Unemployment, wages, productivity
and monetary policy in New
Zealand
At the microeconomic level, the firm hires more labour as
long as the marginal product of labour exceeds the real wage. Hiring stops when
the marginal product of labour is equal to the real wage. When the wage rate is
higher than marginal product of labour, the firm lays off labour, hence
unemployment increases. There are some challenging issues to reconcile the
microeconomic and the macroeconomics of wage dynamics. Blanchard and Katz (1991),
among other papers, is an excellent discussion of this issue.
That been said, the neoclassical theory is quite intuitive
and empirically verifiable at the macro level, which I will show graphically. I
graph below the business cycle fluctuations of the real wage and the marginal
product of labour in New Zealand.[1] The
cyclical fluctuations are deviations from an HP filter’s trends. Clearly there
is a wedge.
Figure 1
The wedge between the real wage and the marginal product of
labour can result for a number of reasons (see Thurow, 1968). First, taxes create a wedge if the
incidence of the indirect taxes is on labour. Second, monopoly power can
explain differences between the marginal product of factor inputs and their
prices. Third, there is a constant substitution between factor inputs along
growth path. Although there is some evidence that the stock of capital is
shallow in New Zealand
(but it has a positive trend, nevertheless). As the stock of capital rises,
labour is displaced. That might cause the returns to labour to fall below its
marginal productivity. Wages fall below the marginal product of labour if the
transition cost is high. When labour is not paid its marginal productivity, the
optimal stock of capital is less than it would be if labour were paid its
marginal productivity; the opposite can be true too. Fourth, if firms set the
wage rate by the marginal product of the marginal worker rather than the
marginal product of the average worker, due to heterogeneity. Maré and
Hyslop, (2008) provide evidence that less skilled labour is hired at the up-turn
of the New Zealand
business cycle. If this were the case then wages will have to be lower than the
marginal product of the average worker. Fifth, some of the wedge between the
marginal products and the returns could be explained by risk premiums. Sixth,
when social returns are not equal to private returns, actual returns must be
corrected for taxes when possible. And, seventh, endogenous growth models
assume an increasing return to scale rather (i.e., less than doubling factor
inputs is needed to double output), which means that capital and labour will
more than exhaust total output. Thus, the marginal product of labour will not
equal the real wage.
The second figure plots the wedge between the real
wage and the marginal product of labour, and the unemployment gap (the HP
filtered unemployment rate). The increase in the real wage over the marginal
product of labour opens a positive wedge, and unemployment increases above its long-run
trend level. The correlation coefficient is nearly 70 percent. The wedge
between the wage rate and the marginal product of labour is a predictor of
unemployment in New Zealand
Figure 2
The unemployment rate in New Zealand New Zealand
Figure 3 is a
95-percent chi-squared confidence ellipse. It shows that the correlation
between the wage-marginal product of capital wedge and the unemployment gap is
significant.
Figure 3
email: razzakw@gmail.com
References
Blanchard, O. J., and L. Katz, (1999), “Wage Dynamics:
Reconciling Theory and Evidence,” American Economic Review 89 (3), 69-74.
Maré, D. C., and
D. R. Hyslop, (2008), “Cyclical Earnings Variation and the Composition of
Employment,” Working paper, Statistics New Zealand, Wellington , New Zealand
Razzak, W A, (2014),
“New Zealand Labour Market Dynamics – pre and post global financial crisis,”
Forthcoming Working Paper, New Zealand Treasury, Wellington , New Zealand
Thurow, L. C., (1968), "Disequilibrium and Marginal Productivity of Capital and Labor," Review of Economics and Statistics Vol 50, No.1, 23-31.
Thurow, L. C., (1968), "Disequilibrium and Marginal Productivity of Capital and Labor," Review of Economics and Statistics Vol 50, No.1, 23-31.
[1] All the data are taken
from Statistics New Zealand online. The sample is March 1991to September 2013.
GDP data are only available to September 2013. The marginal product of labour
is a calibrated derivative of output (real GDP) with respect to labour of the
Cobb-Douglas production function. I assume a simple Cobb-Douglas production
function, where real GDP is a function of capital and labour with the shares
fixed at 0.4 and 0.6 for capital and labour respectively. Capital stock is
measured by the Perpetual Inventory equation with the assumption that the initial
period capital stock equal to 3 times GDP and a depreciation rate 0.08. Labour
is measured by working age population (15-64. Gross capital formation is
deflated by the capital price index. Wages are average hourly total ordinary
wage minus expected inflation, which I measure as a 6 quarter moving average of
the inflation rate. The inflation rate is the log-difference of the CPI.
Different functional forms and assumptions could be used, e.g., differentiating
between skilled and unskilled labour in a CES production function. The business
cycle fluctuations are deviations from trend measured by the HP filter. So
unemployment fluctuations are the deviations of unemployment from trend.
