Labour Markets
Imperfections and Unemployment

In recent years, much attention has focused on the roles of factor and product market imperfections in the persistence of high unemployment in Europe. A CEPR workshop on `The Role of Imperfect Information and Imperfect Competition' was held in Dublin on 12/13 May to discuss these issues. It was organized by Brendan Walsh (University College Dublin and CEPR) as part of CEPR's research programme on `Product Market Integration, Labour Market Imperfections and European Competitiveness', supported by the European Commission's Human Capital and Mobility programme. Additional support was provided by University College Dublin.
Peter Dolton and Donal O'Neill (University of Newcastle) presented `The Impact of Restart on Reservation Wages and Long-Term Unemployment', an examination of the UK Restart programme, which has been credited with significant effects on unemployment duration. The paper estimates elasticities of the reservation wage with respect to the unemployment benefit level and the arrival of job offers. It concludes that the programme may have been effective in increasing the rate at which job offers arrive, but that it had little effect on the reservation wage of the long-term unemployed. The notion that individuals in long-term unemployment have unrealistic expectations of their potential earnings is not supported by the research.
`A Contribution to Unemployment Dynamics' by Marika Karanassou (Birkbeck College, London) and Dennis Snower (Birkbeck College, London, and CEPR) explored the effect of interactions between lags in labour market decisions and labour market shocks with temporary and permanent components on the dynamics of unemployment. Using data for Germany, the UK and the US, the paper estimates employment, wage setting and labour-force participation equations that allow an evaluation of the sources of persistence and imperfect responsiveness in the labour market. The results suggest that countries with a comparatively high degree of unemployment persistence need not necessarily display unemployment under-responsiveness. In addition, different lags have quite different effects on the persistence and responsiveness of unemployment, a consideration the authors believe to be important for policy formulation. Lastly, the results indicate that the responsiveness of unemployment differs between countries, making it difficult to generalize about the design of appropriate policies.
`Competitive Equilibrium Recessions' by Jeff Frank (Royal Holloway College, London, and CEPR) explored the macroeconomic implications of a theory of competitive multiple equilibria. Although this paper shows that steady-state welfare is higher at the high output equilibrium, this is not Pareto superior to the alternative. There is a potential conflict of interest in an overlapping generations model between pensioners, who prefer the higher interest outcome, and workers, who prefer the higher wage outcome. Fiscal policy helps to establish the high output equilibrium by, for example, a tax on the young to provide a transfer payment to the old.
`Information Acquisition and Normal Price Adjustment' by Torben Andersen (Universiteit van Aarhus and CEPR) and Morten Hviid (University of Warwick) focused on how informational problems can cause nominal price rigidities. In this paper, when the information structure is asymmetrical in the sense that some firms are informed about relevant exogenous variables, such as the money supply, while others are uninformed and naïve, the latter can have a disproportionately large effect on aggregate prices, because the former take account of the prices set by the latter in their pricing behaviour. When this finding is incorporated into a model, there can be positive or negative externalities to the acquisition of information. Consequently, the information acquisition game may have multiple or non-existent equilibria. The paper concurs with the findings of previous research to the effect that `small' information costs may have `large' consequences for welfare.
The effects of labour market institutions on wages were analysed by Michael Burda (Humboldt Universität zu Berlin and CEPR) and Antje Mertens (Humboldt Universität zu Berlin) in `Competition versus Cooperation in the Labour Market'. In the US, shocks to local labour markets tend to result in migration rather than local wage adjustments. But in Europe, collective bargaining rather than market clearing determines wages and labour is much less mobile. This paper predicts a levelling of wages across regions in countries where centralized unions are active, workers are immobile and the demand for insurance is positive. Consistent with these expectations, it finds that, in Germany, local differences in unemployment rates and in productivity have little net effect on local wages, in contrast with the US. This helps to explain the regional wage rigidity and widening unemployment differentials in Europe, in contrast with the relatively constant regional pattern of unemployment rates and the higher but uniform wage dispersion in the US. The different functioning of local labour markets in Europe and America is attributed to the greater risk aversion of European workers.
Morten Ravn and Jan Rose Sørensen (Universiteit van Aarhus) examined the long-run effect of labour market distortions in `Schooling, Training, Growth and Minimum Wages'. There are two sources of labour productivity: schooling and on-the-job training. Firms have no incentive to provide general training, but they do use the prospect of training to attract unskilled workers. Workers are prepared to accept contracts that specify sub-optimal levels of training. This paper explores how this outcome would be affected by the imposition of a minimum wage. Firms react to the minimum wage by offering unskilled workers less training, which has a negative effect on growth, but makes young people increase their schooling. The net effect on growth depends on whether schooling or training is more effective in enhancing productivity.
The question of how unionization affects the seniority gradient of wages was addressed by Alison Booth (University of Essex and CEPR) and Jeff Frank in `Seniority Wage Scales, Merit Pay and Trade Unions'. Using data from the British Household Panel Survey, this paper confirms the conventional finding that there is no difference between unionized and non-unionized firms in the seniority-wage profile. But when exploring the effect of the existence of an incremental pay scale on the experience-wage profile, the paper finds that in unionized firms the existence of a pay scale makes the experience-wage profile steeper. In contrast, the existence of a scale appears to have no effect in non-unionized firms. This finding fits into a discriminating monopoly model of union behaviour. Seniority scales allow unions to maximize workers' income through the efficiency of multi-part pricing.
In `The Effect of Labour Market Subsidies in the Presence of Efficiency Wages', Frank Walsh (University College Dublin) discussed the policy implications of the payment of wage premia by firms in order to extract effort from workers. These premia are treated as a cost by firms, whereas they are a rent to workers and do not represent a social cost. As a result, the equilibrium level of employment will not be optimal. The paper shows that subsidies to the sectors that incur these costs may, however, lower welfare when account is taken of how they affect the labour market. The expansion of the high wage sector reduces the threat of unemployment and exacerbates the effort elicitation problem.