MACROECONOMICS cover art ROW 1 (90) C H A P T E R © 2008 Worth Publishers, all rights reserved SIXTH EDITION PowerPoint® Slides by Ron Cronovich N. GREGORY MANKIW Unemployment 6 This presentation has lots of data. Some from the textbook (or updated versions of what’s in the textbook), plus some additional data, including data that supports some of the textbook’s key points about the causes of the natural rate of unemployment. Yet, it is one of the shorter chapters. It is also less difficult than the preceding chapters. So, most professors are able to cover this material more quickly than usual. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment In this chapter, you will learn… §…about the natural rate of unemployment: §what it means §what causes it §understanding its behavior in the real world § > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Natural rate of unemployment §Natural rate of unemployment: The average rate of unemployment around which the economy fluctuates. §In a recession, the actual unemployment rate rises above the natural rate. §In a boom, the actual unemployment rate falls below the natural rate. The natural rate of unemployment is the “normal” unemployment rate the economy experiences when it is neither in a recession nor a boom. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Actual and natural rates of unemployment in the U.S., 1960-2007 Unemployment rate Natural rate of unemployment 0 2 4 6 8 10 12 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Figure 6-1, p.160. The actual unemployment rate fluctuates considerably over the short run. These fluctuations will be the focus of chapters 9-13 later in the book. For this chapter, though, our goal is to understand the red line: the so-called “natural rate of unemployment,” or the long-run trend in the unemployment rate. Source: BLS Obtained from http://research.stlouisfed.org/fred2/ Unemployment data are based on seasonally-adjusted, monthly unemployment rates for the civilian non-institutional population of the U.S. The actual u-rate for each quarter is an average of the three monthly unemployment rates in that quarter. The natural u-rate in a given quarter is estimated by averaging all unemployment rates from 10 years earlier to 10 years later; future unemployment rates are set at 5.5%. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment A first model of the natural rate §Notation: § L = # of workers in labor force § E = # of employed workers § U = # of unemployed § U/L = unemployment rate Section 6-1 cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Assumptions: §1. L is exogenously fixed. §2. During any given month, § s = fraction of employed workers that become separated from their jobs § s is called the rate of job separations § f = fraction of unemployed workers that find jobs § f is called the rate of job finding § s and f are exogenous cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment The transitions between employment and unemployment Employed Unemployed s ´E f ´U Figure 6-2, p. 161 (note: The size of the boxes containing the words “employed” and “unemployed” are not proportional to the number of people in each category.) cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment The steady state condition §Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant. §The steady-state condition is: s ´E = f ´U # of employed people who lose or leave their jobs # of unemployed people who find jobs cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Finding the “equilibrium” U rate § f ´U = s ´ E § = s ´ (L – U ) § = s ´ L – s ´ U §Solve for U/L: § (f + s) ´ U = s ´ L §so, cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Example: §Each month, §1% of employed workers lose their jobs (s = 0.01) §19% of unemployed workers find jobs (f = 0.19) §Find the natural rate of unemployment: cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Policy implication §A policy will reduce the natural rate of unemployment only if it lowers s or increases f. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Why is there unemployment? §If job finding were instantaneous (f = 1), then all spells of unemployment would be brief, and the natural rate would be near zero. §There are two reasons why f < 1: § 1. job search § 2. wage rigidity > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Job search & frictional unemployment §frictional unemployment: caused by the time it takes workers to search for a job §occurs even when wages are flexible and there are enough jobs to go around §occurs because §workers have different abilities, preferences §jobs have different skill requirements §geographic mobility of workers not instantaneous §flow of information about vacancies and job candidates is imperfect > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Sectoral shifts §def: Changes in the composition of demand among industries or regions. §example: Technological change more jobs repairing computers, fewer jobs repairing typewriters §example: A new international trade agreement labor demand increases in export sectors, decreases in import-competing sectors §Result: frictional unemployment Sometimes the unemployment caused by sectoral shifts is severe. Due to increasing imports of cheaper foreign-made textiles (particularly since the expiration in 2005 of long-standing quotas on textiles from China), the U.S. textile industry has been in decline for years. Tens of thousands of workers in this industry have lost jobs. Many of these workers are in their 50s and have worked in this industry for decades. Such workers are unlikely to have the skills necessary to get jobs available in newly booming industries, and they are less likely to invest in the acquisition of the necessary skills for these jobs. Hence, such workers are at greater risk for becoming “discouraged workers.” cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment CASE STUDY: Structural change over the long run All figures are industry shares in U.S. GDP. “Other industry” includes construction, mining, electricity, water, and gas. From 1960 to 2000, there are huge changes in all four categories. Manufacturing falls by about a third. Even the “tiny” category of agriculture drops by nearly two-thirds: from 4.2% to 1.6% of GDP. These changes represent HUGE structural shifts, which vastly alter the kinds of jobs in demand. Source: World Development Indicators, World Bank. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment More examples of sectoral shifts §Late 1800s: decline of agriculture, increase in manufacturing §Late 1900s: relative decline of manufacturing, increase in service sector §1970s: energy crisis caused a shift in demand away from gas guzzlers toward smaller cars. In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment. Most of the examples on this and the previous slides are big changes that have occurred over many years. These examples give students a good idea of what sectoral shifts are. Perhaps more important for the natural rate, though, are the many smaller changes that occur more frequently. Ours is a dynamic economy: the structure of demand is shifting almost continuously, due to changes in preferences, technology, and the location of production. As a result, there is a near-continual flow of newly frictionally unemployed workers. Sectoral shifts are distinct from recessions (which also cause unemployment). In recessions, there is a general fall in demand across industries, and the unemployment that results is cyclical. Sectoral shifts, though, are changes in the composition of demand across industries, and lead to frictional unemployment as described above. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Public policy and job search §Govt programs affecting unemployment §Govt employment agencies: disseminate info about job openings to better match workers & jobs. §Public job training programs: help workers displaced from declining industries get skills needed for jobs in growing industries. You might want to “hide” (omit) this slide from your presentation if you plan on doing the class discussion in Slide 27, which asks students to think of things the government can do to try to reduce the natural rate of unemployment. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Unemployment insurance (UI) §UI pays part of a worker’s former wages for a limited time after losing his/her job. §UI increases search unemployment, because it reduces §the opportunity cost of being unemployed §the urgency of finding work §f §Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment. The text includes a nice case study on unemployment insurance (pp.164-165). It discusses evidence that unemployment insurance reduces the job finding rate. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment §By allowing workers more time to search, § UI may lead to better matches between jobs and workers, § which would lead to greater productivity and higher incomes. Benefits of UI cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Why is there unemployment? §Two reasons why f < 1: §1. job search §2. wage rigidity DONE ü Next è The natural rate of unemployment: cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Unemployment from real wage rigidity Labor Real wage Supply Demand Unemployment Rigid real wage Amount of labor willing to work Amount of labor hired If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around. Figure 6-3 on p.166. Abbreviation: “eq’m” = equilibrium cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Unemployment from real wage rigidity Then, firms must ration the scarce jobs among workers. Structural unemployment: The unemployment resulting from real wage rigidity and job rationing. If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around. Other texts define “structural unemployment” as unemployment that results from a mismatch between the skills or locations of workers and the skill or location requirements of job openings. This would occur, for example, if there were a decrease in demand for domestic steel (and hence steel workers) and a simultaneous increase in demand for financial consulting services (and hence employees of such firms). However, if wages are perfectly flexible, then the decrease in demand for steel workers would simply cause their wage to fall until all were again employed, and the increase in demand for workers in financial firms would simply increase until equilibrium in that labor market was reestablished. So, the critical ingredient for structural unemployment is wage rigidity. Hence Mankiw’s definition. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Reasons for wage rigidity §1. Minimum wage laws §2. Labor unions §3. Efficiency wages > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment 1. The minimum wage §The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers. §Studies: a 10% increase in min. wage reduces teen unemployment by 1-3% §But, the min. wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the min. wage. > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment 2. Labor unions §Unions exercise monopoly power to secure higher wages for their members. §When the union wage exceeds the eq’m wage, unemployment results. §Insiders: Employed union workers whose interest is to keep wages high. §Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them. > See p.165 for more discussion about insiders and outsiders. The theory has two implications we can confront with data: 1) Union members’ average earnings should be higher than non-union members’ average earnings. 2) The difference between union and non-union wages should be higher in industries that are more heavily unionized (and hence, in which unions have more market power) than in less heavily unionized industries. The following slide shows 2005 data on union membership and wage ratios by industry in the U.S. The data are consistent with the theory. 105,508 Private sector (total) 20,381 Government (total) 14,045 Health care 3,312 Education 10,951 Professional services 6,304 Finance, insurance 4,379 Transportation 14,973 Retail trade 15,518 Manufacturing 600 Mining 122.3 121.7 115.1 112.7 90.6 90.7 129.2 114.0 107.8 113.7 156.9 8.5% 40.5 8 15.4 3.1 2.1 24.4 5.8 13.7 9.5 13.8 8,053 Construction wage ratio U % of total # employed (1000s) industry wage ratio = 100´(union wage)/(nonunion wage) slide 25 Union membership and wage ratios by industry, 2005 For this slide, “union members” includes workers that are in a union or similar worker association, or whose jobs are covered by a union contract. •U % of total = “union members” (as defined above) as a percentage of all workers •Wage ratio = average weekly earnings of “union members” (as defined above) as a percentage of average weekly earnings of nonunion workers. For example, in the transportation industry, 24.4% of workers are in unions and earn 29.2% more than non-union workers in this industry. Source: BLS.gov Note: Due to space constraints on the slide, some industries were omitted. In 2005, about 13% of all workers in the U.S. were members of unions. The data on this slide show two things: 1) union workers typically earn more than non-union workers (about 22-23% more on average). 2) the greater the percentage of union workers in an industry, the higher the wage ratio is likely to be (the correlation is about 0.5) cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment 3. Efficiency wage theory §Theories in which higher wages increase worker productivity by: §attracting higher quality job applicants §increasing worker effort, reducing “shirking” §reducing turnover, which is costly to firms §improving health of workers (in developing countries) §Firms willingly pay above-equilibrium wages to raise productivity. §Result: structural unemployment. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Question for discussion: •Use the material we’ve just covered to come up with a policy or policies to try to reduce the natural rate of unemployment. •Note whether your policy targets frictional or structural unemployment. > It is useful to pause your lecture at this point and give students an opportunity to apply what you’ve covered so far to answer this policy question. Possible answers: 1.Stop raising the (nominal) minimum wage, so that its real value will gradually erode to zero. 2.Regulate unions (just like other monopolies are regulated) to reduce unions’ impact on wages. 3.Reduce the generosity of unemployment insurance benefits. 4.Implement government employment agencies to increase the accessibility of information about job vacancies and available workers. 5.Increase public funding to help retrain workers displaced from jobs in declining industries. Suggestions for conducting the discussion: If you ask for responses immediately after posing the question, it is likely that a small number of students will volunteer to participate - the same students that always do, the ones that are the best prepared and/or the quickest thinkers. To elicit participation from a larger number of students, I suggest the following: Pair students up. Allow 10 minutes for the students, working in their pairs, to come up with answers to the question. During this time, circulate around the room and ask the pairs if you can be of assistance, either to help them get started or give feedback on what they’re coming up with. Then, reconvene the class and ask for volunteers. Doing this increases the quantity and quality of participation: students who would not otherwise participate are more likely to do so because they have had time to formulate their answers and have had a chance to run their answers by a classmate. Additionally, even students who don’t participate will have at least had the opportunity to discuss the question with one other student. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment The duration of U.S. unemployment, average over 1/1990-6/2007 # of weeks unemployed # of unemployed persons as % of total # of unemployed amount of time these workers spent unemployed as % of total time all workers spent unemployed 1-4 38% 6.1% 5-14 31% 18.8% 15 or more 31% 75.1% How to interpret this data: The second column shows the percentage of all unemployed workers whose spell lasted the number of weeks shown (average over January 1990 to May 2006). The third column shows the share of total time spent unemployed attributed to workers in that category. I calculated it as a ratio. The denominator is the total number of weeks spent unemployed, obtained by multiplying the total number of unemployed persons by the number of weeks of the average spell of unemployment. The numerator is, for each category, the number of people in that category times the duration of the average spell of unemployment for that category. 6.1% of total time spent unemployed is accounted for by people who were unemployed for less than 5 weeks. 75.1% of total time spent unemployed is accounted for by people who were unemployed for 15 or weeks or longer. The point of this data: More spells of unemployment are short term (38%) than medium term (31%) or long term (31%). But, most of the time spent unemployed is long-term. Source: Bureau of Labor Statistics (www.bls.gov) and author’s calculations. The variable labels at bls.gov are: LNS13000000, LNS13008396, LNS13008756, LNS13008516, LNS13008876, LNS13008636, LNS13008275 cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment The duration of unemployment §The data: §More spells of unemployment are short-term than medium-term or long-term. §Yet, most of the total time spent unemployed is attributable to the long-term unemployed. §This long-term unemployment is probably structural and/or due to sectoral shifts among vastly different industries. §Knowing this is important because it can help us craft policies that are more likely to work. > Regarding the point about structural unemployment and sectoral shifts: Structural unemployment - workers are waiting for jobs to become available, but there just aren’t enough jobs to go around; hence, this can be long-term unemployment. Sectoral shifts across vastly different industries, e.g. a shift in demand from textiles to software design; obviously, jobs in these industries require vastly different skill sets. Sectoral shifts can occur among similar industries (e.g., demand shifts from desktop to laptop computers), but this is less likely to produce long-term unemployment. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment TREND: The natural rate rises during 1960-1984, then falls during 1985-2007 The purpose of this slide is to establish the trend behavior of the natural rate in recent decades: rising until the early 80s, then falling from the mid-80s through the early 2000s. The following slides will show that the theories in this chapter are (mostly) consistent with the trend behavior of the natural rate. The graph on this slide is similar to Figure 6-1 (near the beginning of this PowerPoint presentation). However, since we are now focusing on the trend behavior in the natural rate, I have altered the vertical axis to make the trend more apparent, and I’ve dimmed the actual unemployment rate data – now light gray. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment EXPLAINING THE TREND: The minimum wage 0 1 2 3 4 5 6 7 8 9 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 minimum wage in current dollars minimum wage in 2006 dollars The trend in the real minimum wage is similar to that of the natural rate of unemployment. The trend in the real minimum wage rises until the mid to late 1970s, then falls. This is fairly similar to the trend of the natural rate of unemployment. The U.S. Department of Labor has lots of good information on the minimum wage, at: http://www.dol.gov/dol/topic/wages/minimumwage.htm cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment EXPLAINING THE TREND: Union membership Since the early 1980s, the natural rate of unemploy-ment and union membership have both fallen. But, from 1950s to about 1980, the natural rate rose while union membership fell. Union membership selected years year percent of labor force 1930 12% 1945 35% 1954 35% 1970 27% 1983 20.1% 2006 12.0% source: AFL-CIO website http://www.aflcio.org and, for the 2006 figure, www.BLS.gov (specifically, http://www.bls.gov/news.release/union2.toc.htm) Also see http://www.lib.umich.edu/govdocs/steclab.html#unions good set of links to info on labor unions http://stats.bls.gov/news.release/union2.toc.htm The BLS’ annual news release of info on union membership, earnings. Earlier in the chapter, we saw cross-sectional data that showed a positive correlation between the union wage premium and union members’ share of the labor force across industries. We would expect that, other things equal, changes over time in the aggregate share of unions in employment should be associated with similar changes in unions’ impact on average wages, and hence on the natural rate of unemployment. In plain English, we would expect that the decline in the extent of unionization shown on this slide would correspond to a decline in the natural rate of unemployment. Unfortunately for the theory, this is only true for the time period beginning in the early 1980s, when the natural rate started coming down. From the 1950s through 1980, the natural rate rose, but union membership fell. Does this mean the theory is not relevant? Not necessarily, as other things (other determinants of the natural rate) were not constant during this time period. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment EXPLAINING THE TREND: Sectoral shifts Price per barrel of oil, in 2007 dollars From mid 1980s to early 2000s, oil prices less volatile, so fewer sectoral shifts. source: Dow Jones & Company obtained from: http://research.stlouisfed.org/fred2/ Earlier in the chapter, we learned that sectoral shifts are a source of job separations and lead to frictional unemployment. One would expect that a decrease in the frequency and magnitude of sectoral shifts would be associated with fewer job separations, less frictional unemployment, and a lower natural rate of unemployment. Unfortunately, there is no single “index of sectoral shocks.” However, we know that large changes in oil prices are one source of sectoral shocks. A significant fall in the price of oil causes a decrease in demand for workers at oil fields in Oklahoma and Texas, and an increase in demand for workers at factories that produce SUVs. A significant increase in oil prices would do the opposite. The graph shows data on the price of oil since 1970. •During 1970-1985, the real price of oil fluctuated between $18 and $98. Also during this time, the natural rate of unemployment was rising. •During 1986-2002, the real price of oil fluctuated between $20 and $40, except for a brief spike during the Gulf War. Also during this time, the natural rate of unemployment was falling. The data are roughly consistent with the notion that sectoral shifts contribute to the natural rate. Note the recent increase in oil prices: from about $22 to $70 during 2002-2006:1. This represents a sectoral shift and may contribute to an increase in the natural rate of unemployment. Or maybe not, as oil consumption per dollar of GDP is lower today than in the 1970s and 1980s. cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment EXPLAINING THE TREND: Demographics §1970s: The Baby Boomers were young. Young workers change jobs more frequently (high value of s). §Late 1980s through today: Baby Boomers aged. Middle-aged workers change jobs less often (low s). > For details on this, plus one other explanation involving productivity, see pp.174-175. Unemployment in Europe, 1960-2006 cover R1,C4 slide 35 Italy Germany France U.K. 0 3 6 9 12 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 updated version of Figure 6-4, p.177 Source: bls.gov, obtained from http://www.bls.gov/fls/home.htm cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment The rise in European unemployment §Shock Technological progress has shifted labor demand from unskilled to skilled workers in recent decades. §Effect in United States An increase in the “skill premium” – the wage gap between skilled and unskilled workers. §Effect in Europe Higher unemployment, due to generous govt benefits for unemployed workers and strong union presence. > cover R1,C4 slide ‹#› CHAPTER 6 Unemployment CHAPTER 6 Unemployment Percent of workers covered by collective bargaining United States 18% United Kingdom 47 Switzerland 53 Spain 68 Sweden 83 Germany 90 France 92 Austria 98 Table 6-1, p.169 Source: Same as text (OECD Economic Outlook 2004, as reported in NBER Macroeconomics Annual 2005.) Chapter Summary §1. The natural rate of unemployment §the long-run average or “steady state” rate of unemployment §depends on the rates of job separation and job finding §2. Frictional unemployment §due to the time it takes to match workers with jobs §may be increased by unemployment insurance § CHAPTER 6 Unemployment slide 38 cover R3,C1 > Chapter Summary §3. Structural unemployment §results from wage rigidity: the real wage remains above the equilibrium level §caused by: minimum wage, unions, efficiency wages §4. Duration of unemployment §most spells are short term §but most weeks of unemployment are attributable to a small number of long-term unemployed persons CHAPTER 6 Unemployment slide 39 cover R3,C1 > Chapter Summary §5. Behavior of the natural rate in the U.S. §rose from 1960 to early 1980s, then fell §possible explanations: trends in real minimum wage, union membership, prevalence of sectoral shifts, and aging of the Baby Boomers CHAPTER 6 Unemployment slide 40 cover R3,C1 > Chapter Summary §6. European unemployment §has risen sharply since 1970 §probably due to generous unemployment benefits, strong union presence, and a technology-driven shift in demand away from unskilled workers CHAPTER 6 Unemployment slide 41 cover R3,C1 >