Frank & Bernanke 3rd edition, 2007 Ch. 8: Workers, Wages, and Unemployment in the Modern Economy

Labor Market Trends During the last century real wages in the industrialized world increased substantially. Since the 70s, the rate of growth of real wages slowed. Wage inequality rose substantially in the recent decades in US. In the US, recent decades saw substantial job creation. Western Europe has experienced high unemployment rates in recent decades.

Real Wages Compared to before the Great Depression, an average American worker earns four times as much. Real wages grew at a rate of 2.5% between 1960 and 1973 but at a rate of 1.2% between 1973 and 1999. Real wages for unskilled labor declined by one-fourth since the 70s. Real wages for bachelor’s and master’s degree holders increased substantially; a master’s holder earns twice the highschool graduate. (http://www.census.gov/population/socdemo/education/tableA-3.txt)

http://www.census.gov/population/socdemo/education/tabA-3.pdf

http://www.census.gov/statab/www/employ.html

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Employment/Unemployment In 1970, 57% of over 16 population had jobs; in 1999, 64% had jobs. Between 1980 and 1999, US economy created more than 34 million new jobs. Many of the EU countries experienced very high (some double digit) unemployment rates for over ten years; job creation has been very low.

Explaining The Trends The labor market trends mentioned will be explained using the traditional supply-demand analysis. The “product” demanded is the “labor” of the worker. The horizontal axis can be measured in terms of number of workers or number of hours worked. The “price” on the vertical axis is the real wage - what firms pay to acquire labor.

Deriving the Demand for Labor Demand for labor comes from employers/firms. An employer will have to do the marginal benefit vs. marginal cost calculation to determine how many people (or many hours of work) to hire.

Supply and Demand in the Labor Market Wages and the Demand for Labor The demand for labor depends upon: The productivity of workers. The price of the worker’s output.

Demand for Labor

Demand for Labor

Bob’s Demand for Labor How do we define the demand curve? At each and every price how much is demanded in the market. Apply this to Bob. At each and every real wage, how much labor will Bob hire?

Shifts in Demand

Shifts in Demand

Supply of Labor The decision to work or not to work, again, depends on the cost-benefit principle. If your reservation price (how much you would pay another to do the job) is less than what you are offered to do the job, you should take the job. In this view, the higher the real wage, the more hours of work will be offered by workers. There is also the substitution effect: leisure for work.

Shifts in Supply of Labor Any thing that changes the size of the working age population. Increase in domestic birth rate. Immigration. Emigration. Change in the age a typical person enters the work force. Change in the age a typical person retires.

Explaining Political Stands Employers usually favor immigration while labor unions oppose it. Given our simple Supply and Demand analysis, explain why. What happens to real wages due to immigration? Supply curve shifts right, depressing real wages.

Immigration Real Wages S S’ Labor

Why Did Real Wages Rise Fourfold During 20th Century Average labor productivity rose shifting the demand for labor to the right. The reasons for average labor productivity growth were technological advances; increases in capital stock; increases in human capital.

Rise in Population and Average Labor Productivity Real wage MP L

Why Did Real Wages Rose Much Slowly After 1973 Average labor productivity slowed down significantly, eliminating the large rightward shifts in the demand for labor. Labor supply increased (labor participation rates rose) shifting the supply to the right.

After 1973

Growth Rates in Productivity and Real Earnings Annual Growth Rate (%) Productivity Real Earnings 1960 - 1970 2.33 2.89 1970 - 1980 0.84 0.79 1980 - 1990 1.38 1.15 1990 - 2000 1.89 1.92 Observations Reduced growth in productivity reduces the demand for labor and real wage growth Increases in the supply will cause employment to increase and hold real wages down

Increasing Wage Inequality Technological changes in services favored skilled labor against unskilled labor unlike the technological changes in manufacturing. Looking at two labor markets, skilled and unskilled, the changes in demand would create the observed gap.

Technological Change S S D D Unskilled Labor Skilled Labor

Increasing Wage Inequality Trade dependent on comparative advantage, lowers the demand for labor by importing industry but raises the demand for labor by exporting industry. Unskilled labor loses in the process. However, the bulk of the trade is between industrialized countries, buying and selling similar products.

Globalization Pharmaceutical Industry Furniture Industry (Exporting) Real wage L Pharmaceutical Industry Furniture Industry (Exporting) (Importing)

The Economist, Feb. 19, 2004 The best-known report, by Forrester Research, a consultancy, guesses that 3.3m American service-industry jobs will have gone overseas by 2015—barely noticeable when you think about the 7m-8m lost every quarter through job-churning. And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing. Even at their peak in 2001, the number of all “trade-related” layoffs represented a mere 0.6% of American unemployment.

“Outsourcing” Even at the best of times, the American economy has a tremendous rate of “churn”—over 2m jobs a month. ... The process allocates resources—money and people—to where they can be most productive, helped by competition, including from outsourcing, that lowers prices. In the long run, higher productivity is the only way to create higher standards of living across an economy. The Economist, Feb. 19, 2004

Sucking Sound? Between 1980 and 2002, America's population grew by 23.9%. The number of employed Americans, on the other hand, grew by 37.4%. Today, 138.6m Americans are in work, a near-record, both in absolute terms and as a proportion of the population. The Economist, Feb. 19, 2004

Should Technology and Globalization Be Stopped? Specialization increases the total amount produced. Free trade increases the total amount available. Increasing worker mobility from shrinking to expanding industries would help. Providing government help during transition should be easy because of the increasing pie.

Churning + Productivity In 1960 only one in 25 workers was employed in the business-services and health-care industries. Today, one in six is. In terms of output, manufacturing has risen, but, thanks to that productivity spurt, these goods are produced by fewer people—12% of the workforce, less than half the proportion of three decades ago. The Economist, Feb. 19, 2004

Types of Unemployment Frictional unemployment - the short-term unemployment when people are searching for a job that match their wishes. Structural unemployment - long-term mismatch between the skills and jobs. Cyclical unemployment - unusually high rates of unemployment experienced during recessions.

Unemployment Total unemployment is the sum of frictional, structural and cyclical unemployment. Even if the economy is producing at full employment, there will be structurally and frictionally unemployed.

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Unemployment Impediments to Full Employment Minimum Wage Laws: Benefit workers who are employed. Hurt those who lose their jobs. Create economic inefficiency.

Do Minimum Wage Laws Alleviate Poverty? Minimum wage laws affect unskilled labor. Higher wages should increase the income of the unskilled labor. If the labor market is in equilibrium, a minimum wage law that sets the wage above equilibrium will create unemployment and solve the poverty of some by making other poor worse off.

Wage/P = Real wage Wage S VMP = MP x P Unemployment VMP/P = MP VMP L

Unemployment Labor Unions Benefits Reduced worker exploitation Support progressive labor legislation Increase productivity Promote democracy in the workplace

Unemployment Labor Unions Costs Unions cause otherwise competitive labor markets to function inefficiently. Unions may prevent companies from competing in the global economy.

Labor Unions It could work as a minimum wage law. It could increase unemployment. In a perfectly competitive labor market with low costs of searching for a job, labor unions would increase unemployment. In monopsony situations labor unions improve efficiency.

Unemployment Unemployment Insurance: Helps to reduce the costs of unemployment. May give the unemployed an incentive to search longer and less intensely. Unemployment benefits must balance the benefit of providing support to the worker with the cost of reducing the incentive to work.

Unemployment Insurance A state that pays unemployment insurance for 13 weeks will force the unemployed to search for a job more vigorously than a state that pays unemployment insurance for 52 weeks.

Unemployment Other Government Regulations Health and Safety Regulations These regulations can reduce the demand for labor by: Increasing employer costs. Reducing productivity. The reduction in demand will: Increase unemployment. Lower wages.

Other Regulations Some health and safety regulations increase the cost of labor significantly. It works similar to minimum wage laws. Employment cost index keeps track of the benefits plus wages.

Barriers That Create Structural Unemployment Minimum wage laws. Labor unions. Unemployment insurance. Other governmental regulations.

Unemployment Rates in Western Europe, 1980 - 2001

Why Unemployment Rates Are Very High in EU? Structural barriers are very strong in EU because of political commitment to social safety laws. Higher percentage of workers are unionized. Unemployment insurance is very generous. Benefits and severance pay provisions are much higher than US.

Why Did EU Unemployment Rates Soar the Last 20 Years? Technological change with skill bias. Globalization. Both of these forces reduced the demand for unskilled labor yet social safety laws kept the wages high.

http://www.economist.com/surveys/displaystory.cfm?story_id=8621685

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