Labor Market Frictions Research Articles

Optimal long-run money growth rate in a cash-in-advance economy with labor-market frictions

AbstractWe revisit the Friedman rule in a labor search model and extend Heer (2003), Cooley and Quadrini (2004), and Wang and Xie (2013) to one that allows for endogenous growth. We show that, even without a liquidity effect or a CIA constraint on firms’ wage payment, our model offers a different channel for moderate money growth to increase welfare. Intuitively, in a one-sector endogenous growth economy, the technology is of constant returns with respect to capital. When the labor market is frictional, a moderate increase in money growth induces an expansion in vacancy and employment. Labor and capital are complements in production. With an increase in employment, when the technology is neoclassical, the decreasing return in capital leads to a lower marginal product of labor. However, in an endogenous growth framework wherein the technology exhibits socially constant returns in capital, the marginal product of labor is constant. Due to a constant marginal product of labor, modest inflation raises employment, enlarges economic growth, and increases welfare. Moreover, the optimal long-run inflation rate departs from the Friedman rule, even when the Hosios rule holds. Finally, we find that our model with sustainable growth fits the data better than that without sustainable growth.

The welfare effects of tax progressivity in a frictional labor market

A progressive tax schedule is usually justified in terms of redistribution and insurance. When the labor market is frictional and there is no intensive margin of labor supply, progressive taxation has been shown to reduce unemployment by lowering wages. However, a more progressive tax schedule discourages the individual's supply of labor and (precautionary) savings, thus potentially reducing capital accumulation and total production.I examine the different effects of a progressive tax and transfer schedule on unemployment, labor income, an individual's labor supply, and savings. My modeling strategy follows Setty and Yedid-Levi (2020), who build on the workhorse model of Krusell et al. (2010), to which I add individual labor supply. I allow for ex ante heterogeneity in productivity, as well as in preferences, while the only idiosyncratic risk is the endogenous risk of unemployment. I compare my baseline model with a frictional labor market to one with a Walrasian labor market where the unemployment risk is exogenous.Steady state comparisons, based on a utilitarian welfare criterion, show that a tax and transfer schedule with a positive degree of progressivity is optimal in both frameworks, and that the presence of labor market friction implies that the optimal level of progressivity is (slightly) higher.

Productivity growth, industry location patterns and labor market frictions

This paper constructs a two-country model of international trade to study how labor market frictions affect industry location patterns, unemployment rates, and fully endogenous productivity growth. We show that when the larger country offers subsidies to labor search costs or reduces unemployment benefits, the domestic unemployment rate falls, causing greater industry concentration and faster productivity growth, but higher unemployment for the smaller country. When similar labor market policies are implemented in the smaller country, however, the resulting fall in domestic unemployment leads to lower industry concentration and slower productivity growth, while lowering unemployment in the larger country.

How Does the Labor Protection Law Affect Sustainable Economic Growth: An Empirical Analysis Based on Psychological Contract Perspective.

This article studied the influence of Labor Contract Law and employee psychological contract on enterprise investment and sustainable economic growth. The results indicate that the Labor Protection Law has no significant influence on the investment of state-owned enterprises. In the early stage of the implementation of Labor Protection Law, the Labor protection Law will observably reduce the investment level of private enterprises, and this effect is more obvious in labor-intensive industries and small and medium-sized enterprises. However, in the later stage of the implementation of Labor Protection Law, the impact of Labor protection Law on the investment of private listed companies is weak. The results indicate that the Labor protection Law increases the illegal costs of private enterprises, reduces the flexibility of employment, and ultimately reduces the investment level of enterprises. Moreover, our article examines the impact of the Labor protection Law on regional economic growth, and finds that the Labor protection Law will significantly reduce the regional GDP growth rate in China, and this effect is mainly reflected in the regions where private enterprises provide more jobs and the proportion of private economy is high. This article takes China’s emerging markets as the background, on the one hand, expands the relevant research on labor market friction from the viewpoint of enterprise investment and economic growth, on the other hand, provides new evidence for state-owned enterprises to fulfill social goals.

Market Conditions and the Labor Productivity Advantage of Business Groups

Using a large sample of firms from 208 subnational regions across 21 European countries, we investigate if labor market conditions affect the potential value of internal labor markets in business groups—i.e., set of firms under common ownership and control. Building on the “institutional voids” perspective on business groups and the strategic human capital literature, we theorize that slack labor market conditions facilitate and enhance the value of labor reallocations within these interfirm networks by inhibiting trade in human capital outside them. In these environments, we find that firms with internal labor market access—i.e., with an increasing number of sister companies in the same region-industry—show relatively higher labor productivity. Further, our findings suggest that the labor market frictions arising from both slack labor market conditions and employment protection regulations synergize to enhance the benefits of internal labor markets.

Revisiting the determinants of unemployment duration: Variance decomposition à la ABS in Spain

Using the methodology developed in Alvarez et al. (2014), we decompose the variance of unemployment duration in Spain into three main components: labour market frictions, duration dependence and heterogeneity. Crucial to our analysis are the comparisons by different demographic groups over the business cycle to shed light in the mechanisms behind duration dependence. We offer a general approach for interpreting administrative data that is closer to unemployment than non-employment and includes different types of unemployment spells, particularly short spells without the right to claim benefits. Labour market frictions account for the bulk of the variance of unemployment duration, and become more prominent during recessions. Duration dependence constitutes 25% of the total variance, followed by heterogeneity, which represents 18%. Women and college graduates have larger shares of duration dependence. Finally, the share of duration dependence does not vary over the business cycle for non-college workers. But it is higher during expansions for college workers, which is consistent with a statistical discrimination mechanism due to dynamic sample selection.

The wage dispersion effects of international migration in the European Union

This paper investigates the impact of international migration on wages across workers using a search theoretic model of the labor market with an endogenous migration decision for workers. In a two country model with ex-ante identical workers, the presence of frictions in the labor market, and costs to workers to migrate, I show that substantial wage dispersion can be generated by only those factors. An empirical parameterization of the model replicates the observed migration and wage conditions in the European Union from 1998–2016. The application indicates that incorporating endogenous costly migration with labor market frictions has significant effects on expected wages. In contrast to existing work, which relies on the imperfect substitutability between skills, I find that skill heterogeneity dampens the wage dispersion generated. Ignoring either the migration decision or costs to migration, even within skills, results in misattribution of the wage effects of migration, and distorts welfare analysis resulting from any such study. Despite the tendency to focus on migration as a negative force for workers, the model in this paper finds that migration is not necessarily bad for workers’ wages.

Labor markets during pandemics

The COVID-19 pandemic has killed millions across the globe and government responses have led to tens of millions of jobs lost. This paper combines the SIR epidemic model with a frictional labor market to examine the interaction between infection, wages and unemployment.The labor market is not efficient during the pandemic. Optimal policies show that it is often optimal to shut down businesses and impose a quarantine before the pandemic peaks. A quarantine itself is not enough, however, and must be complemented by additional policies. The policies are not unique and include a Pigouvian “infection tax” on those infected, a tax on susceptible individuals, higher unemployment benefits and a tax on vacancy creation. All policies are state dependent and depend both on the number of unemployed and on the number of infected.

Unemployment insurance, mobile capital, output, and distributive effects

Scholars and policymakers have focused on the effects of unemployment insurance on job search effort. However, output is an important measure of economic performance, and this paper studies the effects of unemployment insurance on output in a model with capital and labor market frictions. The question concerns whether unemployment insurance is needed to maximize output and whether unemployment should be subsidized or taxed if needed. The answer hinges on the relationship between the elasticity of the marginal product of capital and the elasticity of vacancy-filling rate. Workers’ risk aversion, the known reason in the literature, is neither necessary nor sufficient for unemployment insurance to increase output. In addition, unemployment insurance tends to redistribute from capitalists to workers even if unemployment insurance is financed by taxes on the employed. The paper thus provides new insights into unemployment insurance by focusing on output and distributive consequences.

Factor Market Failures and the Adoption of Irrigation in Rwanda

Factor market failures can limit adoption of profitable technologies. We leverage a plot-level spatial regression discontinuity design in the context of irrigation use by farmers provided free access to water. Using irrigation boosts profits by 43–62 percent. Yet, farmers only irrigate 30 percent of plots because of labor costs. We demonstrate inefficient irrigation use, by showing farmers irrigating one plot reduce their irrigation use on other plots. This inefficiency is largest for smaller households and wealthier households, suggesting labor market frictions constrain use of irrigation. (JEL D24, O13, Q12, Q15, Q16)

The costs and benefits of tournament in a frictional labor market

This study provides a search and match model with endogenous firm growth, wherein firms post tournament contracts. We show that workers tend to shirk their efforts as firms grow if the right tails of idiosyncratic productivity shocks decay fast enough. Therefore, a dynamic innovation process of the compensation scheme is required to persistently provide incentives. Tournament induces wage dispersion both within and between firms. The quantitative analysis indicates that tournament induces better performances than the quota contract, especially with thin-tailed shock distributions. Nevertheless, with heavy-tailed shock distributions, single-prize schemes induce the involution problem, which reduces the performance improvement of enforcing tournament in large firms. This inefficiency is mitigated by offering prizes to multiple workers.

Can labour market institutions mitigate the China syndrome? Evidence from regional labour markets in Europe

AbstractThis paper investigates how labour market regulations alter the adverse impact of rising import competition from China in European local labour markets between 1997 and 2006. The paper constructs measures of regional exposure to Chinese imports based on previous literature and on regional labour market frictions exploiting involuntary labour reallocations. Taking into account the endogeneity of import competition and its interaction with labour market regulations, the paper finds that regions more exposed to the rise of China have suffered from a reduction in manufacturing employment shares. This shock grows larger with regional labour market frictions; hence, it exacerbates the impact of trade shock on employment. Moreover, the paper finds that employment in public services, and not in construction or private services sector, absorbed the negative shock to the manufacturing sector. The unemployment rate, the labour force participation rate and wages in all sectors are unresponsive to import competition from China.

Persistent Monetary Policy in a Model with Labor Market Frictions

In a basic New Keynesian DSGE model with involuntary unemployment and inflation target shocks, we study the role of labor markets in the transmission of persistent monetary policy shocks that increase households' inflation expectations. The model predicts that labor market conditions can play an important role in the transmission channel of the persistent inflation target shock: quantitatively realistic labor market frictions increase the expansionary effect of inflation target shock on output by around a half compared to that under the model without labor market frictions. Using VAR analysis, we further provide empirical evidence consistent with the predictions of our theoretical model.

The negative hiring rate premium on stock returns in the Korean stock market

This study examines the effect of labor market friction on asset pricing in the Korean stock market. We find a general negative relation between hiring rates and future stock returns, but this relation almost disappears for firms experiencing financial distress or high labor turnover. In addition, we demonstrate that the negative hiring premium is larger across firms with high-skilled workers than those with low-skilled workers and is more prominent for male than for female hiring rates. Finally, we show that firms belonging to large business groups have larger labor adjustment costs due to their unique recruitment process.

Labor mobility and corporate investment—Evidence from a Quasi-natural experiment in China

This paper studies how labor supply affects corporate investment by exploiting an exogenous policy relaxation of urban household registration (hukou) in China. We find that following the staggered hukou policy change, low-skilled labor inflow leads to an increase in the capital expenditure of local firms, consistent with the complementarity hypothesis of low-skilled labor and physical capital. The results are stronger for firms that are less automated and more labor intensive and for regions with lower household income. Our findings suggest that labor mobility induced by labor market friction reduction stimulates corporate investments.

Optimal Currency Areas with Labor Market Frictions

I study efficiency and optimal monetary policy in a two-country monetary union with frictional labor markets. With heterogeneity in labor market frictions, the constrained efficient allocation generically cannot be achieved even if productivity shocks affecting each country are the same. The second-best optimal policy targets smaller inflation and output gaps in the more sclerotic labor market. A quantitative calibration to the eurozone implies welfare gains from redefining the union’s inflation target to put more weight on its sclerotic members. (JEL E23, E24, E31, E52, F33, F45)

Monopsony in the Labor Market

This paper surveys recent theoretical and empirical research on monopsony in labor markets, broadly defined as upward-sloping labor supply to an employer. We compare older monopsony models based on small numbers of employers with newer models based on labor market frictions such as moving costs and search. We also compare older econometric approaches that focus on static wage-concentration relationships with newer approaches that focus on dynamics. Our review of empirical estimates suggests that monopsony power based on small numbers of employers is probably rare but occasionally large, while monopsony power based on frictions is probably widespread but small on average.

Tax enforcement and corporate employment: Evidence from a quasi-natural experiment in China

This study investigates how tax enforcement affects corporate employment in China. We utilize the merger of the State Tax Bureau and Local Tax Bureaus as a quasi-natural experiment and adopt a difference-in-differences framework to identify causality. The results show that tougher tax enforcement has a significant and negative effect on corporate employment and that this effect is more pronounced for firms with higher labor intensity, greater financial constraints, more severe labor market frictions, a lower initial tax rate, lower tax transfer ability, and greater credit market imperfections. Further, the mechanism tests demonstrate that tougher tax enforcement leads to increases in the effective income tax rate, cash holdings, and the cash flow sensitivity of real investment but decreases in accounts receivable and dividend payments. These results are consistent with the liquidity constraints channel. In addition, we exclude several alternative explanations and conduct a series of robustness checks. Overall, our findings indicate that corporate tax enforcement has large effects on the local labor demand, which provides some useful insights for local governments to stabilize employment during the COVID-19 pandemic.

Redistribution with labor market frictions

We study distributive and insurance policies in frictional labor markets where workers are privately informed about their abilities. The combination of selection and moral hazard constraints demands the use of new tax instruments that are redundant in frictionless labor markets to target vacancy creation. We characterize efficient allocations and derive new optimality conditions on effort and employment probability wedges. Wedges on both effort and vacancy creation are always positive at the bottom of the income distribution. For strong enough distributive motives, the same is true for all but the most productive agents. We devise a method for the quantitative assessment of inefficiencies, calibrate our model to the U.S. economy, and find that it is possible to increase government revenues by 3.48% while preserving everyone's utility.

Labor adjustment and productivity in the OECD

Labor productivity is more procyclical in OECD countries with lower employment volatility. To capture this new stylized fact, we propose a business cycle model with employment adjustment costs, variable hours and labor effort. We show that, in our model with variable effort, greater labor market frictions are associated with procyclical labor productivity as well as stable employment. In contrast, the constant-effort model fails to replicate the observed cross-country pattern in the data. By implication, labor market deregulation has a greater effect on the cyclicality of labor productivity and on the relative volatility of employment when effort can vary.