Below is an interesting graphic from the FT which shows GDP and Inflation over the last couple of years in New Zealand – you can select other countries as well and it is good to compare different parts of the world. Note that NZ’s inflation and GDP is lower than the global average. You would normally experience stagflation when the stagnant growth is accompanied by high levels of unemployment – NZ has 3.3% unemployment. However the labour markets globally are very tight with just today British Airways cancelling 10,000 flights due to labour shortages.
If you look at Japan you will see very little difference between GDP and Inflation and you could say they may be eventually coming out of a deflationary period.
Below is a very good video from CNBC that covers the main causes of recessions – overheated economy, asset bubbles and black swan events. Good analysis of soft and hard landings as well as the wage price spiral effect.
“History teaches us that recessions are inevitable,” said David Wessel, a senior fellow in economic studies at The Brookings Institution. “I think there are things we can do with a policy that makes recessions less likely or when they occur, less severe. We’ve learned a lot, but we haven’t learned enough to say that we’re never going to have another recession.” As the nation’s authority on monetary policies, the Federal Reserve plays a critical role in managing recessions. The Fed is currently attempting to avoid a recession by engineering what’s known as a “soft landing,” in which incremental interest rate hikes are used to curb inflation without pushing the economy into recession.
Michael Cameron in his blog ‘Sex, Drugs and Economics’ wrote a piece on full employment and the fact that it doesn’t benefit all workers. It was based on his published article in The Conversation.
Full employment has normally been the concept that has been used to describe a situation where there is no cyclical or deficient-demand unemployment, but unemployment does exist as allowances must be made for frictional unemployment and seasonal factors – also referred to as the natural rate of unemployment or Non-Accelerating Inflation Rate of Unemployment (NAIRU). Full employment does suggest that the employee has a lot of bargaining power as the supply of labour is scarce relative to the demand. In theory a tight labour market should lead to higher wages and improved conditions of work as the employer has less labour to chose from. We have seen in the labour market incentives for employees in recommending potential candidates for vacancies in the company. Other incentives for potential employees include shorter working weeks, hiring bonuses and special leave days.
However this doesn’t apply to all workers as Michael Cameron alludes to. A lot depends on the bargaining power of the worker and the elasticity of supply of labour. If the supply is very inelastic for a particular job (higher skilled) it is harder and most likely more expensive for the employer to find an alternative worker. This is evident when unemployment is low as the worker can easily look around at other job opportunities. On the contrary if the supply of labour is more elastic (lower skilled jobs) the worker has less bargaining power and the employer will have more potential workers to chose from. The graph below shows the elasticity of supply of labour – high skilled has a steeper curve (inelastic) whilst low skilled as a flatter curve (elastic)
Many low-income workers are in jobs that are part-time, fixed-term or precarious. Low-wage workers are not benefiting from the tight labour market to the same extent as more highly qualified workers.
Nevertheless, a period of full employment may allow some low-wage workers to move into higher paying jobs, or jobs that are less precarious and/or offer better work conditions. That relies on the workers having the appropriate skills and experience for higher-paying jobs, or for increasingly desperate employers to adjust their employment standards to meet those of the available job applicants.
Add to this the increase in the cost of living and those in low skilled jobs with little bargaining power are under pressure to accept whatever is available. The alternative is welfare benefits which are always playing catch-up
Below are figures and a graph for the NZ labour market from 2020 – 2022. Although the unemployed figures have fallen to 3.2% of the working population, the drop in those actively looking for work – participation rate – have fallen by a similar amount. The number of those employed increased although matched by the change in the working age population. This gives the impression that people who were previously unemployed in 2020 have not got a job, but are not making themselves available for work. Notice the difference in the graph between the growth in employment and the unemployment rate from 2020 onwards. Also the majority of extra jobs in the economy have been full-time roles as employers struggled to find labour.
Below is a flow chart that shows how you calculate the participation rate, unemployment rate etc with some older figures. This is important for MCQ as well as essays on the labour market.
Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Unemployment. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.
There are those that see the problem of unemployment in most economies (but especially the US) as a structural issue. This refers to the mismatch between the jobs that are available and the skills that people have. Cyclical unemployment can be reduced by boosting demand – dropping taxes and increasing government spending (fiscal policy) and lowering interest rates (monetary policy). However, if unemployment is mainly structural patience is needed to wait for the market to sort things out, and this takes time.
The Beveridge curve is an empirical relationship between job openings (vacancies) and unemployment. It serves as a simple representation of how efficient labour markets are in terms of matching unemployed workers to available job openings in the aggregate economy. Economists study movements in this curve to identify changes in the efficiency of the labour market. It is common to observe movements along this curve over the course of the business cycle. For instance, as the economy moves into a recession, unemployment goes up and firms post fewer vacancies, causing the equilibrium in the labor market to move downward along the curve (the red arrows in the figure above). Conversely, as the economy expands, firms look for new hires to increase their production and meet demand, which depletes the stock of the unemployed – see graph below.
Careful analysis of Beveridge Curve data by economists Murat Tasci and John Lindner at the Cleveland Federal Reserve shows that it’s behaving much the way it has in previous recessions: there are as few job vacancies as you’d expect, given how desperate people are for work – see graph below. The percentage of small businesses with so-called “hard-to-fill” job vacancies is near a twenty-five-year low, and open jobs are being filled quickly. And one recent study showed that companies’ “recruiting intensity” has dropped sharply, probably because the fall-off in demand means that they don’t have a pressing need for new workers.
The Beveridge Curve and COVID
The graph below shows the Beveridge Curve pre and post covid. The pre-covid curve is a typical which relates to theory above, however the post-covid curve has become a lot steeper in showing that changes in the unemployment rate are not as responsive to changes in the vacancies. If the matching process between workers and firms becomes less efficient, employers need to post more vacancies to fill a given number of positions. In terms of the model, an outward shift of the Beveridge curve can therefore be explained by a decline in match efficiency. Since match efficiency has declined, any reduction in unemployment now requires a much higher job opening rate than before the pandemic. During the pandemic, job creation has become more difficult, and firms have had to recruit more aggressively to find workers. Looking forward, a reduction of the unemployment rate to pre-COVID levels would require job openings to be at twice the level they were before.
Source: Revisiting the Beveridge Curve: Why has it shifter so dramatically. Economic Brief October 2021
The Inflation globally has been on the increase and above the target band in most developed economies. This applies to both Headline and Core inflation.
Headline Inflation – all goods and services Core Inflation – all goods and services excluding food and energy.
Economic theory suggests that inflation could accelerate and return to levels seen in the 1970’s. A lot will depend how policymakers react to the challenge of bringing inflation down to their specific target level – RBNZ 1-3% but CPI in NZ is 5.9%. See chart for inflation breakdown in OECD countries.
Source: IMF
Key reasons for inflationary pressure.
Supply chain bottlenecks: Lockdowns and shipping problems (container shortages) but latterly the demand side has accelerated – economic recovery and demand for durable goods as well as panic buying.
Demand for more goods than services: Much of the inflation has been in durable goods whilst service inflation has only seen a small increase. This is dependent on which country – for instance demand for used cars in the US has soared.
Fiscal and Monetary stimulus: Approximately US$16.9trn of government spending has been injected into the global economy. This is accompanied by expansionary monetary policy (low interest rates) is conducive to more spending and higher inflation. Savings that accumulated during the lockdowns were now being spent. There was a debate between leading economists whether the inflation would be transitory or persistent. It seems that the data now supports those of the persistent camp. Whether it persists depends on central banks.
Labour supply: Labour participation rates have dropped – for instance for every job opening in the US there is only 0.77 unemployed people per job. See previous post – US Economy – potential for wage-price spiral. This is due to continue meaning that there is a job seekers market where there is likely to be pressure on wages.
Russian invasion of Ukraine: Russia and Ukraine are big exporters of food and major commodities so higher prices have been inevitable with major disruptions to the supply either through sanctions or conflict areas. They supply 30% of global wheat exports so prices have been increasing.
Source: IMF
What should central banks do?
Mainstream policy by central bankers should ignore supply-side shocks like higher commodity prices as this is only temporary. When central banks have intervened and raised interest rates they have ended up worsening economic conditions – ECB raising rates post GFC in 2008 and 2011. Already inflation globally is increasing but there is little central banks can do with higher global energy prices. A focus on home grown inflation (core) might be a better indicator to watch as well as the labour market – fast wage growth might mean higher interest rates. Economist John Cochrane argues that bringing down inflation through higher interest rate is a blunt tool, especially when prices have risen predominately through a loose fiscal policy. He states that inflation might get worse if people doubt the government’s ability to repay its debt without a discount from inflation.
Ultimately the outlook for inflation depends on how determined central banks are to rein in inflation and the confidence of the bond market to governments willingness to pay their debts. Below is a good video from the IMF on the inflationary problem.
The COVID pandemic has been prevalent in the global economy for just over two years now but although there seems to be plenty of job opportunities where is the available labour? According to a recent report from the IMF there are various reasons for this:
Reduced labour force participation: disadvantaged groups, the low-skilled, older workers, or women with young children—have yet to fully return to the labour market.
The pandemic: health concerns and favourable pension plan valuations have contributed to a lot of older workers departing the labour force
Worker preference: workers are moving away from some low-pay jobs. A lot workers in contact -intensive, physically strenuous and less flexible jobs are moving into other areas or have left the labour force.
Occupational mismatch: due to COVID some industries and firms have cut back on production due a lack of demand for their products/services or can’t function in the pandemic environment. As a result in a mismatch between those that are looking for work and the requirements of the labour market.
Border restrictions means limited immigration: this has led to large shortages of labour especially in primary industries and other low-paid jobs
Changing job preferences: COVID-19 affected hospitality work in particular and although the industry maybe recovering health concerns may be discouraging workers from keeping such jobs and job seekers from taking them up, leaving many vacancies unfilled
Source: Deloitte Insights – The global labor shortage
For more on Unemployment view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
Invariably I get the question in class “Does this economic theory actually happen in the real world?” We then proceed to discuss upward sloping demand curves, trickle down theory, the GFC and the fact that few economists saw it coming and how Japan ran a massive stimulus programme but inflation was stagnant.
Most theories in economics rest on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an introductory economics textbook, even though the assumptions behind those diagrams virtually never hold true in the real world. To understand economics you have to understand human nature.
Below is a table that I found in James Kwak’s book “Economism”. It takes theories found in most introductory economics textbooks and suggests what actually might happen to these theories in the real world.
For more on secondary school economics courses view the key notes (accompanied by fully coloured diagrams/models) on elearneconomicsthat will assist students to understand concepts and terms for external examinations, assignments or topic tests.
The New Zealand unemployment rate of 3.2% doesn’t reflect how tight the labour market is – there were 93,000 people unemployed in the December quarter in seasonally adjusted terms. In setting the Official Cash Rate (OCR) the RBNZ consider the labour market and look at a number of indicators. The figure below shows the range of indicators and how they have been performing since 2000.
Note: Yellow (inner) circle = worst outcome since 2000, Orange (outer) circle = best outcome since 2000, Dark blue = current outcomes, Light blue = 2019 Q4, when the RBNZ saw employment as “at or slightly above” maximum sustainable employment.
Looking at the number of average hours worked the lockdown has seen employers reduce hours of work rather than laying off workers which puts them in a good position for when the country changes alert levels. With COVID restrictions easing unemployment could have further to fall (forecast 3%) and this can only serve to increase the wage negotiating power of the employee. As well as the fact that labour will be more scarce, the level of inflation is on the way up and employees will want to maintain their purchasing power. These factors will most likely lead to higher wages. While there is no shortage of downside risks on the demand side of things as interest rates rise (globally) and the housing market cools, there’s also no quick fix on the labour supply front. It’s also worth bearing in mind that the labour market tends to lag activity by quite some months.
Source: ANZ Bank New Zealand Weekly Data Wrap – 5th November 2021
From 1st April this year the minimum wage in New Zealand will increase from $20 to $21.20 as the Labour government stay true to their election pledge of commitment to supporting employees. Currently inflation at its highest level for 30 years at 5.9% and unemployment is at a record low of 3.2%. In theory the minimum wage increase should see consumers spending more of their income and thereby supporting businesses. However the living wage, the rate at which someone would need to afford the necessities of life and participate as an active citizen, increased to $22.75.
Theory behind the minimum wage On the graph above a minimum wage of W1 means that the level of employment has fallen but those prepared to work but are involuntary unemployed has increased. However the people still employed are better off as they are paid more for the same work; their gain is exactly balanced by their employers’ loss. The jobs that someone would have been willing to do at less than the wage of We and for which some company would have been willing to pay more than We.
Does the theory of the minimum wage apply in reality? In reality the theory of the minimum wage explained above is not as simple as it is made out to be. From records in the USA there is no obvious relationship between the minimum wage and unemployment: adjusted for inflation, the federal minimum wage was highest from 1967 through 1969, when the unemployment rate was below 4%. One study (whose authors won the Nobel Prize in Economics) in 1994 by David Card and Alan Krueger evaluated an increase in New Jersey’s minimum wage by comparing fast-food restaurants on both sides of the New Jersey – Pennsylvania border. They concluded, “contrary to the central prediction of the textbook model … we find no evidence that the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”
The idea that a higher minimum wage might not increase unemployment goes against the the theory in textbooks as if labour becomes more expensive firms will take on less employees. But there are several reason why this might not be the case:
The standard model states that firms will replace labour with machines if wages increase, but what happens if labour saving technologies are not available at a reasonable cost.
Some employers may not be able to maintain their business with fewer workers especially in service based industries. Therefore, some companies can’t lay off employees if the minimum wage is increased.
Small firms are traditionally labour intensive and can’t afford large capital investment. Therefore the minimum wage doesn’t have the impact of laying off workers.
If employers have significant market power that the theory of the supply and demand for labour doesn’t exist, then they can reduce the wage level by hiring fewer workers (only those willing to work for low pay), just as a monopolist can boost prices by cutting production (think of an oil cartel, for example). A minimum wage forces them to pay more, which eliminates the incentive to minimize their workforce.
Even though a higher minimum wage will raise labour costs many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.
Higher wages boost productivity as they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better. A higher minimum wage motivates more people to enter the labor force, raising both employment and output.
Higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs.
All the above add a range of variables that are not considered in the simple supply and demand model for labour. It maybe useful as a starting point in discussing the minimum wage but has its limitations in the more complex real world.
Here Martin Sandbu of the FT discusses the UBI as part of his Free Lunch on Film – taking unorthodox economic ideas that he likes and putting them to the test. He looks at both sides of the UBI argument with examples from Alaska and Finland where results showed that there was little reduction in working hours when people received the UBI. Good discussion and well presented.
Why has the UBI become such a popular talking point?
The coronavirus pandemic has seen wage subsidies – a no-strings attached regular cash transfers to just about everyone in the economy.
The automation of a lot of jobs has left people very concerned about redundancy.
The modern economy can’t be expected to provide jobs for everyone
The UBI is easy to administer and it avoids paternalism of social-welfare programmes that tell people what they can and can’t do with the money they receive from the government.
Concerns
Potentially drives up wages and employees will compare their wages with the UBI.
Easier for people to take risks with their job knowing there is the UBI to fall back on.
It takes away the incentive to work and lowers GDP
UBI – not cheap to administer and would likely cost 13% of GDP in the US
Positives
In the Canadian province of Manitoba where the UBI was trialled, working hours for men dropped by just 1%.
The UBI would make it easier for people to think twice about taking unrewarding jobs which is a good consequence.
In the developing world direct-cash grant programs are used very effectively – Columbian economist Chris Blattman.
In New Jersey young people with UBI were more likely to stay in education
If the U.B.I. comes to be seen as a kind of insurance against a radically changing job market, rather than simply as a handout, the politics around it will change. When this happens, it’s easy to imagine a basic income going overnight from completely improbable to totally necessary.
The New Zealand economy Q3 2021 labour market data published today was simply bizarre and cannot be maintained. Below is a summary of the data:
Unemployment rate is now at a 14-year low of 3.4% which is well below the NAIRU which is estimated to be around 4.5%. Consequently the labour cost index has increased annually by 2.5% which is well above the 2% considered consistent with the Reserve Bank of New Zealand (RBNZ) meeting its inflation target of between 1% – 3%. With inflation already at 4.9% you can be reasonably certain that the RBNZ will be tightening the OCR (interest rate) on the 24th November.
Despite having over a third of the country in lockdown for half the survey period annual employment growth increased to 4.2% from 1.6%. The increase was driven by full time positions – 2.3%. Why is this the case?
Businesses are afraid of losing staff when COVID restrictions are lifted
Demand for labour in growth industries cancels out those jobs lost in affected sectors
The wage subsidy is keeping people in jobs
The government is taking on a lot of staff – contact tracing and health sector.
Construction industry is booming
Some key questions to be asked:
How long will the COVID workforce be maintained? What impact will the removal of the wage subsidy have (1.27 million jobs are covered by it)?
With this added pressure on inflation will the RBNZ raise the OCR by 50 basis points?
Source: BNZ ‘Maximum unsustainable employment’ 3rd November 2021
One reason for the increasing inequality in society is the stagnant wages for the lower and middle income groups – in the USA the top 0.1% have as much wealth as the bottom 90%. Labour compensation at the very top has increased dramatically since the 1970’s.
1970’s – the top 0.1% took home less than 3% of all income 2010 – the top 0.1% took home more than 10% of all income
In the USA the top CEO’s average compensation has grown since the late 1970’s by over 900% to around $15 million a year. In contrast the lower income groups have gone up by only 10%. However when you look at hedge fund and private equity fund managers the salaries are astounding. In 2014 which was seen as not a great year for the industry 25 fund managers made at least $175 million each, and 3 made more than $1 billion.
Are CEO’s worth every cent?
In theory the demand for labour is determined by their marginal revenue product – that is the value of revenue generating by employing an additional worker. Labour markets are imperfect and a monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. The monopsonist will hire workers where:
Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)
Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.
So if Goldman Sach’s CEO, Lloyd Blankfein, made $24 million in 2014, that’s because he is worth $24 million to his company. In short, you make what you deserve based on your skills, effort, and productivity, in this fairest of all possible worlds.
However this theory has little to do with how the world actually works. The idea that good CEO’s are entitled to enormous rewards is based on the belief that success or failure of the company depends on one person. According to historian Nancy Koehn, business is a team sport: not only is it impossible to quantify a single leader’s marginal revenue product; it is hard even to describe it clearly. Ultimately a CEO can appoint friends and place them on the compensation committee which recommends the CEO salary. The committee invariably proposes to pay at least as much as the median comparable company, because no board wants to admit that its company has a below-average leader. CEO’s do have key performance indicators (KPI’s) but the CEO can encourage the committee to select metrics that will be easy to satisfy. John Kenneth Galbraith describes CEO pay very succinctly – “The salary of the chief executive of a large corporation is not a market reward for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.”
Luck plays an important role in CEO’s pay. Heads of oil companies were paid more when profits increased, even when the profits were not due to their decision making but simply by a rise in the price of oil. On the contrary it is argued that some boards actually do a good job in firing under-performing leaders and that in the end, high compensation is simply the result of the market for talent – supply and demand. The financial sector tend to use the marginal revenue product of labour theory in their awarding of compensation for CEO’s. Bonuses of traders and investment bankers’ are based on the profitability of their own deals but because bonuses can never be negative, individual employees can generate enormous payouts on bets that turn out well while sticking shareholders with the losses on bets that go bad. Furthermore even if bankers do make money by buying low and selling high in the securities markets there is no value generation as there is no tangible output that anyone can consume.
In aristocratic societies such as 18th century France or 19th century Russia, wealthy noblemen who owed their riches to the accident of birth had to worry about the prospect of violent rebellion by the have-nots. By contrast in the US today the wealthy are protected by the widespread belief that their extraordinary incomes – and the inequality that they generate – are simply the product of inescapable economic necessity.
Marginal revenue productivity (MRPL) is a theory of wages where workers are paid the value of their marginal revenue product to the firm.
The MRP theory outlined below is based on the assumption of a perfectly competitive labour market and the theory rests on a number of key assumptions that realistically are unlikely to exist in the real world. Most labour markets are imperfect, one of the reasons for earnings differentials between occupations which we explore a little later on.
Workers are homogeneous in terms of their ability and productivity
Firms have no buying power when demanding workers (i.e. they have no monopsony power)
There are no trade unions (the possible impact on unions on wage determination is considered later)
The productivity of each worker can be clearly and objectively measured and the value of output can be calculated
The industry supply of labour is assumed to be perfectly elastic. Workers are occupationally and geographically mobile and can be hired at a constant wage rate
Marginal Revenue Product (MRPL) measures the change in total output revenue for a firm as a result of selling the extra output produced by additional workers employed. A straightforward way of calculating the marginal revenue product of labour is as follows:
MRPL = Marginal Physical Product x Price of Output per unit
Therefore the MRP curve represents the firm’s demand for labour curve and the profit maximising condition is where:
MRPL = MCL (Marginal Cost of Labour) where the revenue generating by employing an additional worker (MRPL) = the cost of employing an additional worker (MCL).
Mind Map below adapted from Susan Grant’s book CIE A Level Revision Guide
Covering the labour market with my A2 Economics class and remembered this post from earlier in the year. President Biden is pushing the US congress to gradually increase the federal minimum wage from $7.25 to $15 by 2025. The Economist video below talks about what economists have traditionally said – ‘increasing the minimum wage will mean that there will be job losses’. In most economics textbooks the labour market is shown with a simple graph of the supply of labour and the demand for labour and where they intersect the wage that employees receive for their service and the amount employed.
The minimum wage distorts the market equilibrium as there is now a wage floor – a level which the wage cannot fall below. If the minimum wage is below the equilibrium wage then there is no impact as the market will ensure that is reaches equilibrium. However a minimum wage above the equilibrium means that companies will hire fewer workers and therefore result in more unemployment. On the graph below a minimum wage of W1 means that the level of employment has fallen but those prepared to work but are involuntary unemployed has increased. However the people still employed are better off as they are paid more for the same work; their gain is exactly balanced by their employers’ loss. The jobs that someone would have been willing to do at less than the wage of We and for which some company would have been willing to pay more than We. Those jobs are now gone, as well as the goods and services they would have produced.
Real Impact of the Minimum Wage.
In reality the theory of the minimum wage explained above is not as simple as it is made out to be. From records in the USA there is no obvious relationship between the minimum wage and unemployment: adjusted for inflation, the federal minimum wage was highest from 1967 through 1969, when the unemployment rate was below 4%. One study in 1994 by David Card and Alan Krueger evaluated an increase in New Jersey’s minimum wage by comparing fast-food restaurants on both sides of the New Jersey – Pennsylvania border. They concluded, “contrary to the central prediction of the textbook model … we find no evidence that the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”
The idea that a higher minimum wage might not increase unemployment goes against the the theory in textbooks as if labour becomes more expensive firms will take on less employees. But there are several reason why this might not be the case:
The standard model states that firms will replace labour with machines if wages increase, but what happens if labour saving technologies are not available at a reasonable cost.
Some employers may not be able to maintain their business with fewer workers especially in service based industries. Therefore, some companies can’t lay off employees if the minimum wage is increased.
Small firms are traditionally labour intensive and can’t afford large capital investment. Therefore the minimum wage doesn’t have the impact of laying off workers.
If employers have significant market power that the theory of the supply and demand for labour doesn’t exist, then they can reduce the wage level by hiring fewer workers (only those willing to work for low pay), just as a monopolist can boost prices by cutting production (think of an oil cartel, for example, see graph Monopsony Labour Market). A minimum wage forces them to pay more, which eliminates the incentive to minimize their workforce.
Even though a higher minimum wage will raise labour costs many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.
Higher wages boost productivity as they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better. A higher minimum wage motivates more people to enter the labor force, raising both employment and output.
Higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs.
Monopsony Labour Market
All the above add a range of variables that are not considered in the simple supply and demand model for labour. It maybe useful as a starting point in discussing the minimum wage but has its limitations in the more complex real world
When covering Labour Markets with my A2 level classes I put together an exercise which tests them on calculating MCL, MRPL etc and also showing why MCL = MRPL is the number of workers a firm should employ. There is an exercise for both Perfect and Imperfect Labour markets – see ‘Word’ document. The excel document is a model answer showing the data in a table and a graphical format. Hope it is of use.
New Zealand’s unemployment rate has fallen 4.0% and with positive growth forecasts it will no doubt fall further. This low rate has meant that labour bargaining power has increased and the Labour Cost Index has risen to 2.2% and private sector average hourly earnings were up an annual 4.5%.
In the June quarter this year the participation rate was at 70.5% one of the highest in the world – this shows how fully employed the NZ economy is. Many other countries have achieved falls in their unemployment rates, after the initial shock of COVID–19, but only as swathes of people gave up looking for a job.So how tight is the labour market? The RBNZ judged an unemployment rate of around 4.5% as being consistent with the notion of maximum sustainable employment without causing a rise in inflation. Economists refer to this as the NAIRU (non-accelerating inflation rate of unemployment), the rate of unemployment at which inflation remains constant.
The lack of workers from overseas has impacted these figures and a relaxing of border restrictions might ease labour constraints. However it can work the other way with labour leaving New Zealand and therefore a net loss of people. But at the moment the falling unemployment figures are very problematic and inflationary and the Reserve Bank Reserve Bank’s Monetary Policy Committee need to think about when and how it returns New Zealand to a more neutral interest rate – neither expansionary nor contractionary. The current OCR (interest rates) rate is 0.25% but the RBNZ has estimated that the neutral rate is between 1.5% and 4.5% which seems to suggest that it is still very expansionary. Therefore with unemployment set to fall and further inflationary pressure should see the RBNZ increase the OCR.
Economic Rent and Transfer Earnings To most of us “rent” is defined as a periodical payment made for the use of a particular asset – usually a residential or commercial property. However, the concept is not limited to land or buildings because it can also be applied to the other factors of production. When a factor is earning more than its supply price, it is receiving a part of its income in the form of economic rent. This situation arises when demand increases and supply cannot fully respond to the increases in demand. For example, labour already employed will experience an increase in income so that they must be earning more than their supply prices.
Present Wages – Wages when initially employed = Economic Rent
The minimum payment required to prevent a person transferring to another employer or another occupation is know as transfer earnings. It is determined by what the factor could earn in its next best paid employment. Transfer earnings may be regarded as the opportunity cost of keeping an employee in their present job or it may be regarded as the employee’s supply price in their present occupation. For example, if the minimum weekly wage that would persuade someone to work as a shop attendant is $200 but he or she actually receives a wage of $250, then the transfer earnings amount is $200 and he or she is receiving $50 in the form of economic rent. Therefore, economic rent can be defined as any payment to a factor of production that is in excess of transfer earnings.
The graph below shows the demand and supply for labour. The equilibrium wage is $120 with a quantity of 50 units. Total earnings is equal to $120 x 50 units of labour = $6,000 and employees receive the same wage of $120. However, all workers except the last one taken into employment were prepared to offer their services at wages less than $120. Therefore, provided the supply of labour slopes upwards (i.e. it is less than perfectly inelastic) an increase in demand will give rise to rent payments to those factors that were already employed at the original wage of $120. The area of economic rent and transfer earnings is shown in the graph below. Only the last labour unit employed earns no economic rent because the wage of $120 is the supply price to that particular labour unit.
Inelastic and Elastic labour supply
The amount of economic rent and transfer earnings in the return to labour depends upon the elasticity of supply and the level of demand. The greater the occupational mobility of labour, the smaller the element of economic rent. If labour can do a variety of occupations then quite small changes in the wage rate will cause large movements of labour into an industry when wages rise, and out of that industry when wages fall.
Very specialised labour has an inelastic supply curve. This includes surgeons, top CEOs, scientists and jobs that require high skill levels or involve significant danger and skill, eg, deep sea divers. The relatively high rewards to this labour are due to the fact that they are in very scarce supply relative to the demands for their services. Their transfer earnings will be much less than their salary because the market values outside their own specialised professions are probably very low. A frequently quoted example of earnings that contain a large amount of economic rent are those of top sports people. Today these people can earn significant amounts of money in a short period of time. A footballer such as Christiano Ronaldo earns €326 923 per week because of his ability to attract big crowds, merchandise sales and sponsorship deals when he was at Real Madrid Football Club. His skill levels are unique and in very limited supply when considering other players. This reflects a very high marginal productivity leading to a higher wage.
Some other occupations that are held in high regard by society do not command such high salaries because of their low marginal productivity. This includes nurses, firefighters, teachers, etc. Furthermore, the supply of labour for these jobs tends to be elastic because there are many people to choose from, unlike their footballing counterparts who have unique skills.
Quasi rent
Where the supply of labour is less than perfectly elastic an increase in demand will lead to some workers receiving economic rent. This rent may be of a temporary nature, however, because the higher wage may lead to an increase in supply, which in turn, lowers the wage. Increased wages might entice other workers to undertake the necessary training. The economic rent that is earned during the period before supply can be increased is referred to as quasi rent. True economic rent refers to the remuneration of factors that are fixed in supply.
Been reading an excellent book by Martin Sandbu (FT) entitled ‘The Economics of Belonging’. In it he addresses the problem that when an economy moves to more efficient ways of production new methods are established and old ones decline. For some who have been part of the old methods of doing things, the economic system has passed them by. He explains four ways how this has happened.
The plight of the uneducated. Economic value is now derived from cognitive skills and knowledge. The competitive nature of the global economy demands increased productivity which has streamlined production using technology and is cognitively demanding for the labour force. This results in the diminishing use of blue collar (manual) workers which tend to use little knowledge or initiative. As a result manual labour is not demanded like before and if there is any demand the wage is does not equate to what they received 10-20 years ago. As Sandbu states: If the world today offers much less than it once did to routine workers with only basic schooling or training, it is because they are less useful to the modern economy.
The triumph of cities. In most western economies poorer areas grew faster than richer ones therefore they were catching-up with the big cities. However at the start of the Thatcher and Reagan era the richer urban areas have pulled away from their rural counterparts. Deindustrialisation, especially in the UK, with the move from manufacturing to the service sector favouring urban areas where there is a concentration of people today’s most valuable skills and talent. If urban and rural areas go about different economic direction for long enough, inequality will increase as well as cultural separation which is turn leads to political separation. Sandbu points out that the strongest support of antiestablishment movements is found in the regions that have lost out in the competition to attract capital and skill.
The cost of staying put. If you stay in an area that is ‘the wrong side of the train tracks’ moving away from home will increase your chances of success. In the last 40 years those that have moved have reaped the benefits of higher incomes. One thinks about the UK and the North South divide with the migration flows south in search of opportunity. Regional inequality favours those who actually move, but also those capable of moving. Mobility reflects risk taking and a tolerance for what is new, different and uncomfortable whilst staying put comes with greater economic disadvantage than it did 40 years ago. From the 2016 US election: White Americans who still lived in the community where they were raised supported Donald Trump by 57% against only 31% for Hillary Clinton. Even those who lived two hours’ drive away preferred Trump. Among those who had moved further away, however, more supported Clinton.
Feminism is good for your wallet. The old blue collar work whether it be on production lines, oil rigs, truck driving, farming etc. were traditionally done by men. There was a macho image portrayed in these jobs but the new jobs were focused on the skills that create value in the new service and knowledge economy. It is estimated in the US that one in four jobs in the next decade are expected come in health care, social assistance, and education which tend to come with low status and lower pay. This means that more men (particularly unskilled) must be prepared to work in the service sector in jobs that are traditionally done by women. Soft skills are now increasingly rewarded and traditional manual work (mainly done by men) no longer attract much pay in the job market. Job roles must adapt in parallel with changing cultural expectations of gender roles in the home. Trump’s make America great again was a call to bring back the blue collar jobs but this was never going to happen with globalisation.
Sandbu points out that the one group which has been particularly effected by these four changes is low-skilled white men in small rural communities and subscribe to traditional cultural attitudes. Often blamed on globalisation, these consequences are the result of how we now produce output which has been driven by labour saving technology. Sandbu states that:
But we should recognise that much else of value was lost with jobs, and the dissatisfaction from these structural changes goes far beyond the financial.
It is only to be expected that these groups have become more visible within the populist insurgency and fresh in our memory is the attack on the US Congress on 6th January.
Source: The Economics of Belonging – Martin Sandbu 2020
I always encourage students to be aware of what is happening in the global economy as well as their own. Below are growth, unemployment and interest rates for the main economies. Note the high rates of quarterly economic growth which indicates a bounce back from the previous quarter when most of the world was in a serious lockdown. The unemployment rates you would expect to be a lot higher with COVID-19 and a 4.9% rate in NZ was a surprise. An area of employment growth in the December quarter was Construction, along with many government-dominated industry types. Monetary policy been very accommodative and although rates have been very low note that in Japan and the Euro zone areas it has been like this since 2016. These figures could be used for discussion purposes in you class.
Quarterly Economic Growth Rates
Unemployment %Global Interest Rates
Source: Monthly Economic Review – February 2021 – NZ Parliamentary Service
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