also low in the 1950s and 1960s but
increased sharply after the ”oil-shock” of the
early 1970s.
◦ UE in ”OECD-Europe” in 1980 was 6% (2%
in Sweden)
During the 1990s depression Swedish
unemployment rates were only a little below
the European average. But when they started
to fall (1998) they fell more rapidly in
Sweden.
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Unemployment has negative effects on the health
and well-being of the unemployed and their
families. It can lead to social exclusion, especially
for the long-term unemployed.
There is an opportunity cost to society of what the
unemployed could have produced.
A long period of unemployment leads to loss of
skills and experience. This means lower future
earnings for the individual and lower productivity
for the economy.
Unemployment leads to increased differences in
living standards and to social conflicts and tension,
particularly if some groups are more affected than
others.
Unemployment insurance and social security to the
unemployed have to be paid by the public sector.
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In1960s unemployment was twice as high in
the US as in most European countries and
remained higher until the late 1970s.
Since the early 1980s, US unemployment
rates have decreased (with one minor upturn)
while European mostly have not.
During the 1990s recession, EU
unemployment rates soared, while the US
decreased.
unemp 1991-2001
Sweden
EU
US
12
10
8
6
4
2
0
2 001
2 000
1 999
1 998
1 997
1 996
1 995
1 994
1 993
1 992
1 991
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
Sweden
EU27
US
2.0
1.0
0.0
Age 15-74
12.00
10.00
8.00
EU15
Denmark
6.00
Germany
Netherlands
4.00
Sweden
USA
2.00
0.00
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In Sweden (2006) one could take into account :
UE (old definition) was 5.4%
Students wanting to work 2 %.
Other latent unemployment 2 %.
Persons in labour market programs.
Early retirement ”for labour market reasons”.
Involuntary part-time (partial unemployment)
UE + in LMP
18
16
= total
% av arbetskraften
14
12
10
arblösa
8
åtgärder
summa
6
4
2
0
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In the US one could take into account (but not
simply add):
Discouraged job-seekers (about 1% of LF)
Involuntary part-time (Borjas fig. 12-5)
Prison population (2.3 m in 2006, eq. to 1.5 %
of the labour force).
Working poor.
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1. Gender
Traditionally women had higher
unemployment rates than men. That is not
necessarily true today.
In Sweden, female UE was a little higher
than the male up to 1980, then ≈ equal. In
the 1990s, more men were unemployed.
(Manufacturing reduced workforce more
than the public sector.)
In some other countries too, like Norway &
UK, there is lower UE among women. In
others, there is higher. (In Spain, Italy &
Greece about twice as high as that of men.)
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2. Age
In most countries, UE is higher among young
people.
Countries with apprentice systems tend to
have more young people with jobs.
But youth unemployment figures should be
interpreted with care – they depend on:
◦ Numbers unemployed.
◦ Participation rates of young people.
unemployed aged 15/16-24 in 2008
0.25
0.2
0.15
unemployment
0.1
unemployed/population
0.05
0
Denmark 15-24
Germany 15-24
Sweden 15-24
United Kingdom United States 1616-24
24
Source: Laborsta
Activity rates
Denmark Germany
15-24
15-24
0,66
0,53
Sweden
15-24
0,52
United
Kingdom
16-24 United States 16-24
0,60
0,59
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3. Education.
UE-rate in LFS 2010 (%):
Less than upper Upper secondary Post-secondary Not known
secondary
18.2
7.9
5.0
31.4
(Average was 8.4)
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.
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Unemployment = proportion who become
unemployed * the length of time they stay
unemployed.
The analysis of the unemployment rate can be
divided into analysis of
◦ The inflow into unemployment
◦ The duration of unemployment
Note that duration is the average length of
unemployment of those who become unemployed
at a particular time not those who are unemployed
at particular time.
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Example: Assume that 5
people become unemployed
each month. 4 remain
unemployed one month but
the 5th is unemployed for 6
months.
Average duration:
(4*1 + 6)/5 = 2
But of the people who are unemployed
in a particular month:
Nr of UE in
months
Nr
1
5
2
1
3
1
4
1
5
1
6
1
Average =(5+2+3+4+5+6)/10 =
2.6
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The labour market is a dynamic system
(Lecture 1)
Employed
Outside LF
Unemployed
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US (Borjas fig. 12.3): Of the unemployed
◦ Roughly half have lost their jobs
◦ Roughly a third have quit a job
◦ About one tenth each of new entrants and reentrants to the LF.
Sweden (Björklund et. al. Arbetsmarknaden based
on LFS): Inflow to unemployment 2003:
◦
◦
◦
◦
26
16
46
12
%
%
%
%
new or re-entrants
redundancies
contracted work finished*
other
* Was only 29% in 1980
Let
l = the proportion of workers who lose their jobs in each period
h = the proportion of the unemployed who find a job in each
period
LF = the labour force, E = the employed, U=the unemployed
 In steady state inflow=outflow
lE = hU
l(LF-U) = hU
lLF=(h+l)U
U
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Unemployment rate =
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LF
h
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Frictional unemployment
Seasonal unemployment
Structural unemployment
Cyclical unemployment
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– Firms go in and out of business, workers go
in and out of jobs (or in and out of the LF).
Information is not perfect. Workers and firms
need time to ”match up”.
Policy action: Improve information to workers
about job openings, and information to
employers about job-searchers.
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A substantial minority of the unemployed
who get work, are re-hired by a previous
employer. (Partly as an effect of legislation,
LAS.)
Employers may lay workers off with the
mutual understanding that they will be rehired.
Examples: Winter/summer tourism,
construction
If the workers receive unemployment
benefits ”the public purse” subsidises these
firms
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In a changing economy chances are big that
skills supplied do not match skills
demanded – there are both vacancies and
unemployment.
Policy action: Provide and subsidise training
that improves the match between supply
and demand. Decrease the cost of moving
to where the jobs are.
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There may be more unemployed than
vacancies.
According to the supply/demand market
equilibrium model, wages should fall when
there is unemployment, until the market
clears. In reality, wages are sticky, at least
downwards.
Government expenditure, taxes and
benefits and interest rates influence
aggregate demand and therefore
unemployment. They can be used countercyclically.
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Search theories of unemployment
Inflation and unemployment
Wage theories. (Why do wages not fall to the
market clearing level?).
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It takes time and money for workers/
employers to find good worker/job
matches.
Assume
 unemployed workers do not know where there is
a job with a particular wage
 but they do know the distribution of wage offers
“out there” in the market.
 For example, the worker knows that the best
paying job/s he/she could get have a monthly
wage of 30 000 SEK but there are also jobs
paying only 15 000 – and many in between.
Frequency
$5
45
15
$8
18
$22
27
$25
30
Wage
The chance that a wage
offer
will be in the tails – say
above
27 000 or below 18 000
is small.
If the offer the worker
receives is
17 000, the probability
that next
offer will be better is
large. If the offer
is 27 000 the chances
that the next will
be better is small.
Wage offers in 1000 SEK
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In a non-sequential search, the stopping rule is
to stop searching after a certain number of
offers (decided in advance). Not optimal – does
not take into account what the offers are.
In a sequential search, the worker’s stopping
rule is to stop searching when there is an offer
above a certain level – the asking wage.
If the worker receives an offer at or above the
asking wage, searching stops. If the offer is
less than the asking wage, he/she does
another search. The expected duration of
unemployment is longer, the higher the
worker’s asking wage.
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The cost of continuing the search – direct
costs and the opportunity cost of the rejected
wage offer. The higher the offer that is
rejected, the larger the MC of another search
round.
The higher the wage offer, the larger the
marginal benefit of accepting it.
The asking wage will be the wage at which
MC = MB
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The asking wage depends on the distribution of job
offers (the probability of getting job offers at
different levels.)
A higher time discount rate  lower asking wage.
To continue the search involves a cost now and a
gain later.
Higher unemployment insurance  higher asking
wage.
A long unemployment period tends to reduce the
asking wage.
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A well functioning Employment Service
(Arbetsförmedling) makes search quicker.
Lower unemployment rate
◦ makes the chance of a new offer greater
◦ increases the asking wage.
High unemployment insurance increases the
duration of unemployment
Exits from unemployment tend to increase just
before a time-limit for unemployment insurance.
The asking wage tends to decrease over time
A long unemployment period reduces the chances
of job offers – depreciation of skills, stigma effect,
discouragement.
Search efforts may increase or decrease with time
in unemployment.
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Thus, the probability of leaving unemployment during a
certain time (week, month) can vary over a period of
unemployment. This is called duration dependence.
Without duration dependence for each person, observed
decreasing exit rate may be due to heterogeneity – those who
have the greatest difficulty finding employment will be overrepresented among long-time unemployed.
Probability of
Leaving unempl.
Positive dur. dep.
No dur. dep.
Negative dur. dep.
Unemployment in weeks
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With generous UI we can expect:
◦ Longer unemployment periods.
◦ Higher wages after unemployment.
If employers (US) or workers/unions
(Sweden) pay more towards financing the
UI, more account may be taken of
unemployment risks in wage-setting.
Unemployment insurance and social
welfare:
◦ Ethical reasons why unemployed people who
want to work should have a “decent” standard of
living.
◦ It can be economically efficient to allow the
unemployed time to search for a good match.
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Entitlement to unemployment benefit depends on the following
conditions. The jobseeker must:
1. be fit and available to work for an employer at least three hours
every working day and for an average of at least 17 hours per week
2. be prepared to accept an offer of appropriate work during the
period, where no impediment has been accepted as admissible by
the unemployment insurance fund
3. be registered as a jobseeker with the Employment Service, in
compliance with government regulations or those applied by one of
its agencies
4. cooperate in drawing up an individual back-to-work plan in
consultation with the Employment Service
5. actively seek but be unable to find appropriate work.
6. fulfil the work requirement (prior to becoming unemployed, you
must have worked for at least six months and at least 80 hours in
every calendar month, or for at least 480 hours over six consecutive
calendar months and for at least 50 hours in each of these months. )
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If you are a member of an unemployment insurance fund you
receive:
◦ 80 % of previous income up to a maximum of 680 SEK/day
for 200 days. (For parents with children under 18 it is 450
days.)
◦ 70 % of previous income (up to SEK 680/day) for another
100 days.
If you are not a member you receive 320 SEK/day.
The compensation is reduced for a period of time if you
refuse one or two job offers.
If you refuse three, you are cut off from compensation.
If you do not fulfil the requirements you do not receive UI,
only social assistance (försörjningsstöd) which is much less
and requires that you do not have major assets like a house,
car, bonds, equity etc).
Source: Arbetslöshetskassornas samorganisation.
http://www.samorg.org/so/Index.aspx?id=105
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In addition to the state system of UI, the
labour market organisations (unions &
employers) have agreed to provide support to
workers who are laid off:
◦ Help in search for new jobs
◦ Severance (redundancy) pay
◦ Support during unemployment “topping up” the UI.
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This influences the actual effect of state
decisions on UI (time limits, replacement
ratios)
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Is there a ”trade-off”
between inflation and
unemployment?
A famous study
(Phillips, 1958) found a
negative correlation
between
unemployment and
inflation in Britain over
a century.
Infl.
rate
UE-rate
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When there is high unemployment:
◦ Smaller wage increases
◦ Low aggregate demand
 Low inflationary pressure.
When there is a high level of employment:
◦ High aggregate demand  high level of production
 increased marginal costs  price increases
◦ With low unemployment workers have good
”outside options” and can make higher wage
demands
 High inflationary pressure.
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In Sweden in the 1950s and early 1960s, data on inflation and
unemployment fit a convex Phillips curve.
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To have both low unemployment and low inflation, the
Phillips curve has to be ”pushed” inwards.
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This was the idea behind Swedish economic and labour
market policy in the post-war
According to labour economists Gösta Rehn och Rudolf
Meidner it could be done with a combination of:
◦ Restrictive fiscal policies
◦ Solidaristic wage policy (uniting modernisation of the
economy and egalitarianism)
◦ Targeted measures to create jobs and active labour market
policies
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From late 60s both inflation and unemployment
increased.
After 1973 many countries experienced stagflation
– high UE AND high inflation.
In Sweden in the 1980s UE and inflation moved in
opposite directions between years but the ”curve”
was farther from the origin.
Either there was no Phillips-curve, or it had shifted
outwards. (Compare Borjas fig. 12-17 for the US.)
Stagflation increased the influence of neo-liberal
economists like Milton Friedman and Edmund
Phelps.
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They claimed that in the short run there might be a
negatively sloped Phillips curve but in the long run
the Phillips curve was VERTICAL. There was no
trade-off between unemployment and inflation.
Only one level of unemployment was compatible
with a stable rate of inflation - the NAIRU – NonAccelerating Inflation Rate of Unemployment.
Unemployment below NAIRU  ACCELERATING
inflation.
Why? People learn to expect inflation and adjust to
that. They include compensation for expected
inflation in their wage claims and in price setting.
Rate of
Inflation
4
B
C
A
3
If inflation – including wage infl. increases from 3 to 4 %, more
workers will find jobs above their
reservation wage and firms will
increase production and
employment.
The economy moves from A to B.
When firms and workers realise that
the new nominal wages/prices are
not
real, employment will fall again and
the
economy moves to C.
Unemployment
Rate
Expansionary fiscal policy  increased
nominal purchasing power. If firm’s
believe that real demand has
increased they increase production
and prices. But price increases trigger
an inflationary spiral:
 Inflation  expectation of inflation 
higher wage demands and prices 
higher production costs  firms
decrease production  decreased
demand for labour.
 Finally: The economy is back at NAIRU.
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During the adjustment process, there are
temporary positive effects on production and
employment.
High unemployment levels can increase
NAIRU, since unemployment tends to be
persistent. Those who have been unemployed
long have less chance of returning to
employment.
Policies and institutions which improve the
functioning of the economy and of the labour
market can achieve a lower NAIRU.
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Support/subsidies for labour mobility and
training is one side of flexibility
Others which employers’ organisations
emphasise are
◦ Wage flexibility (differentiation & lowest level)
◦ Employment flexibility (make temporary contracts
and lay-offs easier)
One example of reforms is the Danish “flexicurity”.
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Collective bargaining can lead to higher
wages but less employment than in a perfect
competition equilibrium.
Another theory of wages that explains this is
the theory of efficiency wages.
In the human capital model and the
labour demand model, we assume that
higher productivity  higher wages.
 It could work the other way around
too.
 Workers could be more productive if
they are paid better.
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The derivative of e*N/w with respect to w
 e 
de
d

 w  e 1
 w   dw
dw
w2
de
we  0
dw
At a maximum the derivative = zero de
w  e
dw
de w
 1
dw e
The profit-maximising firm should pay a wage at which the
wage elasticity of production = 1, even if it is > the outside
wage.
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A firm which pays efficiency wages will
attract more workers than it wants to hire
but over-supply will not lead to a wage
reduction since this wage is profitmaximising.
This can explain several things that seemed
odd in the neoclassical models.
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Wages above the market rate will attract
workers – if there is a queue of workers
wanting to be hired (job-rationing) it is
costless to avoid the discriminated group.
If the effort functions of different groups are
different it can be economically rational to
pay them different wages.
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Not what we would expect from the human
capital theory, unless work conditions are
different – but even then the utility should be
the same.
Efficiency wages are believed to be a reason for the
persistent wage differentials between industries
and between small and large firms.
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Why do firms not lower the wages when
there is an oversupply of labour?
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Or, in other words, why are wages “sticky”?
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Or, in other words, how can there be
involuntary unemployment?
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Why does some empirical research find that
industries and regions with high wages also
tend to have high unemployment?
Efficiency wages and the business cycle – sticky
wages will cause business cycle fluctuations in
employment (but the argument is beyond this
course).
Wage level
Unemployment rate
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1. Health and nutrition model
2. Shirking model
3. Labour turnover model
4. Adverse selection model
5. Sociological models such as “gift
exchange model”.
All these approaches lead to a positive
relation between wage and
effort/productivity.
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It is often impossible to stipulate exactly how hard
or well an employee should work.
Workers can “shirk”.
Firms could fire shirkers if they are caught.
But if the wage in the firm is higher than outside
OR if there is unemployment in the “efficiency wage
sector”, it is costly to loose a job there.
Efficiency wages should be important where direct
supervision and control is difficult, where the
employer needs to create incentives for the worker
to work hard or to take a lot of responsibility.
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A model related to the shirking model.
Labour turnover can be costly (hiring costs,
training of new workers, need for firm-specific
human capital).
If all workers are paid the same, new workers will
cost more than their marginal productivity.
It is important to the employer that they stay long
enough to cover the training costs.
If all firms pay a wage above the market clearing
there will be unemployment and workers will avoid
quitting their jobs.
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Firms which pay higher wages will attract
more able job-seekers – but they need to be
able to screen before hiring or monitor
afterwards.
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Gift exchange models are important in sociology
and anthropology.
A gift demands reciprocity.
Akerlof (1982) gives and example where workers’
effort was above the required level because (not
despite) there was no sanction for slow workers.
Relations to the firm and within the group of
workers created certain ”work norms”.
Compare Solow and Marshall (from Introduction”).
”A Fair Day’s Wage for a Fair Day’s Work” but also
”A Fair Day’s Work for a Fair Day’s Wage”.