Unemployment Notes

UNEMPLOYMENT: FINALS REVISION

Contents

• Trends in OECD Employment

• Natural Rate of Unemployment & PS/WS Framework

• Open Economy Theory

• Labour Market Institutions:

  • Employment Protection Legislation (EPL)

  • Minimum Wage

  • Unemployment Benefits

  • Trade Unions

• Alternative Models:

  • Efficiency Wage Hypothesis

  • Calmfors Driffel Model

  • Search Model

• Hysteresis:

  • A Model

  • Unemployment duration and hysteresis

  • Evidence

• Education & Unemployment

• Past essay questions

• Tutorial Essay Plan: Can demand shocks alter the equilibrium rate of unemployment

Trends in OECD Unemployment

1. Unemployment rates lower in Europe than in US at start of 1970s but soared in 1980s to over 10%. Less educated suffered disproportionately. US unemployment: no real trend over period though increase in dispersion (partially attributed to declining real wage in 1980s)

2. General rise in unemployment levels, especially in Europe (having been best performing in 3 decades post WWII), often attributed to less flexible labour markets.

3. UK:

   1. Thatcher: 1979-1981: unemployment doubled. Partially just recognising reality of natural rate.

   2. UK unemployment initially fell substantially post 1992 while French (and other EU countries) stayed high. Then got worst of both – rise in unemployment and inequality.

4. Increase in divergence in divergence between unemployment for educated/skilled, and uneducated/unskilled

5. Recession.

   1. UK: peaked at 8.4% in 2011, but fell to 7.8% in Jan 2013

   2. Germany: now 5.9% (recent increase). Had been 12% in 2006, but generally kept falling throughout recession

   3. Spain: 26.7% (55% u25 unemployed) from 8.7% in 2006

   4. France: 10.5% vs 9.5% in 2006

   5. Greece: 27.7% (59% u25 unemployed)

   6. US: peaked 10.1% in October 2009 vs 4% in 2006!

   7. Eurozone: 12.1% average in March.

6. NGDP currently estimated to be 15% below trend

7. CPI rose 1.2% in the year to April across Eurozone, slowdown from March’s 1.7% rise.

Natural Rate of Unemployment

Natural rate: Friedman: ‘the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is embedded in them the actual structural characteristics of the labour and commodity markets, including market imperfections, stochastic variability in demand and supplies, the costs of gathering information about job vacancies and labour availabilities, the costs of mobility etc.

NAIRU: level of unemployment consistent with stable inflation. Could be generated by wider range than Friedman’s model, eg. Carlin/Soskice. Broader concept which can include Friedman concept.

Equilibrium unemployment: rate of unemployment consistent with stable inflation and balanced trade.

What determines it?

Nickell: Threeway trade off between:

1. Low measured unemployment

2. Stable inflation

3. Balanced current account

• For some countries trade off is relatively benign. For others is malign.

• Nickell claims that how benign or malign that trade off is a function of the supply side.

• All that demand side can do is pick a point on the trade off.

• If believe in hysteresis and believe it could be lingering, 3 way trade off affected by demand side.

Original Phillips curve – 1958. Regarded as menu for policy choice.

Friedman 1968 questioned it – curve should be drawn for given level of price inflation expectations. Workers are surprised as don’t expect prices to change; adjustment lag. (Information story from C&S: W/P^E > W/P). So monetary expansion only achieves higher inflation but shame unemployment – VPC. Can only change by changing supply side.

What determines the natural rate of unemployment?

WS lies below LS curve.

PS lies below L_d (MPL) curve: excess of real wages on real demand curve is supernormal real profits per worker associated with IC in product market. Often assume PS horizontal. Lower elasticity pushes PS curve down (less competitive).

With IC labour market, unemployment at ERU must involve some involuntary unemployment. Know this because WS curve > LS curve so at ICE real wage must be workers willing to supply labour at that wage who are not employed.

Labour market imperfections necessary to generate involuntary unemployment, but product market imperfections also affect level of ERU.

NB if had PS curve and competitive labour supply curve, would be no involuntary unemployment, but employment would not be the same as with competitive labour demand curve.

Framework can explain differences internationally and over time.

Anything shifting PS up and WS to right will reduce ERU.

WS curve

w^WS = b(E, z_w) where z is set of wage push variables. Lies above LS curve because of labour market imperfections. The distance is the mark up per worker associated with labour market imperfections. The real wage demanded by workers rises as employment rises since the bargaining strength of workers improves.

Labour market not competitive in practice:

1. Unions: wage bargaining trade unions seek high real wage for members, while recognizing too high a wage will reduce employment. Don’t care about unemployed non-members in simple model.

2. Efficiency wages: firms set wages above market clearing level to retain well-qualified/productive workforce. Hard to specify exactly what a worker must do in a given job, so firm uses wage to motivate worker to perform well and to overcome adverse selection/moral hazard.

These determine the position of the WS curve. WS curve shifts closer to LS curve if:

1. Lower replacement ratio or UB duration (shifts balance towards accepting job at lower real wage at any given unemployment rate)

2. Reduced trade union power

3. Bargaining restraint – eg wage accord

PS curve

Perfect competition: real wage = MPL. In IC, firms set prices to maximize profits. The mark-up of prices over MC depends on the elasticity of demand: as the elasticity of demand rises, the mark-up falls until the extreme of PC holds, where elasticity is infinite.

In the case of monopoly, have the standard pricing formula:

The excess of the real wage on the labour demand curve above that on the PS curve is the supernormal...

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