Today

1
Today

• Change in homework 3c Question should read
  Note that if equilibrium output had stayed the
  same, then the tax revenue collected under the
  income tax would be the same as that collected
  under the lump-sum tax system. Does the
  equilibrium level of output change? Why or why
  not?
• Keynesian model of labor market
• Comparison of labor markets in U.S. and Europe

2
Classical model of labor market

• Both firms and households have full knowledge of
  prices and wages.
• Nominal wages adjust instantaneously to maintain
  equilibrium in the market.
• Labor demand is such that real wage is equal to
  the marginal product of labor.
• Labor supply is determined by households utility
  maximization over consumption and leisure.

3
Keynesian contractual view of the labor market

• Assumptions
• Labor force assume that it is constant
• Medium run
• Firms and households have full knowledge of wages
  and prices.
• Employment is determined by the intersection of
  labor supply and labor demand curves.
• Short run
• Wages are determined by contracts.
• Labor supply decisions depend on the current
  nominal wage and the expected price level

4
Labor supply reservation wage

• Determinants of the reservation wage
• Expected price level over the period of the
  contract.
• Current level of employment higher employment
  increases the wage demanded by workers.
• Other factors
• Unemployment benefits
• Preferences for leisure vs. consumption

5
Effect of increasing price level

• No change in the expected price level, or in the
  expected real wage.
• Firms perceive a decrease in the actual real
  wage
• MPL exceeds real wage, so demand for labor
  increases.
• No direct effect on reservation wage, but
  increased demand for labor increases employment.
• Increased employment in turn causes workers to
  demand higher nominal wages.
• Net effect increased employment and nominal
  wage

6
Variables shifting labor demand curve

• Changes in worker productivity
• State of technology
• Increases in costs of energy, intermediate goods
• Changes in cost of labor
• Payroll taxes
• Employment protections

7
Natural rate of unemployment

• In the medium run, prices are equal to expected
  prices. Real wages are equal to expected real
  wages.
• Equilibrium employment is equal to employment
  under the classical model. We refer to this as
  , or the natural level of employment.
• The corresponding unemployment rate is referred
  to as the natural unemployment rate.

8
Positive natural unemployment rate?

• Unemployment benefit systems
• In order to continue to receive benefits,
  unemployed must be actively seeking work.
• But high levels of benefits, may cause unemployed
  to be less willing to accept work.
• Frictional unemployment unemployment occurring
  when workers voluntarily quit, students looking
  first job, etc.
• Structural unemployment unemployment occurring
  when structure of economy is changing. (ex
  layoffs from timber mills in Oregon)

9
Does the natural unemployment rate change over
time?

• Variables affect labor supply/demand other than
  the expected price level will affect both
  short-run and medium-run equilibrium in the labor
  market.
• Example improvement in technology
• Example2 increased unemployment benefit

10
Price markups

• So far, we assumed that both labor market and
  goods market are perfectly competitive.
• Perfectly competitive goods market implies the
  following condition
• Lack of perfect competition firms set their
  prices using a markup

11
Effect of price markups on the labor market

• Price markup condition may be rewritten as
  follows
• Condition in terms of real wage
• Increase in markup real labor costs now exceed
  marginal product of labor.

12
Efficiency wages

• Definition A higher than market-clearing wage,
  set to encourage productivity.
• Historic innovation by Henry Ford
• Decreased turnover and layoff rates
• Hewlett-Packard in the Silicon Valley
  (1960s-1970s)
• Efficiency wages
• Encouragement of more flexible working hours,
  contribution of workers to team productivity.

13
Labor Markets in the United States and Europe
14
Unemployment rates Europe, U.S. and Japan
15
Short-term vs. long-term unemployment

• Dramatic variation in the importance of long-term
  employment, between countries and over time.
• Countries currently experiencing high
  unemployment (France and Germany here) are also
  seeing increases in long-term unemployment.

16
Patterns observed in European labor markets
contradiction of common wisdom

• Europe has high unemployment rates over 30
  of the population in Europe lives in countries
  where the unemployment is lower than that of the
  U.S.
• Social policies in Europe lead to less flexible
  labor markets which lead to high unemployment
  rates
• European countries with low unemployment rates
  include Austria, Germany, Norway, Portugal,
  Sweden and Switzerland
• Not noted for the flexibility of their labor
  markets.

17
Measuring the labor supply various alternatives

• Employment/Population ratio () calculated
  using entire working age population.
• Employment/Population ratio () calculated for
  males age 25-54
• Annual hours worked per worker
• Affected by extent of part-time working
• Also affected by variations in weekly hours and
  annual vacation entitlements.
• Overall labor supply combines
  employment/population ratio and annual hours
  worked as follows
• Take annual hours worked as a percentage of 2080
  hours (working 40 hours a week for 52 weeks)
• Multiply by the employment/population ratio
• Result measure of total potential hours being
  worked.

18
Variation in labor supply across countries (OECD
1996)

• Source of data OECD (Organization for economic
  cooperation and development), consisting largely
  of developed economies.
• Variation in labor supply across countries
• Japan, U.K, U.S. supply 60 of potential
  hours.
• Italy, France barely supply 40.

19
Measures of job and worker mobility

• Job turnover total of all new jobs generated
  plus old jobs destroyed.
• Worker mobility
• includes job creation and destruction
• Also includes occasions where workers enter or
  leave a job even when the overall number of jobs
  does not change.
• Regional mobility of households changing
  residence in a year.

20
Wage flexibility

• Measure percentage increase in wages in
  response to a 1 fall in the unemployment rate.
• Aggregate time series looks at aggregate data
  for the unemployment rate and average level of
  wages. Uses this to estimate the response of
  wages to the unemployment rate.
• Microeconometric measure estimates the same
  measure using data from surveys.

21
What features of the labor market generate high
unemployment?

• Most regulated labor markets countries of
  southern Europe. Least regulated Switzerland,
  Denmark and the United Kingdom.
• Unemployment benefits
• U.S. replaces 50 of salary for six months
• Europe typically higher than U.S., but still
  large amount of variation. Denmark at 90 for
  2.5 years, vs. Italy at 20 for 6 months.

22
Identifying features of the labor market
contributing to high unemployment

• Comparison of labor market characteristics
  between countries
• Direct rigidities
• Treatment of the unemployed
• Labor relations
• Payroll tax rate
• Total tax rate

23
Direct rigidities

• Employment protections measure of strength of
  legislation governing hiring and firing
• General pattern strongest regulations in the
  south of Europe, weakest in the North.
• Regulations in Switzerland, Denmark and U.K.
  similar to those outside Europe.
• Labor standards strength of legislation in 5
  areas (working time, fixed-term contracts,
  employment protection, minimum wages, employees
  representation rights)
• Very similar picture to employment protections
• U.K. and U.S. have weakest legislation, Spain and
  Italy the strongest.

24
Treatment of the Unemployed

• Benefit replacement rate share of income
  replaced by unemployment benefits.
• Benefit duration
• Active labor market policies includes policies
  designed to help get unemployed back to work.
  Measure obtained as follows
• Calculate active labor market spending per
  unemployed person
• Look at this as a percentage of GDP per member of
  the labor force

25
Treatment of unemployed country comparison

• Notable exceptions
• Extraordinary amount of spending in Sweden on
  active labor market policies
• Spain generous benefit system, very little
  spending on active labor market policies
• Italy until recently, hardly any unemployment
  system at all

26
Labor relations

• Measures of importance of unions
• Union density proportion of trade union members
  as a percentage of all workers.
• Union coverage index measure of share of
  workers whose wages are directly influenced by
  union bargaining.
• Coordination of wages among unions and firms
• Union coordination cooperation in bargaining
  among different unions.
• Employer coordination bargaining coordinated
  among different firms.
• Tax burden on labor
• Payroll tax ratio of labor costs to wages, less
  1.
• Total tax rate sum of the average payroll,
  income and consumption tax rates.

27
Labor relations country comparisons

• U.K., Switzerland, Japan little coordination by
  unions over wage bargaining. (Coordination by
  employers)
• Significant coordination by unions and employers
  central Europe and Scandinavia
• Most European countries (except U.K. and
  Switzerland) unions play a significant role in
  wage determination

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How do these features of the labor market impact
unemployment?

• Key criticism How could institutions put in
  place during the 1960s have affected unemployment
  in the 1970s 1990s?
• Institutions affected unemployment in two ways
• How well did the economy respond to the shocks of
  the 1970s?
• How long the effects of these shocks persist, in
  the form of unemployment?

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Effect of direct rigidities

• Employment protection
• Increasing cost of employment adjustment
• Reduces inflow into unemployment (reduces
  short-term unemployment)
• Reduces outflow from unemployment to work
  (increases long-term unemployment)

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Effect of variation in treatment of the unemployed

• Effect of generous benefit systems
• Reduce fear of unemployment, contribute to upward
  pressure on wages from employees.
• Unemployed individuals will demand higher wages
  when accepting jobs.
• Longer-term benefit systems also lead to
  long-term unemployment.
• No net effect on labor supply
• Generous benefits lead to higher participation in
  the labor force
• Higher unemployment (as a result of generous
  benefits) lead to lower participation in labor
  force

31
Policies associated with high unemployment

• Long-term unemployment benefits little pressure
  on the unemployed to find work, low levels of
  active intervention to increase
  ability/willingness of unemployed to work
• High levels of unionization
• Unions tend to raise unemployment, but this is
  offset if unions and employers can coordinate
  bargaining.
• Labor taxes
• Lowering payroll taxes (paid by firm) and raising
  consumption taxes has no long-run impact on
  unemployment.
• The overall tax burden may raise unemployment and
  reduce labor supply.

32
To what extent do these policies lead to higher
unemployment?

• Countries with high unemployment from 1983-1996
  
• France, U.K., and Spain
• Belgium, Denmark, Finland, Ireland
• Current high unemployment countries
• France, Germany, Spain, Italy
• Belgium, Finland.