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5-3-07 - 151 lectures Unemployment Introduction How is...

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Unformatted text preview: 151 lectures Unemployment Introduction How is unemployment defined and measured? What prevents the labor market from clearing? Is labor market rigidity the cause of higher unemployment in Europe, relative to the U.S., with its more flexible labor markets? A. Definition and measures of unemployment (UE) 1. Involuntary unemployment: those who are looking for work but unable to find any, or waiting to be recalled to previous job (temporary layoff). --Temporary layoffs are much less common than thirty years ago. --Unemployed include job losers, job leavers, entrants and re-entrants. 2. Operational definition of unemployed has to include decisions on the boundary between UE and Not in Labor force: --a time frame (how recently looked for work—last four weeks--and at what threshold intensity) -- those who are not working but who have or could have job offers that are below their acceptance (reservation) wage --full-time students and young people (cutoff now sixteen but used to be fourteen) --those in institutions (prisons, hospitals, military) --those who say they are not looking for a job for “family reasons” --those who are under-employed (below their skill and potential earnings levels) 1 --people in government training programs or receiving assistance and who were displaced from their jobs --those who are involuntarily working part-time --marginally attached workers who have looked for work in recent past—last 12 months but not last four weeks. --discouraged workers who have given up looking because they say there are no jobs available to them (subset of marginally attached group) 3. BLS calculates several UE rates, to account for the last three items but not the others. See slides. ---By official operational definitions, unemployment reached thirty percent during the 1930s and twenty percent in some parts of the industrial Midwest in the early 1980s. --The lowest UE rate in the U.S. was 3.5 percent during the Vietnam War and just under four percent in the late 1990s. In Europe, UE was one to two percent in the 1950s, 1960s and early 1970s; in Japan it was similarly low until the early 1990s. --Today, the UE rate is just under six percent in the U.S. and Japan, a bit under ten percent in much of Western Europe and as much as twenty or thirty percent in parts of Eastern Europe. 4. Comparability across countries --These definitions vary a bit among OECD countries and over time. --They are adjusted by the statistical agencies to be comparable across countries. --A different definition—such as including those working below their skill capacities—would change the relative UE rates between the U.S. and Europe quite a bit. 2 B. Theories of unemployment --In a perfectly competitive model, markets clear instantaneously as prices adjust to the point that quantities supplied and quantities demanded become equal to each other. --The existence of unemployment implies that the simple model needs some further elaboration. The debate concerns how to elaborate the model. --All schools of thought today agree that some UE is frictional (entrants, reentrants, leavers, voluntary job changers), that some is structural (mismatches between skills supplied and demanded, barriers because of transportation gaps in inner cities to suburbs). The amount of each is debated. --Controversies center on extent of UE attributable to search (reservation wage) and associated rigidities of labor market, and how much is due to demand deficiencies. 1. Classical (1870s to 1930s) The classical answer: real wages were too high and did not adjust downwards because of unions. 2. Keynesian (1930s to 1970s) --Unions only bargain over the money wage, but since firms set prices and the central bank sets monetary policy, the real wage can adjust via an increase in the price level. --UE is result of wages being too low, and/or investment demand is too low relative to interest and profits, so aggregate demand is insufficient. --Interest rate cannot adjust sufficiently to bring desired investment in line with desired savings. 3 --So have low-level employment equilibrium trap and government spending can be the solution. As full employment approaches, there will be a trade-off with inflation (Phillips curve). 3. New Classical (1970s to 1980s) --Keynes failed to explain why unemployed do not bid down wage rates. Answer is that reservation wage is too high, because of UI benefits, and other nonlabor transfer payments. --This suggests that unemployment is voluntary. --This view is emphasized by E-S text. It is true that UI replacement rate and duration are associated with more and longer-term unemployment, but effects are small relative to size of UE. --Some of the effects of UI benefits have positive efficiency implications (permits waiting and searching for a better job, smoothing out business cycle) as well as equity effects. --New classicals argued also that Phillips curve was vertical—at “natural” rate of unemployment, below which inflation would accelerate. 4. New Keynesian (1970s on) --Response to New Classical economics --Wages are inflexible downwards even under competitive conditions because of efficiency wages and social norms that prevent wage-cutting, benefits of long-term employment relations. --Monetary and fiscal policy can each be effective in reducing unemployment without accelerating inflation. Each are working right now as counter-cyclical policy. 5. Experience of the 1990s 4 --Simultaneous reductions in unemployment and inflation surprised both New Classical and New Keynesian schools of thought. --Improvement in Phillips curve is partly understandable as the result of a) Growth of job insecurity, which means workers make lower wage demands at a given rate of unemployment, so there is less inflationary pressure from wages. b) Reorganization of work and technology that drew more on employee’s participative skills. --Monetary policy by the Fed was much more permissive in the 1990s than in previous decades, and much more permissive than in Europe. C. Relation of UE to wage inequality and wage flexibility 1. Comparison of US - Europe --Before 1970: European UE was 2-3 percent and productivity grew faster, so better Phillips curve. In Germany UE was 1 percent, in US, 6-7 percent. --Explanation: social partners with wage moderation, so rate of change of wages less than rate of change of productivity, and resultant profits were reinvested. No need for stop-go patterns to restrain UE or balance of payments deficits. --After 1970s: no trend in US UE, but large cyclical swings. But European UE trends upwards! Not because size of working population growing faster in Europe; nor because of rising labor force participation rates. 2. Has wage flexibility and labor market flexibility, which generated increase in wage inequality in the U.S., also generated job growth? --Types of labor market rigidities in Europe: generous UE, protections from being fired, higher minimum wage, unions. These play a part, but it turns out only a small part of differences in performance. 5 3. Reasons to doubt “Eurosclerosis” explanation --Timing: no increase in wage rigidities in Europe in mid-1980s; we don’t see the Beveridge curve moving out and we see low level of vacancies, implies low level of labor demand. --More generous UI benefits in Europe can be a response to, not just cause of high UE policies. --More short-run real wage resistance in Europe, yet high profits recently have not led to reduction of UE --Recently, moves to greater flexibility in many European countries, has had only a small effect on UE. --Cross-country regressions estimates: signs and magnitudes of coefficients of rigidity variables are fragile, varying with alternative specifications of time periods, years and right-hand variables. 4. Alternative explanations: --There is more product market power in Europe, so oligopolies slowed change in telecomm, IT. ---Flexibility of US may have been hindrance in 1960s but an advantage during more rapid technological change of past two decades. --Harder to start small businesses in Europe --Fiscal policy in Europe has been repressive because of artificial targets imposed by Maastricht treaty (the Growth and Stability Pact). --Monetary policy: European Central Bank had much higher interest rates compared to US Fed in 1990s. 6 ...
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