APPENDIX II.1 The Labor Market Model
The specification of the model follows Henry and Snower (1996) and Jackman, Layard, and Nickell (1991). The employment equation is derived from a standard CES production function (similar to Henry and Snower and Ferguson, 1969), with output and the real wage the key determinants of employment. The wage equation is based on a “competing claims” model of union-firm behavior (following Jackman, Layard, and Nickell). The real wage is the outcome of a bargain between the firm and the union, where once the wage is determined the firm sets the employment level In this model, wages are dependent upon real unemployment benefits, productivity, unemployment and an index of union strength. The labor supply equation is standard, and is a variant of that outlined in Pencavel (1986) and derived from Hicks (1946), Further details of the model are provided in Brooks (forthcoming). The model is outlined below, with all lower case variables in logs:
ni = α1 yi + α2 (wi - poi) + seasonals
wi - poi = β1 (yi - ni) + β2 log U*(l-UDi) + β3 rr + β4 (poi - pii) + seasonals
Labor force participation
Ifj = γ1 wtj + γ2 zj + γ3 dj + γ4 uj + seasonals
where: n = numbers employed
y = output
w = nominal wage
po = price index of outputs
pi = price index of inputs
U = unemployment rate
UD = union density, i.e., union members as a proportion of numbers employed
rr = replacement rate for the unemployment benefit
If = labor force participation rate
wt = real-after-tax wage
z = real income from sources other than labor (e.g., social welfare benefits, pensions)
d = demographic variables or structural change variables
u = unemployment rate
i = ith sector (aggregate economy, manufacturing or service sector)
j = sex or age group
Ball, L., 1996, “Disinflation and the NAIRU,” NBER Working Paper No. 5520 (Cambridge Massachusetts: National Bureau of Economic Research)
Fahrer and Pease, 1993, “The Unemployment-Vacancy Relationship in Australia,” Australian Economic Review, 4th Quarter, pp. 43–57.
Garbey, S., P. Briggs, and S. Chappie, 1993, Backdating the Household Labour Force Survey, New Zealand Institute of Economic Research, Working Paper 93/35.
Henry, S., and D. Snower (editors), 1996, Economic Policies and Unemployment Dynamics in Europe, (Washington D.C.: International Monetary Fund).
Jackman, R., R. Layard, and S. Nickell, 1991, Unemployment, Macroeconomic Performance and the Labour Market (Oxford University Press).
Jackman, R., R. Layard, and S. Nickell, 1996, “Combating Unemployment: Is Flexibility enough?” Discussion Paper No. 293, London School of Economics.
Singh, A., J. Felman, R. Brooks, T. Callen, and C. Thimann, 1998, Australia: Benefiting from Economic Reform, (Washington: International Monetary Fund), (forthcoming).
This chapter was prepared by Ray Brooks.
Average unemployment benefit replacement rates in Australia for a couple with no children in the first year of unemployment are quite low (about 50 percent in 1995 compared with the OECD average of about 60 percent). However, given that benefits are independent of previous earnings, persons in the bottom 10 percent of the earnings distribution face replacement rates that are close to or even above 100 percent. Furthermore, the fact that benefits are paid indefinitely results in the Australian system being more generous for the long-term unemployed than the OECD average (with a replacement rate of 40 percent for a couple with no children compared with a comparable replacement rate of 19 percent for the OECD).
The argument is that centralization of wage bargaining can help promote wage moderation, while decentralized bargaining enables wages to be closely linked to circumstances at the enterprise level If unions are industry-specific and wage bargaining is not coordinated across industries, unions have an incentive to seek higher wages. This is because an increase in the output price of that industry (needed to offset the impact of higher nominal wages) will only have a limited impact on the aggregate real wage.
Insider power refers to the extent to which unions bargain to improve the position of their members (“insiders”) and ignore non-union members among the ranks of the unemployed (“outsiders”).
The encouraged worker effect arises when other members of the household enter the workforce in response to a reduction in household income if a member of the household becomes unemployed.
Restricting the coefficient for output to equal one in the aggregate employment equation (as in the Australian Treasury’s TRYM model) raises the impact of real wages on employment.
The unemployment benefit replacement rate rose from about 37 percent in 1990 to 42 percent in 1997. This was largely due to increases in housing assistance to the unemployed in the early 1990s. As noted in the “One Nation” statement by Prime Minister Keating in February 1992, the real value of unemployment benefits for a single adult receiving the accommodation benefit (if renting privately) rose by 53 percent between 1983 and 1992.
The impact of the replacement rate on unemployment is somewhat larger than in earlier Australian studies (see, for example, Fahrer and Pease, 1993).
This is only a relatively small adjustment given that real social welfare benefits per person of working age (yg) rose by more than 50 percent between 1990 and 1997.