Simulating the Impact of Economic Shocks on Employment and Wages in Multi-sector Labor Markets James Albrecht Catalina Gutierrez Pierella Paci Beom Park

Background Our knowledge about the potential impact of the crisis on employment and earnings, is limited. Our knowledge about the potential impact of the crisis on employment and earnings, is limited. From past crises we have seen that response in DCs can take very different forms From past crises we have seen that response in DCs can take very different forms Unemployment is just one effect, and not always the most prominent one Unemployment is just one effect, and not always the most prominent one Relocation of labor across sectors, including backward migration to agriculture, and adjustment in earnings are often more important. Relocation of labor across sectors, including backward migration to agriculture, and adjustment in earnings are often more important. Using employment elasticities to predict the effect of crises can be misleading or mask other important issues, when adjustments are not through overall employment changes. Using employment elasticities to predict the effect of crises can be misleading or mask other important issues, when adjustments are not through overall employment changes.

Main objective Construct a model that better reflects the characteristics of labor markets in DC Construct a model that better reflects the characteristics of labor markets in DC –Several segments with different rules for earnings determination for identical workers, and differences in marginal productivity. –Agricultural sector is a large employer, with movement out of it, implying costs and requiring internal migration –Large self-employment, informal sector and share of low earners –Mobility between segments may be limited –Unemployment is many times a luxury state that only the better off can afford This means we need to depart from unified competitive settings This means we need to depart from unified competitive settings

Modeling Strategy: Combine several building blocks Albrecht, Navarro and Vroman (2008) Albrecht, Navarro and Vroman (2008) –Search model with informal sector with informality being a results of optimizing choice for low skill workers Satchi and Temple and (2006), Satchi and Temple and (2006), –Search model with rural-urban migration, bargained and efficiency wages Fields (1975) Fields (1975) –Rural-urban migration with informal sector and informality being a result of exclusion due to fixed non comp. wages

The model : Worker flows and LM structure Unemployment Costly migration Wages are bargained Positive returns to skills There are wage floors Government pays fixed wage High Productivity jobsLow Productivity Jobs Agriculture Workers receive fixed earnings (no returns to skills) Workers are paid average product of labor URBAN RURAL

5. The Model: The structure of segmentation Y* Y** yryr Case 1: y r >Y*Case 1: y r <Y* Only good jobs Both good and bad Only bad jobs skills

Simulating the financial crisis An decrease in TFP in good jobs sector A 1 An decrease in TFP in good jobs sector A 1 An increase in good sector turbulence λ An increase in good sector turbulence λ Should there be other feedbacks to informal and agriculture ? Lower y 0, lower A 0, An increase in bad sector turbulence δ? Should there be other feedbacks to informal and agriculture ? Lower y 0, lower A 0, An increase in bad sector turbulence δ? Simulations: Simulations: –I. -10% in A 1, +10% λ –II. -10% in A 1, +10% λ & -5% y 0, +5% δ –III. -10% in A 1, +10% λ & -10% y 0, +10% δ –Alternative bargaining power as a measure of rigidity ( β=1/2 and β=1/3)

Good Jobs Sector Bad Jobs SectorAgricultureTotal Economy Bargaining parameter =1/2 Average Earnings ($C) Change in Earnings (%) Average Earnings ($C) Change in Earnings (%) Average Earning s ($C) Change in Earnings (%) Average Earning s ($C) Change in Earnings (%) Benchmark 2,415 1,252 1,072 1,225 I. Crisis hits only the good jobs sector 2, , , , II. Crisis hits good jobs sector more than bad jobs sector 2, , , III. Crisis hits good jobs sector and bad jobs sector equally 2, , , Good Jobs Sector Bad Jobs SectorAgricultureTotal Economy Bargaining parameter 1/3 Average Earnings ($C) Change in Earnings (%) Average Earnings ($C) Change in Earnings (%) Average Earning s ($C) Change in Earnings (%) Average Earning s ($C) Change in Earnings (%) Benchmark 2,415 1,252 1,072 1,225 I. Crisis hits only the good jobs sector 2, , , , II. Crisis hits good jobs sector more than bad jobs sector 1, , , III. Crisis hits good jobs sector and bad jobs sector equally 1, , ,

Conclusions Formal sector employment is more likely to contract if the informal sector can buffer the shock and the workers have more bargaining power (firms cant pass the lower profitability in the form of lower wages) Formal sector employment is more likely to contract if the informal sector can buffer the shock and the workers have more bargaining power (firms cant pass the lower profitability in the form of lower wages) Adjustment in formal wages is more likely if workers have a reduced bargaining power and if the informal sector cant buffer the shock. Adjustment in formal wages is more likely if workers have a reduced bargaining power and if the informal sector cant buffer the shock. The stronger the effect on informal sector earnings, the more likely backward migration will take place The stronger the effect on informal sector earnings, the more likely backward migration will take place Allowing for backward migration to agriculture makes unemployment effects rather small. Unemployment effects can be large if there is no backward migration. Allowing for backward migration to agriculture makes unemployment effects rather small. Unemployment effects can be large if there is no backward migration.

Conclusions (cont.) Small changes can have big impacts on the allocation of labor. Small changes can have big impacts on the allocation of labor. Effects are not linear, elasticity is not kte. Effects are not linear, elasticity is not kte. What matters for the allocation of labor are relative returns in each sector. What matters for the allocation of labor are relative returns in each sector. For overall poverty and welfare, returns within sectors will be a key determinant. For overall poverty and welfare, returns within sectors will be a key determinant. To simulate economic shocks such as the financial crisis it is important to understand which sectors will be affected and the likely magnitude of the effects. To simulate economic shocks such as the financial crisis it is important to understand which sectors will be affected and the likely magnitude of the effects.

Extra slides

The Model : the environment Skills differ y~F(y:a,b) Skills differ y~F(y:a,b) Good sector The maximum productivity of a worker of skill y is A 1 y Good sector The maximum productivity of a worker of skill y is A 1 y Bad sector: income y 0. Bad sector: income y 0. Agricultural sector: workers receive average income of labor y a =A a (l a ) γ-1. Agricultural sector: workers receive average income of labor y a =A a (l a ) γ-1. unemployed receive a flow income b < y 0. unemployed receive a flow income b < y 0. Shocks to bad jobs arrive at a rate δ and are destroyed. Shocks to bad jobs arrive at a rate δ and are destroyed. Shocks to good jobs arrive at a rate λ and affect the productivity of the worker, reducing it to yy Shocks to good jobs arrive at a rate λ and affect the productivity of the worker, reducing it to yy Bad sector employment opportunities arrive at a rate α,Bad sector employment opportunities arrive at a rate α, Good Sector opportunities will arrive at a rate that depends on the number of vacancies relative to the number of workers searching m(v/u).Good Sector opportunities will arrive at a rate that depends on the number of vacancies relative to the number of workers searching m(v/u).

The Model : Agents decisions Firms decide whether to open a vacancy and hire a worker when it meets one Firms decide whether to open a vacancy and hire a worker when it meets one Unemployed workers decided whether to accept or not employment opportunities as they arrive. Unemployed workers decided whether to accept or not employment opportunities as they arrive. –They will accept a bad jobs if N 0 > U(y). –They will accept a good jobs if N 1 > U(y) Once an unemployed and a (good sector) firm meet they bargain on a wage. Once an unemployed and a (good sector) firm meet they bargain on a wage. When a shock to good job arrives workers and firms decide whether to destroy the job or not. When a shock to good job arrives workers and firms decide whether to destroy the job or not. – will be a hiring standard R f (y) (firm) and reservation productivity R(y) (worker) below which it is not worth to keep the job, and it will depend on the worker type. Wages are re-negotiated.

4. The Model : agents decisions (cont.) A worker will migrate if the value of agricultural employment N a (y) is lower than the expected value of being unemployed and searching for a job U(y) net of migration costs (M) A worker will migrate if the value of agricultural employment N a (y) is lower than the expected value of being unemployed and searching for a job U(y) net of migration costs (M)

Solution To solve the model we find the value of being in each state, and rules that guarantee that agents take maximizing decisions To solve the model we find the value of being in each state, and rules that guarantee that agents take maximizing decisions The steady state solution of these values (i.e. the equilibrium) has to satisfy: The steady state solution of these values (i.e. the equilibrium) has to satisfy: –Workers and firms are maximizing at the bargained wage –It is not profitable to create new jobs (The value of opening a new vacancy is zero or job creation condition) –The inflow out-of and in-to each state equates (steady state conditions) –There is no migration (benefit of migrating net of migration cost is zero for the marginal migrant with skills yr)