The MacroEconomics of European Economies MSc in Economic Policy Studies John FitzGerald February 2015 Course Outline How does an economy work JF 1612015 The genesis of macroeconomics AM 2312015 ID: 782525
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Slide1
The Labour Market & the Macro-economy
The Macro-Economics of European Economies
MSc in Economic Policy Studies
John FitzGerald, February 2015
Slide2Course Outline
How does an economy work? JF
16-1-2015
The genesis of macroeconomics
AM 23-1-2015
Modern macroeconomics
AM 30-1-2015
Banks and financial markets
AM 6-2-2015
The recent crisis AM
13-2-2015
The labour market
JF
20-2-2015
Fiscal Policy and forecasting JF
6-3-2015
Trade JF
13-3-2015
The economics of global warming JF
20-3-2015
The future of the Irish economy AM and JF
27-3-2015
Slide3Outline of Lecture
Theory
Demographic factors, exogenous in short run
Labour Supply
Labour Demand
Wage Determination, Market Clearing and Unemployment
Interaction with macro-economy
Applied - examples covering a range of EU economies
Human Capital and the labour market
Labour Market Disequilibria in EU economies
Slide4Demography and the Labour Market
Population
N
t
=N
t-1
-D
t
+B
t
+M
t
Where: N=population; D=deaths; B=births; M=immigration
Education
Affects participation, migration, employability and productivity
Working age population
Participation rates
Affected by economic circumstances
Migration
Drivers of migration – economic differences and other factors
Slide5Demography and the economy
Slide6The Role of Education
Rising educational attainment – differs by country and by age
Affects productivity which, in turn:
Affects wage rates – in perfect competition labour paid the marginal product
Affects participation because higher wages v costs of working
Affects employability and numbers unemployed
Slide7Slide8Slide9Labour supply
L=f(W, N, M, UR, welfare,
unions,
T)
Where: W=wage rate; UR= unemployment rate; T= other factors, e.g. culture
Migration = f(UR,
UR
w
, W,
W
w
, T)
Where subscript w signifies the rest of the world
Sensitive to wage rates in Ireland – much less sensitive elsewhere
Female labour supply= f(demographics, education, W, costs, culture)
Fairly elastic – sensitive to wage rates
Male labour supply=
f(demographics, education, W, costs, culture
)
Fairly inelastic – what is inelastic?
Shape of labour supply curve?
How elastic – what is elastic?
Slide10Elastic
Labour Supply
D
L
S
1
L
W
L
W
1
L
2
Wage Rates
Employment
Slide11Inelastic Labour Supply
D
L
S
1
L
W
L
W
1
L
2
Wage Rates
Employment
Slide12Totally Inelastic Labour Supply
D
L
S
1
L
W
L
W
1
L
2
Wage Rates
Employment
Slide13Skilled v Unskilled
Two kinds of labour: skilled (high education) &
u
nskilled (low education)
Are they substitutable?
Unskilled labour may be less employable
While the skilled labour market may clear the unskilled may not
Focus on:
Educational attainment of labour force
Returns to education
Migration – skilled or unskilled?
D
ifferent effects
Slide14Labour Demand
L=f(
Q,W,P
k
,P
m
,T
)
Where L=employment; Q=output; W= wage rate;
P
k
=price of capital;
P
m
=price of materials and other inputs; T=technical progress
Firms choose the mix of inputs (labour etc.) so as to minimise the cost of producing a given output Q
Q=f(
Q
w
,c,c
w,T)Where c= unit cost of production; subscript w signifies the rest of the worldWorld output is located based on the cost of production in different countriesHence wage rates affect employment through two channelsSubstitution of capital and materials for labour and vice versaSubstitution of foreign for domestic output and vice versa
Shape of Labour demand curve? How elastic?
Slide15Market Clearing: Wage Rates
Market clearing? How can there be unemployment?
Speed of adjustment
Structural unemployment
Hysteresis
Bargaining
Philips curve
The tax wedge
Minimum wages
Efficiency wages
Slide16Speed of adjustment
Employers may be slow to adjust employment
Want to hold on to firm specific skills – e.g. Germany
Costs of hiring and firing
Labour laws – if hire may not be able to fire
Employees slow to adjust reservation wage
Expectations
Don’t have requisite skills
Problems with nominal wage cuts v real wage cuts
Market wage < welfare etc.
Result: market may remain out of equilibrium for a long time
Slide17Structural Unemployment
Where skills of the unemployed don’t match needs of employers
Where labour market laws may interfere with market clearing
Reasons for laws may mean that some unemployment is acceptable?
Hysteresis
. A shock to the system shakes out labour that may not be re-employed in a recovery – e.g. because of skills
mismatch
Move from a full employment equilibrium to an unemployment equilibrium
Policy Options?
Measures to increase demand?
Measures to reduce / transform supply?
Slide18Bargaining
One “model” of the labour market:
Employees
bargain in terms of after tax
wages
E
mployers
take the wage and set employment
Bargaining power of employees may be affected by
Legislation
Unions
Insiders v Outsiders
Slide19Philips Curve
Wage rates (or the level of wages) may be affected by unemployment
With high unemployment employees anxious to hold jobs
More willing to take a pay cut or not to look for an increase
With high unemployment more competition for jobs
May result in wage rates lower than would otherwise be the case
With low unemployment labour is scarce and employers have to pay more
If unemployment affects wage inflation
At what level of unemployment is the effect on wage inflation zero?
If higher unemployment – then real wage rates will tend to fall, leading to higher employment and lower unemployment
Similarly if unemployment below this level wages will tend to rise affect unemployment
The non-accelerating wage rate of inflation (NAWRU) is the stable equilibrium
Explains why market clears at a significant rate of unemployment
What happens if infinite labour supply? No Philips curve
Slide20Wage Rates
The tax wedge:
Employers pay W*(1+t
e
); Employees get W*(1-t
p
)
Where
t
e
=employers taxes (rate) and
t
p
=employees taxes (rate)
The higher the tax wedge the bigger the difference between the 2 wage rates
Who pays the taxes on labour – where is the incidence?
Depends on the shape of the labour supply and demand curves
Slide21Tax incidence: affected by labour supply & demand
Impose a tax on labour of W1-W3.
Labour bargains in terms of after tax wages
Labour supply moves from S1 to S2
Labour demand downward sloping
Employment falls from L2 to L1
Wage rates rise from W1 to W2 – that share of the tax is paid by employer
The part of the tax W2-W3 is paid by the employee
The flatter – more elastic – labour supply the bigger the share of the tax is paid by employers – increasing the employment effect
Partnership in Ireland 1987 – trade off tax cuts for wage moderation
This reflected the behaviour of the market with an elastic labour supply
Other countries – labour supply less elastic because limited migration
Slide22Elastic
Labour Supply
D
L
S
1
L
W
L
W
1
L
2
Wage Rates
Employment
Slide23Elastic
Labour Supply
D
L
S
1
L
W
L
W
1
L
1
W
2
L
2
Wage Rates
Employment
S
2
L
W
3
Slide24Replacement Rate or Minimum Wage
Sets a floor on wage rates
Does it lead to unemployment?
Consider the distribution of wage rates
If there are many at the bottom of the distribution ….
If there are
few
at the bottom of the distribution
….
Social considerations:
Higher pay – welfare gain, less welfare payments
;
offset by lost employment?
Protection of the weak e.g. immigrants
Slide25Unskilled Labour
S
1
L
U
L
2
D
L
L
1
S=W
L
W
Wage Rates
Employment
L
3
Slide26Efficiency Wage
Employers do not know the productivity of a new hire
Pay a premium to ensure that they get the best
High pay may affect morale and productivity of workers
Result: may pay more than market clearing wage rate
Slide27Labour Market and the Macro-Economy
Demand for goods and, hence, labour determined in goods market
Wage rate feeds back into prices, competitiveness etc.
Employment, unemployment and wage rates affects public finances
Tax revenue
Welfare payments
Cost of goods and services
Slide28Examples
Education and skills
How does education affect labour supply?
Productivity, participation, employability
Examples of Labour market adjustments
Finland – Crisis 1990
Germany – Unification 1990 and Labour market reforms 2004
Ireland, Spain, Portugal – 25 years of labour market adjustment
Migration: example of Ireland
Labour market policies
Slide29Education – cohort of 1931-5
Slide30Education – cohort of 1951-5
Slide31Education – cohort of 1981-5
Slide32Returns to education: lower secondary relative to upper secondary
Slide33Returns to education: tertiary relative to upper secondary
Men
Women
2000/1
2011/2
2000/1
2011/2
Belgium
128
129
133
134
Chile
271
262
Denmark
132
138
124
126
Estonia
137
160
Germany
143
171
141
172
Ireland
135
169
161190
Portugal
173
172
Spain
125
136
143
155
United Kingdom
152
151
176
178
United States
181
182
169
177
EU21 average
160
165
153
162
Slide34Slide35Investment in Human Capital, 2010
Slide36Slide37Slide38Slide39Slide40Slide41Slide42Examples of Labour Market Adjustment
Finland – Crisis 1990
Germany – Unification 1990 and Labour market reforms 2004
Ireland, Spain, Portugal – 25 years of labour market adjustment
Migration: example of Ireland
Slide43Finland – Unemployment Rate
Slide44Finland – Unemployment Rate by Education
Slide45Finnish wage rates relative to EU 15
Slide46Germany – Unemployment Rate
Slide47Germany – Unemployment Rate by Education
Slide48German wage rates relative to EU15
Slide49Labour market adjustment: Ireland, Spain Portugal
Ireland – post 1980s crisis slow to fall
Hysteresis post 1990 why?
Today?
Spain – pre-crisis – very high, though had been falling
Labour market rigidities?
Today?
Portugal – appears fairly flexible – till the crisis
Today?
Slide50Unemployment Rate
Slide51Ireland: unemployment rate by education
Slide52Spain: unemployment rate by education
Slide53Portugal: unemployment rate by education
Slide54Slide55Wage rates relative to EU15
Slide56Migration
Driven by:
P
otential earnings differentials
Employment opportunities
Cultural factors
Differences between labour markets – inflows and outflows
Impact of migration on:
Receiving labour markets
Origin labour markets
Slide57Ireland v UK, Wage Rates
Slide58Ireland: Net emigration, % of population
Slide59Unemployment: Implications for Policy?
Largely a national responsibility
However a European fiscal policy would have helped in the crisis
How to make European labour markets work
Europe v US
Supply side measures
Education and training
Activation etc.
Demand side measures
Costs of employment
Flexibility
Slide60AMECO Database
Many annual variables for EU economies, US, Japan etc.
Don’t assume that the data are always right!
Where available, runs from 1960. Includes EU forecasts to 2016
Be careful that 2014 onwards are EU forecasts!
Two approaches to accessing it:
Online:
http://ec.europa.eu/economy_finance/ameco/user/serie/SelectSerie.cfm
Excel File: AMECOTCD.xlsx – a limited number of variables, 1 variable per sheet
House prices from BIS
datatbase
:
Online:
http://www.bis.org/statistics/pp_detailed.htm#selected
Slide61Other Data Used in this Lecture
Eurostat Labour Force Survey
OECD Economic Outlook
CSO
Slide62Presentations
The origins and resolution of the current crisis in Estonia, Bulgaria, and Greece (20
th
February)
What were the origins? How
is it resolving?
Look at disequilibria in
markets
The origins and resolution of the current crisis in
Latvia
, Portugal,
and
Italy (20
th
February)
What were the origins? How is it resolving? Look at disequilibria in
markets
The crisis in Scandinavia (Finland, Sweden, Denmark)
1988-1995 (6
th
March)What were the origins? How was it resolved? Look at disequilibria in markets
Slide63Reading for this lecture
Basic text:
Blanchard etc. Probably more theory than you need, but provides the basics
Chapters 7 and 9
The rest of the reading discusses real economic situations.
The objective is to evaluate whether labour markets are out of equilibrium and if so why? How are they adjusting or how have they adjusted? What are the problems?
In addition to previous reading
http://
www.oecd.org/g20/topics/employment-and-social-policy/G20-labour-markets-outlook-key-challenges-and-policy-responses.pdf
On Spain
http
://
www.oecd.org/els/emp/SpainLabourMarketReform-Report.pdf
On
labour market reforms
http://
www.oecd.org/site/sgemrh/46190166.pdf
Slide64Reading for this lecture
As mentioned previously:
FitzGerald
, J., 2013 “Financial crisis, economic adjustment and a return to growth in the EU”,
Revue de
l’OFCE
- Debates and policies
, No.127 pp. 277-302
http://www.ofce.sciences-po.fr/pdf/revue/127/revue-127.pdf
Look at one or two of these publications for the EU and its component economies
IMF World Economic Outlook, October 2014.
http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/text.pdf
OECD Economic Outlook, November 2014,
http://www.oecd.org/eco/outlook/General-assessment-of-the-macroeconomic-situation.pdf
National Institute Economic Review, November 2014,
http://ner.sagepub.com/content/230/1.toc
European Commission: European Economic Forecast, Winter 2014
http://
ec.europa.eu/economy_finance/publications/european_economy/2014/pdf/ee2_en.pdf
See
http://www.oecd.org/eco/surveys/ for surveys of individual countries. They don’t do Bulgaria and Latvia