Econ 460 Lecture 17

Econ 460 Lecture 17

Unemployment: Causes and 
Consequences
Review Questions and Problems
 Explanations of Unemployment
Explanations of Unemployment
• Full information, market‐clearing competitive labour 
market model of some, but limited, usefulness in 
understanding unemployment
• Institutional rigidities such as minimum wages and 
Institutional rigidities such as minimum wages and
union wage bargaining can explain some 
unemployment, as can labour market policies (e.g. UI)
• ‘High
High wage unemployment
wage unemployment’ may also arise for risk‐
may also arise for risk
sharing and incentive pay reasons: see models of 
implicit contracts and efficiency wages
• Insider‐outsider models, another potential source of 
I id id d l h i l f
high wage unemployment, share features of union 
wage bargaining  
 Types of Unemployment
Types of Unemployment
• Traditional to distinguish between cyclical (deficient 
demand) and non‐cyclical  (equilibrium, NAIRU, or ‘natural’ 
unemployment) 
• Cyclical studied in macro, non‐cyclical more micro‐based
• Non‐cyclical includes frictional, structural and seasonal 
unemployment
• Structural would include unemployment due to labour 
Structural would include unemployment due to labour
market policies (e.g. UI), institutional rigidities, ‘high wage’ 
sources , and sectoral shifts leading to mismatch between 
labour demand and supplypp y
• Mismatch may occur along regional, occupational, 
industrial and skill dimensions
 Types of Unemployment
Types of Unemployment
• Frictional unemployment refers to 
p y
unemployment associated with normal turnover 
in the labour market
• Best understood in the context of imperfect 
Best understood in the context of imperfect
information, leading to search and matching 
function
• Unemployed workers are imperfectly informed 
about availability of jobs and associated wages 
and working conditions
and working conditions
• Employers with job openings also uninformed 
about available workers and their characteristics  
 Search Unemployment
Search Unemployment
• Good discussion of basics in text
• Modeled as a problem of choice under uncertainty
• Unemployed face a distribution of potential wages 
(and working conditions) – obtaining draws from this 
distribution requires time and money costs
• Amount of search effort based on expected benefits 
Amount of search effort based on expected benefits
and costs
• Likely that expected benefits display diminishing 
y p p y g
returns with search duration, and costs increase at the 
margin with search duration
 Search unemployment
Search unemployment
• Optimal
Optimal amount of job search occurs when 
amount of job search occurs when
marginal PV of expected benefits equals 
marginal costs (risk neutral case)
• Associated with optimal amount of search is 
an expected search duration
• Under certain conditions optimal search has a 
simple stopping rule form: search until offered 
wage at least equals some minimum value ( 
often called the reservation wage)  
 Frictional or Structural Unemployment

Chapter 18 © 2007 McGraw‐Hill Ryerson Ltd. 7
 Some Implications
Some Implications
• Generally job seekers will cease search prior to being 
yj p g
fully informed about job opportunities
• Unemployed workers and unfilled vacancies will coexist 
i
in equilibrium
ilib i
• Distribution of wages (and possibly working conditions) 
will exist in equilibrium, even for homogeneous
will exist in equilibrium, even for homogeneous 
workers and jobs  
• Thus some employers pay above‐average and some 
below‐average wages in equilibrium
• Situation can be modeled as dynamic monopsony, i.e. 
firms face an upward‐sloping labour supply function
firms face an upward‐sloping labour supply function 
 Frictional or Structural Unemployment

Chapter 18 © 2007 McGraw‐Hill Ryerson Ltd. 9
 Evidence on Search 
Unemployment
• Fair amount of on‐the‐job search –
j about 5% of those 
employed
• Especially prevalent among those employed part‐time
• Contacting employers directly typically most common 
search method
• Informal networks play a large role (friends, relatives)
Informal networks play a large role (friends relatives)
• Increasing use of internet search
• Role of public employment agencies has diminished 
Role of public employment agencies has diminished
over time as a search method
 Empirical Evidence on Job Search
Empirical Evidence on Job Search

Chapter 18 © 2007 McGraw‐Hill Ryerson Ltd. 11
Sectoral Shifts and Unemployment
Shifts and Unemployment
• Process of economic growth involves ‘creative 
ocess o eco o c g o t o es c eat e
destruction’ – some firms and sectors decline  
while others expand
• Growth and sectoral shifts may arise from 
technological change, shifts in location of 
production, and changes in product demand
d ti d h i d td d
• Process of adjusting to change requires re‐
allocation of labour (and other inputs) from
allocation of labour (and other inputs) from 
declining to expanding sectors
• May also require regional labour mobility 
May also require regional labour mobility
 Sectoral Shifts Hypothesis 
Shifts Hypothesis
• Empirically implemented using variance of 
employment growth across industries (or regions) as 
additional covariate in unemployment rate equation
• Identification problem: association could reflect cyclical 
Identification problem: association could reflect cyclical
fluctuations due to economic shocks, as some 
industries more cyclically sensitive than others
• Some support for sectoral
Some support for sectoral shifts hypothesis with 
shifts hypothesis with
Canadian data using regional variation in employment 
growth (see text)
• Evidence for both Canada and US that inter‐industry 
E id f b hC d d US h i i d
mobility of labour declines in downturns, in contrast to 
sectoral shifts hypothesis 
 Displaced workers
Displaced workers
• DWs are those who worked for an employer (or 
s a e t ose o o ed o a e p oye (o
in an industry or occupation) for some time (e.g. 
3 years) and who permanently lose their job
• Considerable amount of recent research on 
consequences of displacement and policies to 
d l ith di l
deal with displacement t
• Need longitudinal data to observe consequences 
(duration of unemployment following job loss
(duration of unemployment following job loss, 
wage in new job, other outcomes
• Research uses both survey an administrative data
Research uses both survey an administrative data
Incidence of p
permanent jjob loss
• Recent study by Morissette et al 2007 covers period
1988 2002
1988-2002
• Administrative data from Stat Can Longitudinal Worker
File
• Permanent layoff rates for men range from 6%-7% in
boom years to 9% in 1990-92 recession
• Comparable rates for females much lower – 3%-4% in
good times, 5%-6% in downturns
• Displacement due to mass layoffs or firm closure: annual
rates range from 1.1% to 2.4% for males, 0.6% to 1.1%
for females
Earnings
g losses from displacement:
p US evidence

• Key findings of many studies:

A
Average earnings
i llosses are substantial
b t ti l
Losses are greatest for long tenure employees
Losses persist much longer than for other unemployed
workers
• JJacobson,
b L
LaLonde
L d and dSSullivan
lli (1993) study
t d off
displaced workers in Pennsylvania
• Study has several key advantages: detailed
administrative data linking workers and firms, several
years of pre-displacement and post-displacement
earnings comparison group of non-displaced workers
earnings,
• Focus is on workers with 6 or more years of tenure with
p y
employer
• Losses were very large: 24% of expected earnings even
5 years after displacement
• Relative earnings losses of DWs began about 3 years
prior to separation
• Farber (2005) analyses data from over 20 years of DWS
covering
g 1981-2003

• In most recent period, 35% of DWs are not re-employed

3yyears later

• About 13% full-time job losers are re-employed part-time

• Full-time job losers re-employed in full-time jobs earn

17% less than earnings without displacement

• Average earnings loss increases dramatically with prior

job tenure
Earnings
g losses: Canadian evidence from LWF
• Morissette et al 2007 find substantial and long-lasting
earnings losses from firm closures and mass layoffs
• Focus is on DWs aged 25-49 with at least 5 years of job
tenure
• As in Pennsylvania study, earnings start to decline
before displacement
• Earnings recovery after sharp decline at displacement is
modest
• 5 years after displacement, earnings losses among high-
seniority DWs are 25% -35% for men and 35% for
women
 Earnings losses: Canadian evidence from
SLID
• Schirle
Schirle (2009) examines displacement over 
(2009) examines displacement over
period 1993‐2004, esp older workers
• She also finds large earnings losses after 
She also finds large earnings losses after
permanent job loss
• Seniority is the major predictor of size of loss; 
Seniority is the major predictor of size of loss;
age doesn’t play much of a role
• Relative to previous earnings, losses are larger 
Relative to previous earnings, losses are larger
among low educated and those in rural areas
Reasons why standard estimates may under-state
losses

• Most estimates compare

p earnings
g pprior to displacement
p
to earnings in the new job among those who obtain re-
employment

• However, those who are not re-employed by the survey

date may do even worse

• Pre-displacement earnings may under-estimate “normal

earnings”

• The event that leads to displacement shows up in

declining earnings up to 3 years prior to displacement
Reasons whyy estimates mayy over-state losses

• “Layoffs and lemons” – downsizing firms may selectively

lay off least productive (Gibbons and Katz, 1991)

• Doesn’t apply to plant shutdowns, and unlikely to apply

to mass layoffs
What explains
p large
g earnings
g losses?

• Loss of firm-specific
p or industry-specific
y p human capital
p

• JLS (1993) and Neal (1995) find that those who change
industries after jjob loss suffer much g
greater losses

• Internal labour markets and wage profiles that depend

on seniorityy ((wage
g <p productivity
y early
y in career,, wage
g >
productivity later in career)

• Loss of economic rents – Kuhn and Sweetman (1998)

find losses larger for U-N transitions than for N-U or U-U
transitions
Key
y role of jjob tenure

• Earnings losses rise dramatically with tenure in prior job

• Figure 2 – evidence from State of Washington (JLS,

2005)

• Long tenure group distinctive:

• Morissette et al find earnings losses for entire sample of

DWs small (approx zero 3 years after displacement)

• Large and persistent earnings losses only experienced

by long tenure DWs
Other consequences
q of displacement
p

• Displacement
p leads to a 15%-20% increase in death
rates (Sullivan and von Wachter 2008)
q
• Equivalent to a reduction in life expectancy
p y of about 1.5
years for someone displaced at age 40
• Parental job loss reduces probability that 15-year olds
proceed to post-secondary education (Coelli, 2005)
• Children whose fathers were displaced have, as adults,
lower annual earnings (about 9%) and have higher
incidence of EI and social assistance (Oreopoulos, Page,
and Huff Stevens, 2008
Summaryy and implications
p I

• Salient and consistent finding:

g earnings
g losses from
permanent job loss are very large for long tenure
workers
• These substantial losses appear to be permanent in
nature
• Losses are similar in magnitude to other catastrophic
events – e.g. having one’s house burn down
• In contrast, most unemployed workers become re-
employed relatively quickly and do not suffer permanent
earnings losses
Summaryy and implications
p II

• Group p that suffers large

g losses from displacement
p is
relatively small

• Permanent jjob loss due to firm closures or mass layoffs

y
constitute about 20% of total layoffs

• Workers with 5 or more yyears of jjob tenure represent

p
about 10% of those displaced by firm closures or mass
layoffs
Summaryy and implications
p III

• Private insurance markets for losses associated with

displacement do not exist
• In Canada, publicly provided insurance (EI Part I) is
inadequate
• EI benefits depend only on employment in 12 months
prior to displacement
• EI only covers portion of lost income during
unemployment spell
• Similar to having auto insurance that pays same amount
for “fender
fender benders
benders” as for vehicles that are totalled
• EI benefits are especially inadequate for DWs in regions
with low unemployment rates
 Unemployment Insurance and 
Unemployment
l
• EI (UI) can have numerous impacts on labour force 
participation as well as incidence and duration of 
unemployment 
• UI alters incentives facing workers and employers
• In a simple search model, UI benefits reduce the marginal 
costs of search, so predict an increase in expected duration 
of search from more generous benefit levels
• UI can also increase the incidence of unemployment by 
altering the net benefits of employed versus unemployed 
search
• As discussed previously, UI can encourage part‐year work 
over full‐year work so predict an increase in seasonal 
unemployment 
p y
 UI and Unemployment
UI and Unemployment
• UI can also encourage entry into LF of those on the 
margin which also predicts an increase in seasonal
margin, which also predicts an increase in seasonal 
unemployment (as well as LF participation)
• In the absence of experience rating, UI benefits also 
reduce the costs to the employer of using layoffs to 
d th t t th l f i l ff t
respond to fluctuations in product demand (seasonal 
or otherwise)
• Reason: without UI benefits, employers that frequently 
lay off workers would need to pay higher wages to 
compensate employees for risk of layoff (compensating 
p p y y p g
differential)
• Subsidizing  worksharing or introducing experience 
rating can offset the tendency to favour layoffs
rating can offset the tendency to favour layoffs
 UI and Unemployment
UI and Unemployment
• Substantial amount of empirical research on impact of 
UI on unemployment
UI on unemployment
• Several key parameters to consider: coverage, eligibility 
(entrance requirement), benefit rate, maximum 
d ti
duration of benefits
fb fit
• Much evidence that Canada’s UI (EI) program raises 
both seasonal and non‐seasonal unemployment
• However, important to keep in mind that UI has 
benefits as well as costs
• Policy issue: how best to design UI to maintain 
Policy issue: how best to design UI to maintain
benefits, while reducing unintended adverse 
consequences
 Review Questions and Problems
Review Questions and Problems
• The
The following are recommended for chapter 
following are recommended for chapter
18:
• Review questions: 1,2,4,5
Review questions: 1 2 4 5
• Problems: 5,6