ECON 2608Advanced Labour Economics

Introduction

Bruno Van der Linden

Université catholique de Louvain

November 8, 2010

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Road-map

1 Is labor a good like any other?

2 Current labour economics

3 A balanced presentation of labour economics?

4 Outline of ECON 2608

5 Unemployment

6 References

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Is labor a good like any other?

Some specificities of the labour market

1 labour is embodied in the seller. Contrary to other goods, labor isinseparable from the worker. Hence, “buying labor” typicallyimplies a direct, personal relationship between the buyer and theseller;Implication: a subordination relationship: workers are paid inreturn of complying with the rules set by the managers of the firm.

2 the employment relationship has often a “long-term” nature;

3 most persons need to work to cover their needs and those of theirrelatives (and become eligible to social security);

4 the worker’s human capital cannot easily be diversified while riskand uncertainty prevail on the labour market;

5 heterogeneity of workers and jobs & multiplicity of labor markets(decentralized exchange).

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Is labor a good like any other?

Some specificities of the labour market

Many authors were and are conscious of this:

Marshall, Pigou, Taussig and other leading theorists weretroubled by the ‘peculiarities’ of the labor market – the factthat the worker sells himself with his services, that hisimmediate financial need may place him at a disadvantage innegotiating with employers, that he is influenced bynon-pecuniary motives, that he has limited knowledge ofalternative opportunities, and that there are objective barriersto free movement of labor. (Reynolds, 1951, p. 2).

Still, how to deal with these specificities remain a challenge.

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Current labour economics

Mainstream (labour) economics

Although somewhat vague, the notion of mainstream (labour)economics can be briefly characterized by:

methodological individualism;

individuals are in a “position” such that they can make choices;

an “instrumentalist” perspective:1 the individual pursuit of wealth2 in combination with an aversion to labor (hours worked, effort on

the job)

Taking sometimes care of the nonpecuniary (dis)advantages of anoccupation (such as the risk of injury considered by the theory ofcompensating differentials)

standard rationality assumptions; no resources invested indecision making.

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Current labour economics

Mainstream (labour) economics challenged

Having an occupation can give more than access to consumption:The compensation provides a certain degree of autonomy in theconduct of one’s life (in comparison with getting the money or thegoods from parents, a husband, social security, . . . );Having a job can mean being part of a social group, a community(creating social ties, possibly the feeling of being member of the“working class”);Having a job can provide the feeling of being useful to others;Being hired by an employer recognizes the worker as someonewho is productive (worth to be recruited);If the job has specific characteristics (e.g. autonomy, creativity), itcan be interesting per se.

To some extent, these dimensions are valued by the workers andmainstream economics can handle this.

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Current labour economics

Mainstream (labour) economics challengedNorms

Fairness: People often care about being fair and treated fairly.This seems to be particularly true in the labor market (see Solow,1990, for an early contribution).More generally: Importance of norms as to how people think thatthey and others should behave.But “with rare exceptions, economists have maintained the basicpresumption that tastes and preferences are individualcharacteristics independent of social context” (Akerlof andKranton, 2010, p. 10)“The noms of how to behave depend on people’s positions withintheir social context” (idem, p. 11)Then, how do norms emerge? From interactions betweenindividual agents who adopt an instrumentalist perspective ?Solow (1990) provides an answer along this view.

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A balanced presentation of labour economics?

Options taken

Main part: Mainstream labour economics (based mainly on thetextbook of Cahuc and Zylberberg, 2004);

Taking care of “features” that seem pervasive on the labourmarket: asymmetric and imperfect information, imperfectcompetition, decentralized matching between job-seekers andvacancies,... ;

Extending at some points mainstream labour economics to takecare of social norms;Introducing from time to time what can be learned from othersocial sciences.

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Outline of ECON 2608

This is a graduate course in labour economicsThe course does not develop labour supply (neither in the short-nor in the long-run), labour demand and the competitive theory ofthe labour market. However, when needed, it recalls the mainproperties under pure competition.Standpoint: The labour market does not function as a standardpurely competitive market.The course discusses why actual labour markets are far morecomplex than this convenient reference model.Four main channels are discussed:

1 imperfect competition: firms’ market power & employees bargainingpower (due to unionisation, turnover costs or investment);

2 risk aversion;3 imperfect (symmetric and asymmetric) information;4 social norms

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Outline of ECON 2608

Structure

Main themes:1 Job-search2 Job reallocation and unemployment (Equilibrium matching

models)3 Collective bargaining4 Contracts, risk-sharing and incentives

Material covered through:lectures: Theories + empirical methodology & applicationshomework (exercices and readings).Short assignments and exercises will be assigned during thecourse.A limited number of compulsory readings.

The course will include both theoretical and empirical literature.ESL (UCL) 10 / 19

Outline of ECON 2608

Organization

General reference:Cahuc, Pierre and André Zylberberg (2004), Labor Economics,London, England: The MIT Press. (available at the library, placedes doyens) At least, the following chapters will be (partially)covered: Chapter 3. Job search; Chapter 6. Contracts,risk-sharing and incentives; Chapter 7. Collective bargaining;Chapter 9. Job reallocation and unemployment.Slides available on iCampus follow the textbook but provides alsoextensions.Also on iCampus: exercises, compulsory readings,...Office hours: On MONDAYS from 8:30 to 10:00 am at CollegeDupriez, 3 place Montesquieu, Office D-108.

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Outline of ECON 2608

Grading:The course material of the lectures will be evaluated on the basisof a written closed-book exam organised during the regularexamination period.Questions may relate to topics discussed during the lectures, theproblem sets and the compulsory readings. Homeworkassignments are examples of exam questions.The exam aims at evaluating whether students are able toconstruct a coherent and critical argumentation of labour marketissues treated in the lectures. It will also gauge whether thestudents understand the logic of arguments within formaleconomic models.

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Unemployment

Discussing briefly unemployment is important per se. It also allows todiscuss more concretely some points raised above.

Definitions and measurement issues:Active population or workforce = population employed +population unemployed

An unemployed has no job, searches for a job and is available totake job offers (International Labour Organization’s definition)

Complex measurement issues: How to measure “job-searcheffort” and “availability”? When is someone “employed”?

Nevertheless, a lot of effort is done (by EUROSTAT, the OECD,B.L.S.) to develop harmonized surveys

See next figure.

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Unemployment

0,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

U.S (OECD & BLS) France Germany U.K. (B.L.S)

Figure: Unemployment rate (%) 1960-2009 (OECD and BLS)

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Unemployment

Standard textbook theory

Perfect information

No role for unemployment: either employed or out of the labourforce ( = “nonparticipant” or “inactivity”)

Still, the supply-demand cross setting is often used in textbooks.

Then, non-employment (i.e. the rationing of labour-supply) canonly arise if

labour supply is flat up to full-employmentThen however, the non-employed are indifferent between workingor notor if the real wage is for some reason above the market-clearinglevel.What’s the reason?

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Unemployment

Why would the labor market clear?

Often, an implicit story about feasible choices out of equilibrium:The unemployed offer to work at a wage below that of those inwork and this puts a downward pressure on wages until themarket clears.There is however empirical evidence of average real wagerigidities (Bewley, 1999, and Babechý, Du Caju, Kosma, Lawless,Messina and Room, 2009 for instance).Several theories have been built to explain these rigidities (e.g.imperfect competition on the labour market). They have been toosome extent successful.Some “institutions” such as the minimum wage can explain(downward) wage rigidity.Solow (1990) and Hahn and Solow (1997) argue that the labormarket is a “social institution” where norms (of fairness) prevail.They explain how these norms can explain wage rigidities.

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Unemployment

Note

Although not related to labour economics, some general equilibriumtheorists have questioned the idea that the labor market necessarilyclears if the real wage can be freely adjusted. Namely,

Lasselle and Svizzero (2002) survey the literature in which firms’excessive market power on the product markets lead to“involuntary unemployment” (it exits at any wage).Drèze (1997) shows that supply-constrained equilibria can bepervasive even if the level of prices and wages are compatiblewith competitive equilibrium! To show this, one needs downwardrigidity of some (relative) prices and coordination failures. Tointuitively see the respective importance of these two ingredients,wage rigidity sustains (not causes) pervasive underutilisation ofresources caused by coordination failures. On pages 1754-5,Drèze (1997) explicitly mentions risk-sharing and incompleteinsurance markets as explanations for wage rigidity.

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Unemployment

The DMP approach: workhorse of labour economicsin the two past decadeshttp://nobelprize.org/nobel_prizes/economics/laureates/2010/info.pdf

According to a classical view of the market, buyers andsellers find one another immediately, without cost, and haveperfect information about the prices of all goods and services.Prices are determined so that supply equals demand; thereare no supply or demand surpluses and all resources are fullyutilized.

[...] The basic idea in search theory is that participants ina market look for cooperative partners in order to implementjoint projects. This may involve simple cases of a buyer and aseller of a product, as well as more complex relationsbetween employers and job seekers or between firms andtheir suppliers.

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Unemployment

The DMP approachhttp://nobelprize.org/nobel_prizes/economics/laureates/2010/info.pdf

In a number of studies, Dale Mortensen and ChristopherPissarides have systematically developed and applied thetheory to examine the labor market – particularly thedeterminants of unemployment. This has resulted in a modelknown as the Diamond-Mortensen-Pissarides (DMP) model.Today, the DMP model is the most frequently used tool foranalyzing unemployment, wage formation and job vacancies.

The two first chapters will consider the search and matching models.These chapters illustrate how mainstream labour economics improvesour understanding of real phenomena by, in this case, taking care ofthe decentralized nature of labour markets.This does not mean that our understanding of the causes ofunemployment cannot be improved by considering social norms (seereferences above).

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References

Akerlof, G. and R. Kranton (2010) Identity economics.Princeton University Press.

Babechý, J., P. Du Caju, T. Kosma, M. Lawless, J. Messina andT. Room (2009) “Downward nominal and real wage rigidity: Surveyevidence from European firms”.Working Paper 182, National Bank of Belgium.

Bewley, T. F. (1999) Why wages don’t fall during a recession.Harvard University Press, Harvard.

Cahuc, P. and A. Zylberberg (2004) Labor economics.MIT Press, Cambridge.

Drèze, J. (1997) “Walras-keynes equilibria coordination andmacroeconomics”.European Economic Review, 9:1735–1762.

Hahn, F. and R. Solow (1997) A critical essay of modernmacroeconomic theory.

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References

Blackwell Publishers, Oxford.

Lasselle, L. and S. Svizzero (2002) “Involuntary unemployment inimperfectly competitive general equilibrium models”.Journal of Economic Surveys, 16:487–507.

Reynolds, L. (1951) The structure of labor markets.Harper and brothers, New-York.

Solow, R. (1990) The labor market as a social institution.Basil Blackwell, Cambridge (MA).

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