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Diploma Preparatory Course Macroeconomics Lecture 3_1 Unemployment

Giammario Impullitti slide 0

Today’s Outline

The natural rate of unemployment What causes unemployment? – Job search

Frictional unemployment Sectoral shifts Unemployment insurance – Wage rigidities

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Unemployment in the US

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Unemployment in the EU

Unemployment rate

Natural rate of unemployment

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Unemployment in the UK

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Recent unemployment figures… Country

2006

2007

2008

2009

United Kingdom

5.0

5.5

6.3

7.4

Germany

8.7

8.6

7.1

7.5

Italy

7.7

6.1

6.9

7.4

Netherlands

4.0

3.4

2.7

3.2

Spain

8.7

8.1

13.9

17.7

Poland

16.8

10.3

6.9

7.9

EU average

8.4

7.3

7.5

8.7

USA

4.7

4.4

6.9

8.9

Source: Eurostat

(http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home)

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Natural Rate of Unemployment Natural rate of unemployment: the average rate of unemployment around which the economy 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

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Why is There Unemployment? Friedman (1968): The natural rate of unemployment is the equilibrium level of unemployment, embedding the actual characteristics of the goods and labour markets, including market imperfections, variability in demands and supplies, costs of gathering information on vacancies, costs of mobility, ... slide 7

Why is There Unemployment?

Through a simple model we will see two main reasons that lead to unemployment: – Job search – Wage rigidities

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A First Model of the Natural Rate Notation:

L = # of workers in labor force E = # of employed workers U = # of unemployed U/L = unemployment rate

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Assumptions 1. L is exogenously fixed 2. During any given month

s = fraction of employed workers

that become separated from their jobs

f = fraction of unemployed workers that find jobs

s = rate of job separations f = rate of job finding (both exogenous) slide 10

Labour Market Flows s ×E

Employed

Unemployed

f ×U

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Steady State (Equilibrium)

Definition: the labor market is in

steady state, or long-run equilibrium, if the unemployment rate is constant

The steady-state condition is:

s ×E = f ×U # of employed people who lose or leave their jobs

# of unemployed people who find jobs

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Equilibrium Unemployment Rate f ×U = s ×E = s ×(L –U ) = s ×L – s ×U Solve for U/L: (f + s)×U = s ×L so, Unemployment rate

U s = L s +f

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Example

Each month, 1% of employed workers lose their jobs (s = 0.01) Each month, 19% of unemployed workers find jobs (f = 0.19) Find the natural rate of unemployment:

U s 0.01 = = = 0.05, or 5% L s +f 0.01 + 0.19

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Drawbacks

This model gives a way to calculate the

natural rate of unemployment in the long run BUT it does not explain why and how there was unemployment in the first place

Assumes job finding is not instantaneous BUT it does not explain why

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Changing the Natural Rate A policy will reduce the natural rate of unemployment only if it lowers s or increases f If job finding were instantaneous (f = 1), then all spells of unemployment would be brief and the natural rate would be near zero

There are two reasons why f < 1 1. job search (frictions) 2. wage rigidity

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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, preferences jobs have different skill requirements geographic mobility of workers not

instantaneous flow of information about vacancies and job candidates is imperfect slide 17

Job Search: Sectoral Shifts DEF: changes in the composition of demand among industries or regions

Example: Technological change increases

demand for computer-complementary workers, decreases demand for less skilled workers

Example: A new international trade agreement

causes greater demand for workers in the export sectors and less demand for workers in importcompeting sectors

It takes time for workers to change sectors,

so sectoral shifts cause frictional unemployment slide 18

Sectoral Shifts in UK 1980

2001

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More examples of sectorial shifts Late 1800s: decline of agriculture, increase in manufacturing

Late 1900s: relative decline of manufacturing, increase in service sector

1970s: energy crisis caused a shift in demand away from gas guzzlers toward smaller cars.

In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment. slide 20

Job Search: Public Policy Govt programs affecting unemployment Govt employment agencies:

disseminate info about job openings to better match workers & jobs Public job training programs:

help workers displaced from declining industries get skills needed for jobs in growing industries

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Job Search: Unemployment Insurance UI pays part of a worker’s former wages for a limited time after losing his/her job (unemployment benefit)

UI increases natural rate, because it: – reduces the opportunity cost of

being unemployed – reduces the urgency of finding work – hence, reduces f

Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment

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Benefits of Unemployment Insurance

By allowing workers more time to search, UI may lead to better matches between jobs and workers

… which would lead to greater productivity and higher incomes

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Wage Rigidity: Structural Unemployment

If real wages fail to adjust to equilibrium where labour demand equals supply

⇒ real wage rigidity ↓ rate of job finding and ↑ natural rate of unemployment

Unemployment from wage rigidity and job rationing called structural unemployment

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Real Wage Rigidity If the real wage is stuck above the eq’m level, then there aren’t enough jobs to go around.

Real wage

Supply Unemployment

Rigid real wage

Demand Amount of labour hired

Labor Amount of labour willing to work slide 25


Then, firms must ration the scarce jobs among workers. Structural unemployment: the unemployment resulting from real wage rigidity and job rationing.

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Reasons for Wage Rigidity 1.

Minimum wage laws

2.

Labor unions

3.

Efficiency wages

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Summary The natural rate of unemployment U/L = s / (s + f)

What causes unemployment? DONE

9 – Job search ⇒ frictional unemployment

Next Î – Wage rigidities ⇒ structural unemployment

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Next hour

Unemployment and labour market rigidities Unemployment in the US and EU Summary/overview of the topics covered so far

Open economy intro

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Equilibrium Unemployment Rate f ×U = s ×E = s ×(L –U ) = s ×L – s ×U Solve for U/L: (f + s)×U = s ×L so, Unemployment rate

U s = L s +f

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Why is there unemployment?

Job search (frictions) Structural unemployment / wage rigidities

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Real wage

Supply Unemployment

Rigid real wage

Demand Amount of labour hired

Labor Amount of labour willing to work slide 32

Structural Unemployment

Structural unemployment: the unemployment resulting from real wage rigidity and job rationing

Causes of wage rigidity: – Minimum wage laws – Labor unions – Efficiency wages

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The Minimum Wage

The minimum wage is well below the eq’m

wage for most workers, so it cannot explain the majority of natural rate unemployment

However, the minimum wage may exceed the eq’m wage of unskilled workers, especially teenagers

If so, then we would expect that increases in the minimum wage would increase unemployment among these groups

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Some Numbers In Sept 1996, the minimum wage in US was raised from $4.25 to $4.75. Here’s what happened:

Unemployment rates, before & after Teenagers Single mothers All workers

3rd Q 1996 16.6%

1st Q 1997 17.0%

8.5%

9.1%

5.3%

5.3%

Other studies: A 10% increase in the minimum wage increases teenage unemployment by 1-3% slide 35

Alternatives to Minimum Wages

Low wage subsidies Tax breaks for low-income families – earned income tax credit – provides incentive to hold job

Improve education (secondary schooling)

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Labour Unions Unions exercise monopoly power to secure higher wages and job security for their members

When the union wage exceeds the eq’m wage, unemployment results

Employed union workers are insiders whose interest is to keep wages high

Unemployed non-union workers are outsiders and would prefer wages to be lower (so that labor demand would be high enough for them to get jobs)

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Some Numbers

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Efficiency Wages Theories in which high wages increase worker productivity: – – – –

attract higher quality job applicants increase worker effort and reduce shirking reduce turnover, which is costly improve health of workers

(in developing countries)

The increased productivity justifies the cost of paying above-equilibrium wages

The result: unemployment slide 39

Patterns of Unemployment

The data: More spells of unemployment are short-

term than medium-term or long-term Yet, most of the total time spent unemployed is attributable to the longterm unemployed

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Patterns of Unemployment

This long-term unemployment is probably structural and/or due to sectoral shifts among vastly different industries

Knowing this is important because it can help us craft policies that are more likely to succeed

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Patterns of Unemployment: US The natural rate rises from ‘60s to early ’80s, then falls from mid-80s to 2000

Data shows that – The trend in the real minimum wage is similar

to the behavior of the natural rate of unemployment – Since the early ‘80s, union membership has fallen - but, from ‘50s to about 1980, the natural rate rose while union membership fell – Since ’80s, less sectoral shifts due to volatile oil prices slide 42

Patterns of Unemployment: Europe France

Percent of labor force

12

U.S.A. 9

6

Italy

3

U.K. Germany

0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 slide 43

European Unemployment

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Eurosclerosis The term is used to express that labour market rigidities have had important negative effects on EU economic performance

Why is EU’s unemployment so much higher than US’s?

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Unemployment in the UK

Pattern quite different from the rest of continental Europe

Similarities with US, e.g. – Sectoral shifts in 70s/80s – Decrease in Union membership after 80s – Etc.

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1998m01 1998m06 1998m11 1999m04 1999m09 2000m02 2000m07 2000m12 2001m05 2001m10 2002m03 2002m08 2003m01 2003m06 2003m11 2004m04 2004m09 2005m02 2005m07 2005m12 2006m05 2006m10 2007m03 2007m08 2008m01 2008m06 2008m11 2009m04

US and UK unemployment rates 10

9

8

7

6

5

4 t,uk

t,us

3

2

1

0

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Unemployment in the EU: Rigidities EU has more labour market rigidities:

EU more diverse than US (culture,

language), means less labour mobility

EU countries have strong union traditions European welfare states (generous unemployment benefits, etc.)

Strong employment protection legislations

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Unemployment in the EU: Hysteresis Hysteresis = shortcoming, to fall short, retardation OED: The phenomenon by which the value

of a property lags behind changes in the effect causing it

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Unemployment in the EU: Hysteresis Refers to the view that an economy’s natural rate of unemployment depends on its history: – If workers unemployed for long ⇒ lose skills – Less skills ⇒ worker becomes more “unemployable” ⇒ becomes discouraged – Unemployment becomes permanent

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Unemployment in the EU: Technological Change

Shift in demand from unskilled to skilled workers, due to technological change

This demand shift occurred in the U.S., too. But the U.S. has less wage rigidity, so instead of causing higher unemployment, the shift caused an increase in the gap between skilled and unskilled wages.

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Unemployment in the EU: Strong Welfare States

Generous social insurance programmes Large unemployment benefits Collective bargaining (unionisation)

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Unemployment in the EU: The Peter Pan Syndrome (south Europe)

Young people staying at home, less incentive to work ⇒ more unemployment slide 53

Unemployment in the EU: Labour Mobility

Source: OECD Mobility rate: Ratio of the total number of persons who changed region of residence to the total population over one year slide 54

Unemployment in the EU: the Black Economy

In south Europe, black economies have significant size

Many unskilled workers hired on the black

market – thus appearing as “unemployed”

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Unemployment in the EU: More leisure less work

Europeans work less per year than Americans

Theories for this: – Higher taxes in Europe – Illegal work (not

recorded) higher in Europe – Europeans have more taste for fun and games

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What Have We Learned So Far? Three important macro variables:

OUTPUT Determined by factors of production and demand for income with the Classical model

INFLATION Depends on money growth (Quantity theory of money)

UNEMPLOYMENT Different types of unemployment; depends on job separation and finding (which depend on labor market institutions) slide 57

What Have We Learned So Far?

Two important assumptions in our study so far:

–

–

We look at the long run •

Flexible prices

•

Market clearing

The economy is closed (i.e. on its own)

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Next Extension: Open Economy Assume that the economy is open, i.e. trades with other economies

The “link” between two open economies is the exchange rate

Rethink the classical model in an open economy (real exchange rates)

– Small open economy – Large open economy

Rethink inflation in an open economy (nominal exchange rates)

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Open Economies Most economies open: – export/import goods and services – borrow/lend money in world financial markets

US exports/imports 2%

0

0%

-200

-2%

-400

-4%

-600

-6%

-800 1950

-8% 1960

1970

NX ($ billions)

1980

1990

percent of GDP

billions of dollars

U.S. Net Exports, 1950-2006 200

2000

NX (% of GDP)

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Imports/Exports as % of GDP, 2003 50% 45%

Percentage of GDP

40% 35% 30% 25% 20% 15% 10% 5% 0% Canada

Imports

France

Germany

Italy

Japan

Mexico

U.K.

USA

Exports

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In an open economy…

spending need not equal output saving need not equal investment

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Next time…

National income identity and net exports Small open economy in the long run Exchange rates, etc…

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