Economics 2 Professor Christina Romer Spring 2017 Professor David - PDF document

Economics 2 Professor Christina Romer Spring 2017 Professor David Romer LECTURE 19 EMPLOYMENT AND UNEMPLOYMENT IN THE LONG RUN April 4, 2017 I. O VERVIEW II. E MPLOYMENT AND P OTENTIAL O UTPUT A. Effects of an increase in N*/ POP B. Effects of an increase in POP III. D ETERMINANTS OF THE N ORMAL E MPLOYMENT - TO -P OPULATION R ATIO AND THE N ORMAL R EAL W AGE A. Review and modification of labor supply/ labor demand diagram B. Change in workers’ tastes (Married women) C. Change in labor demand (Low-skilled males) D. Incentives (Marginal tax rates) E. The large rise in real wages over time IV. T HE N ATURAL R ATE OF U NEMPLOYMENT A. Definition B. Job rationing C. Job search V. A PPLICATION : E UROPEAN U NEMPLOYMENT A. Facts B. Candidate Explanations

Economics 2 Christina Romer Spring 2017 David Romer L ECTURE 19 Employment and Unemployment in the Long Run April 4, 2017

I. O VERVIEW

Aggregate Production Function (1) (2) (3) •

II. E MPLOYMENT AND P OTENTIAL O UTPUT

Decomposition of Potential Output per Person where: • Y* is potential output; • POP is population; • N* is normal employment. • is the normal employment-to-population ratio. • is normal average labor productivity.

Employment-to-Population Ratio in the U.S. Source: Frank, Bernanke, Antonovics, and Heffetz, Principles of Economics .

Source: Charles Jones and Dietrich Vollrath, Economic Growth .

Employment and Potential Output • • Increases in will raise . • But, the effect is limited: • can’t vary very much. • There are countervailing effects on average labor productivity: An increase in POP for a given lowers because it reduces .

III. D ETERMINANTS OF THE N ORMAL E MPLOYMENT - TO -P OPULATION R ATIO AND THE N ORMAL R EAL W AGE

The Labor Market w S D N

Long-Run Labor Market Diagram Real Wage, S w* ∗ w 1 D (MRP L /P) ∗ N 1 N*

Labor Force Participation Rate, Women, U.S., 1962–2017 Source: FRED.

Source: Claudia Goldin, “Gender Gap,” The Concise Encyclopedia of Economics .

An Increase in Labor Supply (Women in the U.S.) Real Wage, S 1 S 2 w* ∗ w 1 ∗ w 2 D 1 (MRP L /P) ∗ N 2 ∗ N 1 N*

Labor Force Participation Rate, Women, U.S., 1962–2017 Source: FRED.

Female Labor Force Participation Rate in the U.S., the U.K., and Japan 75 U.S. 70 U.K. 65 Japan 60 55 50 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Source: Organisation for Economic Co-operation and Development (OECD).

Labor Force Participation Rate – High School Graduates, No College, 25 yrs. & over, Men, 1992–2017 Source: FRED.

A Fall in Labor Demand (Less Educated Men) Real Wage, S 1 w* ∗ w 1 ∗ w 2 D 1 D 2 ∗ N 1 ∗ N 2 N*

Average versus Marginal Income Tax Rates • Average tax rate: Total income tax/total income. • Marginal tax rate: The tax paid on an additional dollar of income.

Labor Supply When There Are Taxes • Think of a household choosing between leisure and everything else that it likes. • Recall: Condition for utility maximization: MU Leisure MU Everything Else = P Leisure P Everything Else • What is P Leisure ? That is, what is the opportunity cost to the household of consuming 1 more unit of leisure? • P Leisure = (1 − t)•wage, where t is the marginal tax rate.

A Reduction in the Marginal Tax Rate Real Wage, S 1 S 2 w* ∗ w 1 ∗ w 2 D 1 (MRP L /P) ∗ N 2 ∗ N 1 N*

Real Wages in the U.K. over the Very Long Run From: Clark, “The Condition of the Working Class in England, 1209-2004”

Large Increases in Capital and Improvements in Technology Real S 1 Wage, w* ∗ w 2 ∗ w 1 D 2 D 1 ∗ N 2 ∗ N 1 N*

IV. T HE N ATURAL R ATE OF U NEMPLOYMENT

The U.S. Unemployment Rate, 1948–2017 Source: FRED; data from Bureau of Labor Statistics.

Unemployment in the U.S., Japan, and France Source: FRED.

The Natural Rate of Unemployment • The economy’s normal or usual unemployment rate.

Types and Sources of Unemployment • Cyclical unemployment • Caused by output being below potential • Structural unemployment • Caused by job rationing • Frictional unemployment • Caused by turnover and job search Normal or natural unemployment consists of structural and frictional unemployment.

Job Rationing Real Wage, S w* w � ∗ w 1 D (MRP L /P) ∗ N 1 ∗ N S ∗ N D N* Structural unemployment

Sources of Job Rationing • Minimum wage laws • Unions • Efficiency wages

Frictional Unemployment • It takes time to match workers and jobs. • At the micro level, the economy is constantly changing. • As a result, at any time there are both unemployed workers and job vacancies. • This process is sometimes described as “churn.”

V. A PPLICATION OF O UR L ONG -R UN L ABOR M ARKET F RAMEWORK : E UROPEAN U NEMPLOYMENT

Unemployment in the Euro Area (blue), Germany (red), and Italy (green), 1993–2016 Source: OECD.

Some Candidate Sources of High Natural Rates of Unemployment in Europe • Measurement issues • High minimum wages and strong unions • High payroll taxes • High firing costs • High marginal tax rates • Generous unemployment compensation

A Wage Floor Real Wage, S w* w � D ∗ N S ∗ N D N* Unemployment

Payroll Taxes, Selected Countries Source: Wall Street Journal .

High Payroll Taxes in the Presence of Job Rationing Real Wage, S 1 w* Tax w � D 1 D 2 ∗ N D1 ∗ N S ∗ N D2 N* Unemployment 1 Unemployment 2

Firing Costs: The Example of Italy “The laws are so unclear that many dismissals of workers end up in the country’s dysfunctional court system, where if a judge decides a worker was let go unfairly, he will likely rule that the employer has to reinstate him with back pay for the time he was gone. ‘When an investor asks about severance costs, all the other countries can provide an answer,’ says Pietro Ichino, an Italian senator and professor of labor law at the University of Milan. ‘Italy can’t.’ Duccio Astaldi, president of Condotte, one of Italy’s largest construction companies, says the difficulty of firing often prevents him from hiring when times are good.” Source: “Italy’s Labor Pains,” BusinessWeek , 11/16/2011.

Firing Costs (in the Presence of Job Rationing) Real Wage, S 1 w* w � D 1 D 2 ∗ N D1 ∗ N S ∗ N D2 N* Unemployment 1 Unemployment 2

Source: OECD.

Problems with the High Marginal Tax Rate Explanation of High European Unemployment • A better candidate explanation for low employment than for high unemployment. • Marginal tax rates are not dramatically higher in Europe than in the U.S. • The evidence indicates that labor supply responds to marginal rates, but that the responsiveness is small.

Maximum Duration of Unemployment Insurance Benefits, 2005 Source: New York Times ; data from the OECD.

Generous Unemployment Compensation Real Wage, S 2 S 1 w* ∗ w 2 ∗ w 1 D 1 (MRP L /P) ∗ N 1 ∗ N 2 N*