Labour Economics Theory PDF

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LABOUR ECONOMICS THEORYIntroduction and overview of the labor marketIntroduction Why study labour economics? People allocate substantial time and energy to labour market. Labour economics studies how labour markets work. Labour economics helps us understand and address many social and economic probl...

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LABOUR ECONOMICS THEORY Introduction and overview of the labor market Introduction Why study labour economics? People allocate substantial time and energy to labour market. Labour economics studies how labour markets work. Labour economics helps us understand and address many social and economic problems facing modern societies. Basics of the labour market Participants are assigned motives: - Workers look for the “best” job - Firms look for profits - Governments use regulation to pursue goals of public policy o Provisions of child care, minimum wages, occupational safety, visa systems Three “Actors” Workers - The most important actor: without workers, there is no “labour”. - Desire to maximize utility (i.e to optimize by selecting the best option from available set of choice). - Supply more time and effort for higher payoffs, causing an upward sloping labour supply curve . Firms - Decide whom to hire and fire. - Desire to maximize profits. - Relationship between the price of labour and the number of workers a firm is willing to hire generates the downward sloping labour demand curve. Governments - Imposes taxes, regulations, etc. - Provides ground rules that guide exchanges made in the labour market. The labour market Brings together the “buyers” (firms) and “sellers” (workers) —> interaction determine equilibrium wages. Why do we observe wage variation associated? The reason is due: - Education levels - Occupation - Experience - Gender - Race How do institutions/legislations affect salaries and employment in the economy? With some thinks like: - Social security - Minimum wage

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Why do we call it a market? The labour market is clearly not the same as the market for grain, cars or mobiles phones. The reason is because they exist a non-pecuniary factors (factors non related with the money) that are much more important than in markets for commodities. For example: - Work environment - Risk of injury – risc de tenir algun trauma o maltia derivada de la feina que fas - Flexibility of hours - Reputation of a job There are many laws and institutions that are specific to the labour market. But in general terms, it is a market because: 1. There are institutions that facilitate contract between buyers and sellers of labour services 2. Once a contract is arranged, information about price and quantity is exchanged 3. When a agreement is reached, a contract is executed, covering compensation, conditions, duration, etc The result of this transaction is the placement of people in jobs at certain rates of pay. Dins d’aquest mercat, labour is allocated to firms, industries, occupations and regions. Model Necessitem models que expliquin la realitat del mercat laboral. Tot i axiò, molts cops el que mirem son les tendencies i afegim els factors mes importants que poden afectar un outcome determinat, deixant de banda els que són menys relevants. És molt important tenir en compte si el nostre model s’assimila a la realitat o no. Per això, agafarem les dades que tenim disponibles i farem un estudi empiric. En cas que el model predigui el que fan les dades es perque aquest es correcte, en cas contrari, no ho és. Anem a posar un exemple sobre com testejar un model. Imaginem el model de “The human capital investment model”. The capital investment model Aquest model ens diu quina quantitat de inversió li fiquem a la nostra educació El simple model ens dius que quan acabem la nostra escola secundaria tenim dos opcions: - Anar a treballar - Continuar estudiant (FP, Batxillerat, grau universitari, etc) Normalment el que fem les persones es comprar els diners que guanyarem si escollim la 1era o la 2na opció amb tots els costos asociats amb aquesta. Una bona predicció d’aquest model és que anar a la universitat incrementa la diferencia (gap) entre els sous de la universitat i els que surten de secundaria. Ara testejem el model, en cas que el model sigui una bona descripcíó de la realitat, les dades ens ho confirmaran. Per això recolectem dades sobre “college enrolment rate and earnings” (See Enhrenberg & Smith). Obtenim aquesta taula i gràfics:

L’anàlisis de la resgresió en indica que quan la diferencia es alta, anar a la universitat també té un elevat nombre de persones. Doncs, les dades ens confirmen la predicció del model d’inversió en educació. Positive vs Normative Economics - Positive economics o Addresses the facts o Focuses on “what is” o Answers questions with the tools of economists - Normative economics o Addresses values o Focuses on “what should be” o Requires judgements Positive economics can help us to understand what would be the effect of A and B by isolating the main forces at work. However, it does not always tell us whether a given policy is “good” or “bad” from a social point of view. Any normative statement that tells us what should be instead of what is, is based on underlying values. Policy decisions - Many government policies affecting the labour market are based on the underlying value that society should try to male the distribution more equal - Economic theory cannot help us make certain decisions that rely on underlying values - Society usually relies on the political system for these decisions, not on economics analysis - Sometimes economics theory and corresponding empirical evidence can help us support certain policies unequivocally

- When it shows that they would be unambiguously good for all the parties involved Example - Suppose our model and empirical evidence tell us that eliminating restrictions to immigration would be good for immigrants, but would hurt Spanish workers. - Then we must decide on the basis of values. - But now suppose that the model and corresponding evidence show that more immigration would actually be good for everyone in the Spanish labour market. - Then we can all support reducing restrictions to immigration, no matter what our political views or values are, at least on economics grounds. Government Intervention - In general, the government should intervene in the labor market if: o Its intervention creates more gains for the beneficiaries than it imposes costs on others  Efficiency gains  Redistribution  Pareto improvement o It helps overcome market failures  Ignorance  Transaction barriers  Externalities  Public goods  Price distortions Summary - Labour economics studies how labour markets work - Models in labour economics typically contain three actors: workers, firms and governments - A good theory should have realistic assumptions and be testable with real-world data - The tools of economics are helpful in answering “positive” questions Overview of the labour market Definitions - Labour force: population aged 16 year or older who are either working, actively searching for employment, or expecting recall from a layoff. - Unemployed: those in the labour force who are not employed but actively looking for a job or expecting recall from a layoff. - Inactive: people not employed and neither looking for a job nor waiting to be recalled from layoff by their former employers. Measures - Population (+16) = Labour force + Inactive - Labour force = employed + unemployed - Unemployed ≠ Inactive - Unemployed: o Jobless o Want to work o Available to work

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o Actively seeking employment Inactive: o Retirees o Students o Parents who stay home to care for their children o Discouraged workers

The structure of the labour market Rectangles are stocks, arrows are flows.

Measures - Labour force participation rate: Labour force/Population - Employment rate: Employed/Population - Unemployment rate: Unemployed/Labour force - Loose market vs tight market: High vs Low unemployment rates Some data facts Spanish unemployment rate

Spanish labour market - Traditionally, high unemployment rates in Spain (up to 24% in 1994), particularly for women - Unemployment rates increased during the period 1980-1994, though with cyclical variation - Rapid decline since 1994 to around 10% - Until 2007 unemployment about the same as EU average - With the Great Recession starting in 2008, unemployment rose rapidly, peaking at 26% in 2013 - Since then steady decline to currently around 14,1% in 2019 - Rapid increase in 2020 due to the covid-19 crisis to 16,1% Spanish vs EU28 and US Unemployment rates

Spanish Labour Force Participation Rates

Participation Trends - In the last 50 years, participation in the labour market increasing for women and mildly decreasing for men - Historically, low female labour force participation rates in Spain - Until 2000 one of the lowest rates in the European Union. Very fast catch-up thereafter - In the USA o 1960: 42% of working age women, 89,8% men o 2019: 68,9% of working age women, 79,5% men - In Spain o 1972: 30% of working age women, 89,2% o 2019: 70,1% of working age women, 79,9% men Spanish vs EU and US LF participation rates

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During the 20th century, agricultural employment declined drastically, while employment in services expanded Data from 1920s to 2007: o Decline in agricultural employment  28% to 1,4% - USA  57% to 4,6% - Spain o Change in industrial employment  45% to 19,8% - USA  20% to 29,4% - Spain o Increase in service sector  28% to 78,8% - USA  20% to 66% - Spain

Wages - Wage rate: price of labour per working hour - Nominal wage: price of labour at today’s Euros o Useful to compare the pay of different workers today - Real wages: nominal wages divided by some measures of prices (consumer price index)

o Useful to compare a worker’s pay over time Wages≠Earnings≠Income - Earnings: Wages (per hour worked) times the number of hours worked - Total compensation: Earnings + Employee Benefits o Health insurance o Paid vacation time o Social security - Total Income: Earnings + benefits + Unearned Income (transfers, interest, etc…) Some Earnings/ Wage facts - Average earnings per moth in Spain. (In 2018): Men (2,228€) and women(1,751€). - Average earnings vary with age and with education level - In the USA and the UK, wage differentials have been increasing since the 1980s (by education and gender) - It did not happen to the same extent in continental Europe (especially not in Spain and France) Wage facts for Spain: Education

Wage facts for Spain: Age

Labour Supply A. Key definition and trends - Labour force o Population aged over 16 years of age who are either working, actively searching for employment, or expecting recall from a layoff - Unemployed o Those in the labour force who are not employed but actively looking for a job or expecting a recall from a layoff - Inactive o People not employed and neither looking for a job nor waiting to be recalled from layoff by their employers

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Population (+16) = Labour force + inactive Labour force = employed + unemployed Unemployed ≠ Inactive Unemployed: o Jobless o Want to work o Available to work o Actively seeking employment Inactive o Retires o Students o Parents who stay home to care for their children o Discouraged workers

Labour force participation rate: Labour force / population Employment rate: Employed /population Unemployment rate: unemployed/labour force Working-age population: 16-64 years olds Loose market vs Tight market : high vs low unemployment rates

Labour force participation - The labour force participation rate —> the proportion of the population that is in the labour force - Main trends in participation over recent decades o Large increase in participation for women o Constant ore decreasing participation for men - It seems likely that common forces are influencing labour supply trends in the industrialized world

Participation trends

Hours of work - A decrease in hours of work has taken place in all industrialized countries during the second half of the 20th century - In Spain since 1983 —> are limited by law to no more than 40 h per week - In Spain since 1979, the average number of hour worked per years has decreased by around 13,7% (OECD employment outlook 2020) Weekly hours of work of production workers, US, 1900-2010

Hours of work across countries In 2019, average weekly hours of work (calculated as annual hours worked divided by 44 working weeks) are:

Full time vs part time - In Spain, women work part-time much more often than men - In 2020, about 6,9% of employed men worked part-time, compared with 23,5% of employed women - The prevalence of par-time employment in Spain has been increasing since the 1990s - But it is still lower than in most other Europeans countries Understanding the trends - Why are more women in paid work today? - Why are more men starting their careers later and ending them earlier? - Why do people tend to work fewer hours? Theoretical framework - Preferences, utility —> Indifference curve - Constraints —> budget and time - Assumptions: o Both leisure and consumption are desirable o Leisure and consumption are substitutes o People know which combination of leisure and consumption to prefer o People always prefer more leisure/consumption to less leisure/consumption Utility function - Measure of satisfaction individuals receive from consumption of goods (C) and leisure (L) U =f ( C , L ) o U is an index o The higher is U, the happier is the person - Derived from the utility function U = f(C,L) - Combination of leisure (L) and consumption (C) that provide the same utility - Questions o Could they be increasing? o What happens when they move upwards? o Could they intersect? o Could they be non-convex to the origin? o What is the meaning of the slope of an indifference curve?

Could they intersect?

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Indifference curve for a person who values leisure a lot o She requires large increases in consumption to give up leisure o Steep (inclinada) indifference curve Indifference curve for a persona who values consumption (money) a lot. o Ella pot renunciar fàcilment a l’oci a canvi de consum o Flat indifference curve The slope of indifferent curve (the marginal rate of substitution in consumption, MRS) is given by:

Difference in preferences

The budget constraint - Budget constraint: all possible combination of consumption and leisure that a worker can afford (given a wage level w) - Time constraint: the total endowment of time (T) must be divided between work (h) and leisure (L) - Both constraints can be combined o C = w*h + V o Consumption equals labour earnings (wage w x hours of work h + non labour income V) o As h= T -L, one can write C = w(T-L) + V

- The slope of the budget line is the hourly wage rate The hours of work decision - Individuals choose consumption and leisure to maximize utility - Optimal consumption is given by the point where the budget line is tangent to the indifference curve o At this point the marginal rate of substitution (MRS) between consumption and leisure equals the wage rate o Any other consumption/leisure bundle on the budget constraint would give the individual less utility - At the tangency point, we have:

Optimal consumption and leisure

The effect of a change in non labour income on hours of work - An increase in on labour income leads to a parallel upward shift in the budget line, moving the worker from point P0 to point P1. If leisure is a normal good, hours of work fall.

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An increase in non labour income leads to a parallel, upward shift in the budget line, moving the worker from point P0 to point P1. If leisure is an inferior good, hours of work increases.

An increase in the hourly wage rate - If I work the same number of hours as before, I make more money o Income effect - But leisure(not working) becomes more “expensive” o Substitution effect - What is the total effect?

A change in the wage rate rotates the budget line around the endowment point E. A wage increase moves the worker from point P to point R, and can either decrease or increase hours of work.

An increase in the wage rate generates both income and substitution effects. The income effect (the move from point P to point Q) reduces hours of work; the substitution

effect (the move from Q to R) increases hours of work.

Income and substitution effect - The theory alone doesn’t tell us the direction of the effect - We need to look at data to find out whether labor supply increases or decreases in response to a change in wage - The decomposition into income and substitution effect is mathematically given by the Slutsky equation:

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Where the first term on the right-hand side represents the substitution effect and the second term represent the income effect. In the data we can see that: o For men  wage increase not followed by an increase in hours worked  Small income and substitution effect o For women  a wage increase typically results in increases in labor supply for married women  The substitution effect dominates  Response mostly in terms of participation

To work or not to work? - Es suficientemente atractiva para el trabajador entrar en la fuerza laboral? Aquí hay un trade off entre hacerlo o no - Reservation wage: the lowest wage rate that would make the person indifferent between working and not working. o Rule 1: if the market wage is less than the reservation wage  person will not work o Rule 2: the reservation wage increases as nonlabor income increases (social assistance, income of other household members)

Individual labor supply curve

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Definition: Relationship between hours worked and the wage rate o At wages slightly above (ligeramente superior) the reservation wage, the labor supply curve is positively sloped (the substitution effect dominates the income effect) o In the income effect begins to dominate the substitution effect, hours of work decline as the wage rates increases o The result is a “backward-bending” (next graph) labor supply curve

Aggregate labor supply - It indicates how many people want to work (or how many hours of work are supplied) in the market at a given wage rate - Obtained by horizontally adding up the supply curve of all workers in the economy - The labor supply elasticity (σ) measures the responsiveness of hour of work to change in the wage rate

The market labor supply curve “adds up” the supply curves of individual workers. When the w A , no one works. As the wage rises, Alice enters the labor market. If wages is below ~ w B , Brenda enters the market. the wage rises above ~ Labor supply elasticity - σ = Percent change in hours worked divided by the percent change in the wage rate.

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Inelastic labour supply: |σ| < 1, less than proportional change in hours of work for a given change in the wage rate. Elastic labour supply: |σ| > 1, more than proportional change in hours of work for a given change in the wage rate. Estimation: hi = βwi + αVi + other variables o Β measure the impact of a rise in wi, on hours of work, holding Vi constant o Α measure the impact of a rise in Vi on hours of work, holding wi constant There are many estimate of the labor supply elasticity in the literature o For men : around -0.1 ( +0.1 due to the substitution effect, -0.2 due to the income effect) o For women: around 0.2 (mostly due to adjustment on the extensive margin)

Policy application - We can use labor supply theory to analyze the effects of various social programs and labor market policies - Social programs and labor market policies alter the choices of hours worked by modifying people’s budget constraints 1. Cash Grants / Unemployment subsides - Programs that grant eligible people a subside as long as they remain outside the labor force o For example: cash grant to single mothers with children - If recipients enter the labor market, they are assumed to no longer need public assistance and therefore dropped from welfare/unemployment benefits. - How to design programs that avoid work disincentives?

A take-it-or-leave-it cash grant of 500€ per week moves the worker from point P...