Transcript Why wage floors?

MBA34
Managerial Excellence – 1° Term
Labor market policies and the labor market
Class 20
The firm and its environment - Francesco Giavazzi
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The importance of the labor market
Labor market functioning determines:
 Level of employment and number of hours worked
(thus per-capita GDP)
And also:
 Unemployment
 Extent of labor market participation of different
segments of working-age population
 Wages of different types of workers
In a nutshell, the importance of the labor market for
welfare of people cannot be missed
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In Oecd countries unemployment rates vary
from 2 to 12% of labor force – Why?
12
10
8
6
4
2
Slk
Spa
Por
Pol
Gre
Hun
Fra
Ger
Euro area
Bel
Fin
Ita
Ire
Uk
Usa
Aut
Cze
Swe
Den
Net
Nor
0
Need to understand effects of labor market institutions
(unemployment subsidies, taxes on labor, employment
protection legislation)
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Two types of unemployment
In actual labor markets, supply and demand fail to
adjust and unemployment shows up.
In two guises:
• Frictional (or search) unemployment is due to
the time needed to match workers with jobs.
Seen as largely voluntary
• Structural (or wait) unemployment arises
because the number of jobs available in some
labor markets is insufficient to provide a job for
everyone who wants one. Typically involuntary
and may have different causes
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Job search unemployment
• Job search is process thru which workers find
“appropriate” jobs (=commensurate to their tastes
and skills)
• Job search unemployment originates for it takes
time for individuals to find appropriate job
• This unemployment is not caused by a high wage
rate inflexible downwards, but by the time spent
searching for the “right” job
• Some search unemployment is inevitable, because
the economy is always evolving (sector shifts). So
do vacancies posted by firms and workers’ skills
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Labor market flows
Some employed lose their job
Unemployment Pool (U)
The Employed (L)
Some unemployed find jobs
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The “flows of workers” model
Flows from employment to unemployment (layoffs)
•
Happen when companies scale down, close down, or
when a particular employee under-performs
•
a fixed fraction “p” of the employed is laid off
•
flow from employment L to unemployment U is (p ∙ L)
Flows from unemployment to employment
•
A fraction “s” of the unemployed receives a job offer
every period. In turn, only a fraction “f” of these job
offers are accepted – only those above the individual
reservation wage (wage at which each unemployed is
willing to work)
•
The flow from U to L is (s∙f∙U)
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Equilibrium flows in and out
Total number = p ∙ L
Unemployment Pool (U)
The Employed (L)
Total number = s ∙ U
The level in the tub is constant (i.e. U doesn’t change) if flows balance
p ∙ (W-U) = s ∙ f ∙ U,
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W=L+U
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The natural rate of U
• Natural Rate of Unemployment: The rate of
unemployment at which flows in and out of employment
balance out:
U/W = NRU = p / (p + f ∙s)
• If p is high, turnover is high, and NRU is high as
well
• If s is low (few jobs created), NRU is high
• If the unemployed are very choosy (i.e. their
reservation wage is high), f is low and NRU is high
• Longer duration of U in countries where the process of
matching unemployed workers to jobs is slow and
unemployed are very choosy
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What makes the unemployed choosier?
Current job offer less appealing with
• labor market slack and high taxes on labor income
Continuing searching for a better job more appealing with
• high and long-lasting unemployment benefits
High labor taxes and generous unemployment
benefits  f, i.e. make workers choosier, and
raise NRU
The combination of both high taxes and generous
benefits makes unemployment a TRAP,
particularly as the economy slows down after a
period of boom (’80s-’90s vs. ’50s-’60s in OECD
countries)
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Another type of U: Wait unemployment
Motivated by the presence of a wage floor
Wage
Labor
supply
A
Wage floor set above
competitive wage
L
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U
Labor
demand
Labor
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Mechanics of wait unemployment
Suppose (real) wages are not allowed to adjust
downwards below the wage floor
 “real” wages. This is what matters for workers & firms
As a result:
L + U willing to work at the wage floor, but only L
are offered jobs by firms
Job rationing arises, U is wait unemployment
Remark: wait unemployment is ALWAYS BAD. But
then: if wait unemployment bad, why is there the
floor?
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Why wage floors?
Three reasons for wage floors (in the economists’
jargon: “downward rigidity of real wages”)
1. Minimum wage laws
2. Monopoly power of unions
3. Efficiency wages
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Minimum wage laws
In most industrial countries, Govts enacted laws setting
lower bound for wages
Pros
 Raise some people out of poverty
 Prevent early dismissal of unskilled adults (vis-à-vis
skilled youngsters)
Cons
 If wage floor binding, unskilled and young workers
stay unemployed. Also lower on-the-job learning
 Other ways of fighting poverty without raising labor
costs (e.g. Earned Income Tax Credit)
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Monopoly power of unions
In most industrial countries, wages of unionized
workers set by sequential union-firm bargaining
Bargaining often in two stages
 First, union and firm negotiate over wages (and
working time), at the state, industry or company
level, depending on countries
 Then, firm has right to manage on how many to
hire at negotiated wage
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Monopoly power of unions: implications
 Negotiated wage typically higher than competitive
wage (wage floor for unionized workers)
 Employment set by firms at lower level than in
competitive labor market, wait U arises
 Even wage of non-unionized often higher if unions
are powerful. Wage floor effectively for everybody
 Two types of workers: Insiders (those who benefit
from higher wages) and Outsiders (those left out of
the labor market). Outsiders would like to work at
current wage level but can’t
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Efficiency wages
Firms may freely choose to pay efficiency wages, i.e.
wages higher than in competitive markets
 To reduce labor turnover
 To motivate workers to work harder
 To make workers well fed and healthier (only
relevant in poor countries)
Same consequences as above
 Wage floor, wait unemployment, two groups of
workers
 This comes from company decisions, not from govt
regulation or bargaining
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Summing up:
How to lower the natural rate of U
Active labor market policies
– assist job search of the unemployed
• agencies for information dissemination. Public? Is the Internet
enough?
– retraining
• Do training programs really work?
– more active measures: subsidies to job search or job
creation
Coordinated wage bargaining
– Union coordination may moderate wage claims compared
to alternative with many (industry-wide) unions
independently setting wages
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Summing up:
How to lower the natural rate of U
Employment Protection Legislation (EPL): another
oft-discussed tool of labor market policy
EPL includes all measures geared to protect jobs
– Severance pay requirements
– Notice requirements
– Government approval for layoffs
Higher EPL has ambiguous effect on U fig
– Reduces probability of being fired for those holding a job
– Reduces probability of finding a job for those who
haven’t one or for those who look for another one
– Lengthens job tenure but also unemployment duration
(fig)
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Conclusions: Europe versus US
% points
2007
(projection)
Participation
rate
Unemployment Employment
rate
rate
Euro area
72.0
7.9
USA
75.0
4.6
66.3
(“Lisbon
goal”: 70,
by 2010)
71.0
But, in the US, also less job stability and more wage inequality.
Which labor market is best? Answer from Class Discussion?
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EPL and unemployment: no relation #
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EPL and duration of U:
positive – but rather noisy - relation)
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