Chapter 7: Unemployment

Chapter 7 Unemployment Natural rate of unemployment is the average level around which the unemployment rate fluctuates In a recession, the actual unemployment rate rises above the natural rate In a boom, the actual unemployment rate falls below the natural rate Actual Unemployment = Natural + Cyclical When actual = natural, cyclical = 0 When actual > natural, cyclical > 0 Determinants of Natural Rate of Unemployment A model of labor force dynamics that shows what determines the natural rate of unemployment A first model of the natural rate L = # of workers in labor force E= # of employed workers U = # of unemployed U/L = unemployment rate L=E+U Assumptions L is exogenously fixed 2. during any given month, S = rate of job separations, fraction of employed workers, who became separated from their jobs F = rate of job finding, fraction of unemployed workers who find jobs. S and F are exogenous Transitions between Employment and Unemployment S denote the rate of job separation, the fraction of employed individuals who lose or leave their job each month. F denote the rate of job finding, the fraction of unemployed individuals who find a job each month. Together, the rate of job separation s and the rate of job finding determine the rate of unemployment The S teady S tate condition Definition: the labour market is in steady stat, or l ong-run equilibrium, if the unemployment rate is constant # of employed people who lose or leave their jobs S xE=FxU # of unemployed people who find jobs Finding the equilibrium U-rate Policy Implication Any policy aimed at lowering the natural rate of unemployment must either reduce the rate of job separation or increase the rate of job finding Any policy that affects the rate of job separation or job finding also changes the natural rate of unemployment Why is there Unemployment? Although this model is useful in relating the unemployment rate to job separation and job finding, it fails to explain why is there unemployment in the first place? If a person could always find a job quickly, then the rate of job finding would be very high and the rate of unemployment would be near zero. This model of the unemployment rate assumes that job finding is not instantaneous, but it fails to explain why. If job finding were instantaneous (f=1), then all spells of unemployment would be brief, and the natural rate would be near zero Job Search - U(natural) = U(frictional) + U(structural) Wage Rigidity Job Search & Frictional Unemployment Frictional Unemployment: caused by the time it takes workers to search for a job Occurs even when wages are flexible and there are enough jobs to go around Occurs because workers have different abilities, jobs have different skill requirements, geographic mobility of workers not instantaneous and flow of info about vacancies and job candidates is imperfect Sectoral Shifts : changes in the composition of demand among industries or regions Example: Tech change – more jobs repairing computers, less repairing typewriters Example: New international trade agreement Examples Of Sectoral Shifts Industrial Revolution (1800s) Energy Crisis (1970s) Public Policies and Job Search Govt Programs affecting unemployment include: Govt Employment Agencies: disseminate info about job openings to better match workers and jobs Public Job Training Programs: help workers displaced from declining industries get skills needed for jobs in growing industries Employment Insurance (EI) EI pays part of a worker’s former wages for a limited time after the worker loses his/her job. EI increases frictional unemployment, because it reduces the opportunity cost of being unemployed and the urgency of finding work Studies: The longer a worker is eligible for EI, the longer the average spell of unemployment. Benefits of EI By allowing workers more time to search, EI may lead to better matches between jobs and workers which would lead to greater productivity and higher incomes Real Wage and Structural Unemployment Wage rigidity – the failure of wages to adjust to a level at which labor supply equals labor demand Sometimes the real wage is stuck above the market-clearing level Structural Unemployment: The unemplo yment resulting from real wage rigidity and job rationing Structural unemployment arises because firms fail to reduce wages despite an excess supply of labor. Three causes of this wage rigidity: 1. Minimum-wage laws, 2. The monopoly power of unions, 3. Efficiency wages 3 Reasons for Wage Rigidity Minimum Wage Laws The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers The equilibrium wages of teenagers tend to be low for two reasons. First, because teenagers are among the least skilled and least experienced members of the labor force, they tend to have low marginal productivity. Second, teenagers often take some of their “compensation” in the form of on-the-job training rather than direct pay. The minimum wage is therefore more often binding for teenagers than for others in the labor force. Labour Unions In Canada, only 32 percent of workers have their wages set through collective bargaining. In most European countries, unions play a much larger role. The wages of unionized workers are determined not by the equilibrium of supply and demand but by bargaining between union leaders and firm management Unions can also influence the wages paid by firms whose workforces are not unionized because the threat of unionization can keep wages above the equilibrium level. The unemployment caused by unions and by the threat of unionization is an instance of conflict between different groups of workers—insiders & outsiders Insiders: Employed union workers whose interest is to keep wages high. Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them. The effect of any bargaining process on wages and employment depends crucially on the relative influence of each group. Efficiency Wages These theories hold that high wages make workers more productive. The influence of wages on worker efficiency may explain the failure of firms to cut wages despite an excess supply of labor. First Theory Applied mostly to poorer countries, holds that wages influence nutrition. Better-paid workers can afford a more nutritious diet, and healthier workers are more productive. A firm may decide to pay a wage above the equilibrium level to maintain a healthy workforce Second Theory More relevant for developed countries, holds that high wages reduce labor turnover. Workers quit jobs for many reasons—to accept better positions at other firms, to change careers, or to move to other parts of the country. The more a firm pays its workers, the greater is their incentive to stay with the firm. By paying a high wage, a firm reduces the frequency at which its workers quit, thereby decreasing the time and money spent hiring and training new workers Third Theory holds that the average quality of a firm’s workforce depends on the wage it pays its employees. If a firm reduces its wage, the best employees may take jobs elsewhere, leaving the firm with inferior employees who have fewer alternative opportunities. Economists recognize this unfavorable sorting as an example of adverse selection—the tendency of people with more information (in this case, the workers, who know their own outside opportunities) to self-select in a way that disadvantages people with less information (the firm). By paying a wage above the equilibrium level, the firm may reduce adverse selection, improve the average quality of its workforce, and thereby increase productivity. Fourth Theory holds that a high wage improves worker effort. This theory posits that firms cannot perfectly monitor their employees’ work effort and that employees must themselves decide how hard to work. Workers can choose to work hard, or they can choose to shirk and risk getting caught and fired. Economists recognize this possibility as an example of moral hazard—the tendency of people to behave inappropriately when their behavior is imperfectly monitored. The firm can reduce the problem of moral hazard by paying a high wage. The higher the wage, the greater the cost to the worker of getting fired. By paying a higher wage, a firm induces more of its employees not to shirk and thus increases their productivity. The common theme : because a firm operates more efficiently if it pays its workers a high wage, the firm may find it profitable to keep wages above the level that balances supply and demand the result of this higher than equilibrium wage is lower rate of job finding and greater unemployment Labor Market Experiences In Canada Duration of Unemployment when a person becomes unemployed, is the spell of unemployment likely to be short or long? Two Components of Unemployment rate: Incidence – likelihood that an individual suffers an unemployment spell Duration – average length of the spell Most unemployment spells are short of duration Most unemployed people on a given date are experiencing unemployment spells of long duration Numerical Example : Labor force = 100; on the first day of every month, two workers become unemployed for one month each; on the first day of every year, four workers become unemployed for one year each Result: 28 spells of unemployment during a year; 24 short (one month), four long (one year); so most spells are short At any date, unemployment = six; four have long spells (one year), two have short spells (one month); so most unemployed people on a given date have long spells Variation across Age Groups and Regions The rate of unemployment varies substantially across different age groups within the population The rate of unemployment varies substantially across different regions While younger Canadians have always had unemployment rates higher than prime-aged adults, they now account for a smaller proportion of unemployed people than they did three decades ago The aging of the Canadian population has resulted in a change in the structure of unemployment. In 1976, almost half of all unemployed people were 15 to 24 years old, compared with just 26% in 2012 Trends Over the past 50 years, the natural rate of unemployment in Canada has not been constant Unemployment averaged well below 5% in the late 50s and 60s Unemployment averaged above 9% in the late 80s and 90s Various explanations Demographics Changing composition of Canadian labor force Entry of baby boomers into the labor force around 1970 Increased participation of women into the labor force Sectoral shifts Increased pace of tech change Natural resource prices Productivity Slowdown in productivity growth, experienced during 1970s, reduced labor demand Sluggish real wage (remaining high prolonged period Increased Unemployment Transitions into and out of Labour Force Model assumes labor force to be fixed Discouraged workers Part time workers want full time jobs are counted as employed Comparing Unemployment: US and Canada 1960s & 1970s, on average similar unemployment rates 1980s, the experiences of the two countries started to diverge Canadian rates on average, 4% above U.S. Rates 2008, rates at almost par Gap can be decomposed in three components 1. Definition of unemployment • 1% out of 4 can be attributed to the way unemployment is defined in two countries In Canada, “looking at job advertisement” is sufficient, while in U.S. More active search is required 2. Capacity utilization • 2% out of 4 can be attributed to the fact that Canadian economy was operating at a lower level of capacity utilization than U.S. Throughout the 1980s & 1990s 3. Set of structural factors • 1% out of 4 can be attributed to the changing roles of unions in the two countries • In 1960s, about 30% of the labor force was unionized in both countries • Canadian labor laws did more to foster unionization than U.S. laws did • Rose in Canada and fell in U.S. • The changes in real wages accompanied change in unionization • 30 % increase in real wages in Canada relative to U.S. • More generous unemployment insurance program in Canada