14 Models of Unemployment

Economics 314 Coursebook, 2010 Jeffrey Parker 14 MODELS OF UNEMPLOYMENT Chapter 14 Contents A. Topics and Tools ............................................................................ 2 B. Defining Unemployment .................................................................. 3 The statistical definition ................................................................................................ 3 Problems with the statistical measures ............................................................................ 4 Natural and cyclical unemployment ............................................................................... 6 C. Introduction to Theories of Unemployment ........................................... 7 D. Minimum Wages and Unemployment ................................................. 10 A simple minimum-wage model .................................................................................. 10 Minimum-wage effects on skilled and unskilled labor ..................................................... 11 E. Unemployment Insurance and the Length of Job Search .......................... 13 A simple model of job search ........................................................................................ 13 Unemployment benefits and search duration ................................................................. 15 Optimal search duration ............................................................................................. 17 F. Unions and Unemployment .............................................................. 18 An economy-wide labor union ..................................................................................... 18 A two-sector model of unions and unemployment .......................................................... 19 G. Sectoral Shifts and Unemployment ..................................................... 20 H. Understanding Romer’s Chapter 9 ..................................................... 22 Efficiency-wage models ............................................................................................... 22 The Shapiro-Stiglitz model .......................................................................................... 25 Implicit-contract models .............................................................................................. 30 Insider-outsider models ............................................................................................... 31 Search and matching models ....................................................................................... 31 I. Suggestions for Further Reading ........................................................ 32 On European unemployment ....................................................................................... 32 Theoretical models ...................................................................................................... 32 J. Works Cited in Text ....................................................................... 33 A. Topics and Tools Unemployment is one of the most visible indicators of economic activity. The rate of unemployment typically rises considerably during recessions then falls as the economic recovers. People commonly view the typical unemployed worker as suffer- ing long-lasting despair and destitution, so the media publicize high unemployment as a great social problem. We shall see that this view of the unemployed worker is not an accurate depiction of the vast majority of those out of work in the United States. In contrast, most of the unemployed find work relatively quickly. While their income loss is significant, it is not catastrophic for most workers who suffer an unemployment spell. Some degree of unemployment is socially and perhaps personally desirable. Much of unemployment in the United States consists of new entrants to the labor market seeking their first job, individuals who are voluntarily changing jobs or occu- pations, and people in jobs for which periodic or seasonal layoffs are normal, ex- pected, and compensated for by higher wages during periods of employment. For these individuals, unemployment is not a problem at all. It is merely part of the natural functioning of a flexible and efficient labor market. Economists often view unemployment as one facet of an inevitable process of search in the labor market. Jobs and workers are heterogeneous along many dimen- sions. Workers differ (among other ways) by intelligence, creativity, education, training, experience, physical size and strength, manual dexterity, ability to sustain repeti- tive tasks, and preferences about their work environment. Jobs vary in the abilities, education, and experience that are required to perform them, as well as in working conditions, location, opportunities for advancement, and many other characteristics. Since workers and jobs are so heterogeneous, the process of matching the characteristics of a particular unemployed worker with the most suitable vacant job often cannot be accomplished quickly. Instead unemployed workers and employers having vacant jobs engage in a two-sided search, seeking to achieve a good match as quickly as possible. The length of this search process for a typical unemployed worker is a major factor in determining the unemployment rate. One can imagine an economy in which this matching problem could be solved trivially. If all workers and jobs were identical, for example, there would be no gain to searching for a better match. Or if everyone had instantaneous and perfect infor- mation about the characteristics of all workers and jobs, searches could be accomplished in just a moment. However, in an economy in which the matching problem cannot be solved trivially it is generally desirable to have both a positive unemployment rate and a positive job vacancy rate. Successful matching requires a pool of searching workers on one side of the market and a pool of available jobs on the oth- 14 – 2 er. The socially optimal unemployment rate depends on the size of the pool that is 1 required in order for optimal matching to occur. The optimal pool size, in turn, depends on the efficiency of the “matching technology” in the economy as well as on a variety of social and policy variables. If the costs and benefits of search are largely internal to the workers and firms doing the searching, we might expect that a competitive market economy would gra- vitate toward the socially optimal amount of search. However, the labor markets of modern economies contain many distortions that might cause the long-run equili- brium unemployment rate (the so-called natural rate of unemployment) to be higher or lower than the optimal rate. In particular, a wide variety of government policies influence the incentives of workers and employers to continue searching, including unemployment insurance programs, job-protection legislation, and “active” labor- market policies such as job-placement assistance and training. Recent analysis of unemployment has focused intensely on one particular empir- ical problem: extremely high unemployment in continental Europe since 1980. From 1950 until 1970, the unemployment rate in most European countries averaged about 2%, roughly half of the rate in the United States during that period. Since 1980, Eu- rope has suffered unemployment rates in the 8 to 12 percent range, about twice the U.S. rate. Moreover, long-term unemployment (of more than one year) is far more common in Europe than in America. Theories of unemployment are able to explain some, but not all, aspects of the divergence of unemployment behavior between Eu- rope and America. The most interesting new tools that we employ in our analysis of unemployment is dynamic programming, which is a common method of analysis of models involv- ing transition in continuous time between alternative discrete states. In the case of unemployment models, the main states are employed and unemployed, with some variations in selected models. Dynamic programming has a complicated side and a simple intuition. We’ll focus on the latter here. B. Defining Unemployment The statistical definition In order to measure unemployment, economists have adopted a statistical definition that is only partially understood by the general public. Unemployment statistics 1 As we shall see below, optimal matching does not generally mean making the best matches that are conceivably possible. Better matches involve costs (longer unemployment spells) as well as benefits (better fit between jobs and workers). The optimal amount of matching bal- ances these marginal costs and benefits. 14 – 3 in the United States are compiled by the Bureau of Labor Statistics (BLS) from the monthly Current Population Survey (CPS) conducted by the Bureau of the Census. This survey of approximately 64,000 households asks general questions about the labor-market status of adult members of the household during the week prior to the 2 week in which the survey is taken. Based on the responses to the CPS questions, every adult is placed into one of three categories: employed, unemployed, or not in the labor force. Anyone who worked for pay at all during the reference week is considered to be employed, including part- time workers. Among those not employed, those who were both actively seeking work and immediately available for work, plus those who were awaiting recall from a temporary layoff from their previous job, are classified as unemployed. Anyone else, i.e., those who did not work, were not on layoff, and either were not

Load more