Equilibrium unemployment and employment in Sweden

1
Equilibrium unemployment and employment in Sweden
A review

• Anders Forslund
• 2008-01-29

2
Outline

• Estimates of equilibrium unemployment in Sweden
• Government reforms and equilibrium
  unemployment/employment

3
Estimates of equilibrium unemployment

• Six studies (that I am aware of) estimate
  equilibrium unemployment (EU) only two of them
  for more recent years
• All studies indicate that EU has gone up since
  the early 1980s, most of them indicate that the
  rise took place in the early 1990s (one
  exception)
• The most recent estimates (NIER) suggest that EU
  has gone up by slightly more than 2 percentage
  points and approx. equals 6 (ILO definition)

4
Government reforms and EU

• Two main areas where reforms may be expected to
  have affected EU
• Unemployment insurance
• Income taxes

5
Unemployment insurance and EU

• Reforms
• Replacement rate lowered from day 200 (from 80
  to 70)
• Daily allowance cap lowered the first 100 days
  (by approx. 7)
• The expected number of insured days shorter due
  to coordination with active labour market
  programmes
• Not completely clear how a comprehensive measure
  should be constructed and what it would show
  (different changes for different groups
  different importance for different margins)

6
Expected effects at given wages

• Carling et al (2001) estimated effects on hazards
  from unemployment to employment of lower replace
  rate elasticity 1.6
• If hazard from work to unemployment is unaffected
  by UI, the elasticity of unemployment w.r.t. UI
  benefits is proportional to the elasticity of the
  hazard from unemployment w.r.t. UI benefits
  proportionality factor equals employment rate
• Hence, elasticity of unemployment w.r.t. UI
  approx. 1.5
• This is a lower bound, because wage-setting
  effects, if anything, will amplify effects at
  given wages

7
Expected effects at given wages an example

• Given
• Elasticity1.5
• EU6
• Reduction of generosity in UI10
• Then EU down by 0.8 percentage points

8
Effects at given wages Timing

• Effects at given wages arise through changes in
  job search behaviour and may appear rapidly
  results in Carling et al (2001) suggest that
  effects may arise already as a reform is expected
  

9
Effects of UI using estimated wage-setting model

• Forslund et al (2008) estimated wage- and
  price-setting schedules. Take account of general
  equilibrium effects
• The estimated model can be solved for an
  elasticity of unemployment w.r.t. UI benefits
  this elasticity equals 3
• Hence, if UI generosity is decreased by 10 and
  EU equals 6, EU is reduced by 1.8 percentage
  points
• In contrast to the adjustment at given wages,
  this adjustment takes considerable time

10
Income tax reforms

• Reforms
• Lower marginal and average (labour) income tax
  rates at low income tax brackets
• Small changes in marginal tax rates at higher
  income tax brackets, lower average income tax
  rates at higher brackets
• Income taxes reduced by 6.5 at annual labour
  income SEK 100 000, 5.1 at SEK 150 000

11
Expected effects on (un)employment

• I disregard effects on hours worked, although
  they may be important for welfare assessments
• No direct estimates of effects of taxes on labour
  force participation/unemployment available for
  Sweden to my knowledge. What to do?
• Use estimated effects of changes in UI the same
  margin affected (relative gain from working), or
• Use estimates of participation elasticity from
  other countries

12
Expected effects on (un)employment (cont.)

• Effects for unemployed persons
• The tax cut equals approx. 5
• Hence, given the same line of reasoning as for
  the cuts in UI benefits, EU should be reduced by
  around .4 percentage points at given wage rates

13
Expected effects on (un)employment (cont. 2)

• Effects on labour force non-participants (using
  estimated effects of UI changes)
• Assume that new entrants will be unemployed to
  the same extent as persons already in the labour
  force
• Then labour supply would increase by approx. 8
  and 5 of these would become unemployed the rest
  employed

14
Expected effects on (un)employment (cont. 3)

• Effects on labour force non-participants (using
  estimated effects from other countries)
• In a survey, Krueger Meyer (2002) claim that
  the best guess about the participation elasticity
  is that it equals one
• If this guesstimate is correct, labour supply
  would instead increase by approx. 5

15
Expected effects on (un)employment (cont. 4)

• However, income tax effect will be moderated if
  wages increase
• Previous studies of swedish wage setting suggest
  that if taxes are lowered by x, wages will
  increase by almost x, leaving wage costs almost
  unchanged. If so, equilibrium will involve a
  larger fraction of unemployed than the supply
  response would suggest
• However, unclear how much bearing aggregate
  studies have on the effects of selective tax cuts
• For example, new entrants are outsiders and it
  is not clear how tax cuts targeted at such groups
  affect wage setting

16
Concluding remarks

• Estimates suggest that EU may be around 6.
  However, large uncertainty
• One reliable estimate would suggest a lower
  number some of the most recent estimates suggest
  higher numbers
• The effects of recent reforms in UI and income
  taxes may have non-trivial effects on EU and
  employment rates. Adding effects under most
  optimistic assumptions gives a guesstimate of
  the effect on EU just above two percentage
  points employment as a share of working age
  population would increase by more

17
Concluding remarks (cont.)

• However, once again, large uncertainty
• Small number of studies
• Not clear exactly how large the changes have been
• Effects of taxes on participation largely unknown
  territory in terms of empirical studies