Labor Market Policies
Flagship Course
March 3 – 14, 2003
World Bank
Washington, D.C. - USA
Labor Market Core Course
Key Concepts and Policy Issues
The Main Objective
•
•
•
•
Basic description of the labor market
A framework for economic analysis
Discuss some policy applications
Discuss some alternative market structures
Labor Market: Market for What?
• Participants:
– Households/individuals: supply side
– Firms/employers: the demand side
• Quantity: number of workers, hours of work
• Price: the wage rate
• Institutions, governments, regulators
Not Any Market
• Why the special attention?
– Large market (labor share), labor as a factor of
production, labor earnings,…
– Work defines who we are!
• Effect of a (well functioning) labor market
– Economics growth, poverty reduction
– Efficiency, fairness
– Social and political stability
A Basic Framework
• Neo-classical approach: market based.
Requires assumptions
• Labor supply and labor demand
• Equilibrium condition
• The role of the wage rate
How Realistic is this approach?
• Very simplifying assumptions.
• Is it a useful concept in a continuously changing
world? Indicates the direction of the change. A
long term view of the market.
• Simple and powerful tool for policy (taxes,
minimum wage, migration, demographics,…).
Labor Supply
• Households decision to supply work:
participation + hours
• Preferences are defined over 2 goods: A
consumption (aggregate) good and leisure
• Households maximize U(C,L) subject to the
constraint c=h*w+non labor income
Labor Supply
W
Supply
W2
W1
H1
H2
H
Labor Demand
• Firms (employers) decision.
• Derived Demand: Firms face demand for
their output, they hire workers to satisfy that
demand
• Maximize profits=P*Y-WH, where
Y=F(H).
Labor Demand
W
W2
W1
Demand
H2
H1
H
Labor Market Equilibrium
• Labor supply meets labor demand.
• Wages will continue to adjust until the
equilibrium condition is satisfied.
• Example: what happens when wages exceed
their equilibrium level?
Graphic Representation
Supply
W
W*
Demand
H*
H
Labor Market Equilibrium
• When market conditions change the equilibrium
will change (Supply and Demand shifts)
• Is it a useful concept in a continuously changing
world? Indicates the direction of the change. A
long term view of the market.
• Simple and powerful tool for policy (taxes,
minimum wage, migration, demographics,…)
Policy Issues
• Employment creation: payroll taxes and
employment subsidy
• Minimum wage: competitive market
• Minimum wage: non-competitive market
• Covered vs uncovered sector
• Human capital
Employment Creation
• Payroll taxes (e.g. imposed on employers to
finance health insurance, or social security)
• Employment subsidy
Payroll Tax: The Demand Curve
W
W0
Cost of labor
W0-t
D
Take Home
D’
H0
H
Payroll Tax: Equilibrium
W
Supply
Cost of labor
W0
Take Home
D
D’
H’
H0
H
Employment Subsidy: The
Demand Curve
W
W0+ t
Take Home
W0
D’
Cost of labor
D
H0
H
Employment Subsidy:
Equilibrium
W
Supply
Take Home
W0
D’
Cost of labor
D
H0
H’
H
Minimum Wage: Competitive
Market
W
Supply
Unemployed
W
W0
Demand
Labor
H0
Demanded
Labor
Supplied
H
W
Minimum Wage: Noncompetitive MarketSupply
W
W0
Demand
H0 = Labor
Supplied
H
Labor
Demanded
H
Covered and Uncovered Sectors
Covered
Unionized Public Sector
Minimum Wage
Uncovered
Non union Private
Informal Sector
S
S
W’
W0
W1
D
H’
H0
D
S’
Covered and Uncovered Sectors
Covered
Unionized Public Sector
Minimum Wage
Uncovered
Non union Private
Informal Sector
S
S
W’
W1
W0
D’
D
H’
H0
D
Human Capital
Give a man a fish and you feed him for one day.
Teach a man to fish and you feed him for a lifetime.
Chinese Proverb
Human Capital
• Workers are different: each has a unique set
of ability and skills (human capital).
• How do we acquire human capital?
– Education: schooling.
– Post schooling: training, vocational programs.
• Why do we acquire human capital?
– An investment decision: private returns, public
returns.
Schooling Model
• Objective: to maximize the present value of
lifetime earnings.
• Costs: (private)
– Tuition, fees, books,…
– Foregone earnings.
• Benefits: (private)
– Higher earnings in the future.
Cost and Benefit to Education
Earning Streams
Schooling
Earnings
Benefits
No Schooling
Forgone earnings
Direct costs
Age
The Schooling Decision
• Discount rate: (r)
– Time preference (e.g. Present oriented, …)
– Market interest rates (access to capital, …)
• Rate of return to schooling: (MRRS)
– The increase in earnings per dollar spend in
education investment
– Decreasing in years of schooling (decreasing
returns)
Stopping Rule
r
MRRS
S*
Years of
Schooling
Education Policy Issues
• Changes in discount rate:
– Better access to capital market. School
subsidies.
• Changes in the MRRS:
– Better access to labor market (reduced
discrimination, easier transition for the
youth,…).
– Increase ability: early childhood development.