Macroeconomics III Prof. Juan Gabriel Rodríguez Chapter 1 The Labor Market.

Macroeconomics III

Prof. Juan Gabriel Rodríguez

Chapter 1

The Labor Market

Thus far, we have assumed constant prices and wages…

But firms respond to increases in demand by increasing production…

In turn, higher production leads to lower unemployment…

Lower unemployment increase wages so production costs also increase…

Higher production costs lead to higher prices…

…and therefore to higher wages, and so on.

The Medium Run:

Exploration of how price and wage adjustments affect output

Task

The noninstitutional civilian population are the number of people potentially available for civilian employment.

(not in the military, prisons and mental hospitals)

The civilian labor force is the sum of those either working or looking for work.

(Those who are neither working nor looking for work are out of the labor force)

The participation rate is the ratio of the labor force to the noninstitutional civilian population.

The unemployment rate is the ratio of the unemployed to the labor force.

Definition of Terms

The Labor Market in Spain

Population 16 and + (38,467.3)

Active population (23,110.4)

Non-active pop. (15,356.9)

Full-time employed (14,817)

Employment (17,417.3)

Unemployed (5,693.1)

Part-time employed (2,600.3)

Wage earners (14,397.3)

Self-employed (3,020)

Permanent cont. (10,990.8)

Temp cont. (3,406.5)

Source: EPA

Decomposing population of working age - Spain IIQ12 (thousands)

Participation Rate by Sex (15-64) in Spain

Employment Rate (15-64)

Unemployment Rate (1993-2010)

Unemployment Rate by Sex (1993-2010)

Unemployment Rate for individuals under 25 (1993-2010)

Tasa de temporalidad ( % Asalariados)

5

10

15

20

25

30

35

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Greece Italy France EU (27 countries) EU (15 countries) Portugal Spain

Duality (“insiders and outsiders”):

27.9%

Hourly Productivity (UE15=100), 1997-2009

Salaries versus Productivity in Spain and the United Kingdom (1996-2005)

Salaries and Productivity

Unitary Labor Cost (2004-2010)

Unitary Labor Costs: Total and manufactures

Index Spain OCDE

Difficulty to employ 78 25.7

Rigidity of hours 60 42.2

Difficulty to layoff 30 26.3

Rigidity of employment

58 31.4

Costs of layoff (weeks of salary)

56 25.8

Differential Features

Differential Features

IIQ07 IIQ08 IIQ09 IIQ10 IIQ11 IIQ12 Dif. 07-12Labour Force (x1000) 22,127.3 22,806.7 23,082.4 23,122.3 23,136.7 23,110.4 983.1Activity rate (%) 58.9 59.8 60.1 60.1 60.1 60.1 1.2Activity rate - Females (%) 48.8 50.2 51.6 52.2 53.1 53.4 4.6Employment (x1000) 20,367.3 20,425.1 18,945.0 18,476.9 18,303.0 17,417.3 -2,950.0Salaried workers rate (% of workers) 82.4 82.5 83.1 83.1 83.6 82.7 0.3Temps ratio (% salaried workers) 31.9 29.4 31.5 24.9 25.5 23.6 -8.2Part-time workers ratio (% of workers) 12.0 12.0 12.9 13.5 14.1 14.9 2.9Unemployment (x1000) 1,760.0 2,381.5 4,137.5 4,645.5 4,833.4 5,693.1 3,933.1Unemployed - 6 to 11 months (% of unemployed) 13.8 14.7 23.2 19.4 17.4 16.6 2.8Long term unemployed (1+ years) (% of unemployed) 24.6 21.1 26.3 42.4 47.8 52.2 27.6Enemployed <25 years old (% of unemployed) 25.1 24.1 20.7 18.7 18.3 16.8 -8.3Unemployed - Females (% of unemployed) 55.6 50.3 44.7 45.4 46.0 45.7 -10.0Unemployment rate (% of Labour Force) 8.0 10.4 17.9 20.1 20.9 24.6 16.7Unemployment rate - Females (% of Female Labour Force) 10.5 12.3 18.3 20.6 21.3 24.7 14.2Unemployment rate young (<25 years old) (% of LF of same age) 18.2 23.9 38.1 42.1 46.1 53.3 35.1Source: Afi from EPA (Labor Force Survey, INE)

Spanish Labor Market Fails

The new productive model requires:

- A more innovative scientific and tecnological system.

- Higher level of human capital: sharp reduction of drops from the education system.

But…


1st. Our labor regulation provokes firms to adapt their production to the business cycle by changing the number of workers (“labor rotation”) instead of changing the labor structure of the firm.

2nd. Collective bargaining is too centralized.

3rd. Unemployment subsidies in some cases disincentive the search for a job.

4th. Active policies for unemployed workers present large deficiencies.


1st Spanish Labor Market FailLarge generation of low-quality jobs in booms which are destroyed during economic crisis (Intensive cyclical job creation and destruction). Thus,

a) The unemployment rate has increased 12 points in 2 years. b) It has mainly concentrated in temporary contracts.

Reason: A dual labor market.Some workers (insiders) have undefined contracts and their jobs are highly secure (45 days of severance pay per worked year, now 33 days).Others (outsiders) have temporary contracts and their jobs are highly unsecure (8 days of severance pay per worked year).


One solution for the dual labor market:

Temporary contracts must disappear and there should be an unique undefined contract (there are so many different contracts). Severance payments should increase with antiquity.

Consequences1. A unique labor market2. Improvement for young people, women and immigrants.3. Increase of partial jobs.


2nd Spanish Labor Market Fail

Agreements at the firm level should be superior to agreements at higher levels.

Consequences1. Higher adaptation of labor conditions in the firm to business cycle.2. Improvements in productivity.


3rd Spanish Labor Market Fail

Subsidies (pasive policy) should be larger at the beginning but lower at the end (less smooth) to incentive the search for a job.

Moreover:

Gratifications to those firms that lay off less workers.Punishments to those firms that lay off more workers.


4th Spanish Labor Market Fail

- Active policies for employment should focus on low-skilled workers (they suffer more from long-run unemployment). Example: Spain 0.5% of GDP while Denmark 1.5% of GDP.

- Evaluation of active policies to improve their design (programs, agencies and public servants).

- Not only public but also private agencies.

Wage Determination

Workers are typically paid a wage that exceeds their reservation wage, the wage that would make them indifferent between working or being unemployed.

Wages typically depend on labor market conditions and the nature of the job…

Wage Determination

How much bargaining power a worker has depends on:

How costly it would be for the firm to replace him—the nature of the job.

How hard it would be for him to find another job—labor market conditions.

Bargaining

Wage Determination

The theories that link the productivity or the efficiency of workers to the wage they are paid are called efficiency wage theories.

These theories also suggest that wages depend on both the nature of the job and on labor-market conditions:

Firms that see employee morale and commitment as essential to the quality of their work, will pay more than firms in sectors where workers’ activities are more routine.

Labor market conditions will affect the wage: when unemployment is low, a firm must increase wages to avoid quits. Therefore, the lower the unemployment rate, the higher the wages.

Example of Efficiency Wages

In 1914,Henry Ford decided his company would pay every qualified employee a minimum of $5 per day for an eight-hour day (before it was around $2 per day for a nine-hour day). While the effects support efficiency wage theories, Ford probably had other objectives as well for raising his wages (publicity, avoiding the unions).

Annual Turnover and Layoff Rates (%) at Ford, 1913-1915

1913 1914 1915

Turnover Rate 370 54 16

Layoff Rate 62 7 0.1

Wage Determination

The aggregate nominal wage, W, depends on three factors:

The expected price level, Pe

The unemployment rate, u

A catchall variable, z, that stands for all other variables that may affect the outcome of wage setting.

W P F u ze ( , )( , )

Wage Determination

Both workers and firms care about real wages (W/P), not nominal wages (W).

Workers do not care about how many Euros they receive but about how many goods they can buy with those Euros.

Firms do not care about the nominal wages they pay but about the nominal wages, W, they pay relative to the price of the goods they sell, P.

But nominal wages are set before the relevant prices so…

The Expected Price Level

Wage Determination

Also affecting the aggregate wage is the unemployment rate, u.

If we think of wages as being determined by bargaining, then higher unemployment weakens workers’ bargaining power, forcing them to accept lower wages. Higher unemployment allows firms to pay lower wages and still keep workers willing to work.

The Unemployment Rate

Wage Determination

The third variable, z, is a catchall variable that stands for all the factors that affect wages, given the expected price level and the unemployment rate.

Unemployment insurance is the payment of unemployment benefits to workers who lose their jobs. But also minimum wage and employment protection.

The Other Factors

Price Determination

Y ANY = outputN = employmentA = labor productivity, or output per worker (constant returns to labor in production but it increases over time)

Further, assuming that one worker produces one unit of output—so that A = 1, then, the production function becomes:

Y N

The production function is the relation between the inputs used in production and the quantity of output produced. Assuming that firms produce goods using only labor, the production function can be written as:

This implies that MgC = W!

Price Determination

Firms set their price according to:

The term is the markup of the price over the cost of production. If all markets were perfectly competitive, = 0, and P = W/A.

P W ( )1

Under a perfect competitive market P=MgC and, therefore, P=W but many goods markets are not competitive so they charge a price higher than their MgC…

More realistically:

The Natural Rate of Unemployment

Let’s assume that nominal wages depend on the actual price level, P, rather than on the expected price level, .eP

Wage setting and price setting determine the equilibrium rate of unemployment.


Since Pe equals P, then:

This relation between the real wage and the rate of unemployment: wage-setting relation.

The Wage-Setting Relation

W PF u z ( , )

W

PF u z ( , )

( , )


The price-determination equation is:

The Price-Setting Relation

To state this equation in terms of the wage rate, we invert both sides:

The price-setting relation


The natural rate of unemployment is the unemployment rate such that the real wage chosen in wage setting is equal to the real wage implied by price setting.

1

A

Unemployment rate (u)

Rea

l Wag

e (W

/P)

WS

nu

PS


Eliminating W/P from the wage-setting and the price-setting relations, we can obtain the equilibrium unemployment rate, un:

The equilibrium unemployment rate (un) is called the natural or structural rate of unemployment.


The positions of the wage-setting and price-setting curves, and thus the natural or structural unemployment rate, depend on μ, A and z.

– At a given unemployment rate, higher unemployment benefits lead to a higher real wage. A higher unemployment rate is needed to bring the real wage back to what firms are willing to pay.

– By letting firms increase their prices given the wage, less stringent enforcement of antitrust legislation leads to a decrease in the real wage.

– Higher labor productivity is somehow equivalent to a reduction in wages


An increase in unemployment benefits leads to an increase in the natural rate of unemployment.

1

A


Rea

l Wag

e (W

/P)

WS

nu

PS

'nu

WS’


An increase in markups decreases the real wage and leads to an increase in the natural rate of unemployment.

1

A


Rea

l Wag

e (W

/P)

WS

nu

PS

PS’'1 A

'nuWhat would happen if A changes?


Given the rate of unemployment and the level of employment (N) we have:

uU

L

L N

L

N

L

1

Employment in terms of the labor force and the unemployment rate equals:

N L u ( )1

The natural level of employment, Nn, is given by:

N L un n ( )1


Associated with the natural level of employment is the natural level of output, and since (Y=N):

The natural level of output satisfies the following:

In words, the natural level of output is such that, at the associated rate of unemployment, the real wage chosen in wage setting is equal to the real wage implied by price setting.

uY

Lnn 1 ,


If equilibrium in the labor market determines the unemployment rate, and therefore, the level of output, we should not need the goods and financial markets…

– Because in the short run there is no reason to believe that the price level equals the expected price level, unemployment (output) can be different to the natural rate (level) at the short run.

– In the short run the factors that determine changes in output are monetary and fiscal policies, consumer confidence and so on. In the medium run the factors are those related to the labor market.

Macroeconomics III Prof. Juan Gabriel Rodríguez Chapter 1 The Labor Market.

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