overview. outline some key definitions – institutions, markets and wedges – labor market states...
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OverviewOverview
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OutlineOutline• Some key definitions
– institutions, markets and wedges– labor market states
• A simple static framework and the wedge• Why institutions?• Learning from reforms: difference-in-
differences. Pressures coming from globalisation.
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Key definitionsKey definitions• An institution is a system of laws, norms or
conventions resulting from a collective choice, and providing constraints or incentives which alter individual choices over labor and pay.
• A labor market is a market where labor services (specified in a vacant job) are sold for a remuneration called wage
• Institutions create a wedge between the value of the marginal job for the firm (fl) and the wage (w)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Labour Market StatesLabour Market States
• Employed, L (OECD-ILO convention)• People in working age who, during the reference week (or
day), have made for at least one hour:
– paid work (also paid in nature) or
– self-employed work
• Paid work includes:– People who are not temporarily working but who have
formally a paid work (e.g. they have a salary, maternity leave, etc.)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Labor Market States (cont.)Labor Market States (cont.)
• Unemployed, U• People in working age who, during the reference week (or
day), were :
– without either paid or self-employed work,
– willing to work and
– looking for a job.
• Inactive O• People in working age neither employed nor unemployed
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Normalization rulesNormalization rules– Labour Force (LF): L+ U – Working Age Population (N): L+U+O
• Unemployment rate: (U/LF)
• Employment rate: (L/N)
• Activity rate (or labor force participation rate) (LF/N)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Problems with OECD-ILO Problems with OECD-ILO definitionsdefinitions
• Porous participation borders: potential labor force excluded
• Relaxing job search requirement, less inactive (about 15% less inactive in the EU countries)
• Some discouraged workers (without work and willing, but not searching) are undistinguishable from the unemployed in terms of labor market transitions (Box 1.3)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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A framework (generalities)A framework (generalities)
• Labor supply derived from labor-leisure (plus home production) choice
• Aggregation assuming that workers do not choose hours, just participation
• Heterogeneity in reservation wages• (Derived) labor demand with markups• Institutions implement a wedge between
labor supply and demand
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Labor/Leisure choice Labor/Leisure choice • Preferences: indifference curves are negatively
sloped in c and l (negative MRS), do not interesect (no incoherence) and convex (MRS declining with l)
• Constraints (assuming away non-labor income)– Hourly wage (w) as slope of the budget constraint
– Maximum amount of hours (l0) to be allocated to labor (h)/leisure (l)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Slope of individual labor Slope of individual labor supplysupply
• Depends on relative magnitude of income/substitution effects.
• With leisure as normal good, income effect negatively affects labor supply
• Substitution effects always positive on hours worked
• Generally substitution effects dominates for low-wage earners while income effect for high wage earners
• Income effect irrelevant at participation margins
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Total effect of a wage riseTotal effect of a wage riseMoney Income
Hours of Leisure
Hours of Work
16
0
0
16
5 8
811
B
C
A
64
128
192
Observed Change
U2
U1
N2
N1
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
N3
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The Income EffectThe Income EffectMoney Income
Hours of Leisure
Hours of Work
16
0
0
16
8 9
78
B
A
64
128
192
Income effect
U2
U1
N3
N1
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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The Substitution EffectThe Substitution EffectMoney Income
Hours of Leisure
Hours of Work
16
0
0
16
5 8
811
C
A
64
128
192
Substitution efffect
U2
N2
N1
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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The (static) reservation wage The (static) reservation wage • It is the lowest wage at which a jobseeker is
willing to work (slope of IC at l0 and non-labor income level)
• At that level elasticity of individual labor supply is always positive (substitution effect dominates)
• Reservation wage is increasing in non-wage income and separates employment from non-employment
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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From individual to aggregate From individual to aggregate labor supplylabor supply
• Adding up hours worked by each individual• Heterogeneity in non-wage income (or
preferences), hence in reservation wages, wr
• If individuals can only offer fixed number of hours of work, then aggregate labour supply follows distribution of wr (N F(wr) where N is working age population) and is always increasing in wages
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Participation rateParticipation rateAggregate labour supplyAggregate labour supply
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
0.2
.4.6
.81
-5 0 5error
cum_ger cum_dnk
cum_bel cum_lux
cum_fra
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(Derived) labor demand (Derived) labor demand and equilibriumand equilibrium
• From profit maximisation of individual firms• The optimal employment level equals the
value of the marginal product of labour (fl) to the wage (w): f (l) = w
• As fl l< 0, labour demand is decreasing in wages
• Role of competition in product markets
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Why Institutions?Why Institutions?Three arguments for their existence:
1. Efficiency: a competitive LM does not exist
2. Equity: as no lump-sum transfer is available, redistribution is distortionary
3. Policy failure: heterogeneity and powerful minority interest groups; inertia of institutions
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Institutions and wedgesInstitutions and wedges
Price-Based Institutions and the Wedge Quantity-Based Institutions and the Wedge
L L
U
Wedge
w w
Ld (w)
LS (w)
L
Wedge
L0S (w)
L1S (w)
L
Ld (w)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Institutions and adjustment to shocks
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Increasing employment bias Increasing employment bias of LM institutions?of LM institutions?
• In the 1950s and 1960s US enviously looking at European institutions. In the 1980s and 1990s the other way round.
• Interactions between shocks and institutions (e.g., shocks create U, EPL or UBs make it longlasting)
• Under stronger competitive pressures, LM institutions may have higher costs in terms of foregone employment
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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More competition in product markets (globalisation) increases the employment
costs of institutions
∆ E
∆ E
w
D0
D1
S
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Stronger pressures for Stronger pressures for institutional reformsinstitutional reforms
• fRDB inventory of labor market and social policy reforms
• Classified by area (e.g. EPL, UBs, RET, MIG, WT), direction (increasing / reducing the wedge) and scope (structural / marginal)
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Acceleration of reformsAcceleration of reforms
1986-1990
1986-1990
1991-1995
1991-1995
1996-2000
1996-2000
2001-2005
2001-2005
0
10
20
30
40
50
60
70
80
90
100EPL NEB
N°
of
Ref
orm
s
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.
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Remainder of the courseRemainder of the course
• Institutions by institution
• Outline of each lecture– description of the institution (measurement)– theory (does it implement the wedge? how?
effects on employment and wages)– evidence (possibly difference-in-differences)– policy issues
Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.