10. Labor supply - number of workers

The focus now shifts to supply side shocks and a positive shock to labor supply is the first of the supply shocks presented in sections 10 - 14.

 

Labor input in ADAM's production function is defined in terms of efficiency corrected labor hours, i.e. as a product of three elements: labor productivity, working hours per year per employed and employment. A change in any of these three components changes the labor input, and the experiments in sections 10 - 12 present a shock to each of the three elements. In all cases, production increases in the medium and long run. In this section increased labor supply is an in crease in number of workers.

 

hmtoggle_arrow1A. Number of workers

 

Here we consider the effect of a permanent increase in the number of people in the work force caused by a reduction of 1 percent of total employment in the number of people outside the labor force not receiving transfers. The work force increases approximately by 27000 people. (See experiment)

 

Table 10a. The effect of a permanent increase in labor supply

    1. yr 2. yr 3. yr 4. yr 5. yr 10. yr 15. yr 20. yr 25. yr 30. yr
    Million 2010-Dkr.
Priv. consumption fCp 54 340 477 528 547 612 799 993 1115 1179
Pub. consumption fCo 1748 1785 1815 1845 1875 2031 2195 2371 2558 2759
Investment fI 598 895 711 575 499 233 167 212 252 265
Export fE -65 -135 -228 -342 -475 -1291 -2016 -2457 -2662 -2749
Import fM 843 1066 1006 951 922 783 722 729 763 816
GDP fY 1498 1828 1783 1673 1549 862 512 496 617 762
    1000 Persons
Employment Q 1.09 1.61 1.77 1.78 1.71 0.75 -0.02 -0.28 -0.26 -0.16
Unemployment Ul -0.59 -0.83 -0.90 -0.90 -0.85 -0.37 0.01 0.14 0.13 0.08
    Percent of GDP
Pub. budget balance Tfn_o/Y -0.06 -0.05 -0.05 -0.05 -0.06 -0.10 -0.13 -0.15 -0.16 -0.17
Priv. saving surplus Tfn_hc/Y 0.01 -0.02 -0.02 -0.02 -0.02 0.00 0.01 0.00 0.00 0.00
Balance of payments Enl/Y -0.05 -0.07 -0.07 -0.07 -0.07 -0.09 -0.12 -0.14 -0.16 -0.18
Foreign receivables Wnnb_e/Y -0.10 -0.20 -0.28 -0.35 -0.42 -0.79 -1.20 -1.65 -2.12 -2.59
Bond debt Wbd_os_z/Y 0.03 0.07 0.10 0.14 0.19 0.49 0.91 1.36 1.80 2.23
    Percent
Capital intensity fKn/fX -0.11 -0.11 -0.10 -0.09 -0.07 -0.02 0.00 0.01 0.01 0.00
Labour intensity hq/fX -0.08 -0.08 -0.06 -0.06 -0.05 -0.04 -0.05 -0.05 -0.05 -0.05
User cost uim 0.00 0.01 0.02 0.04 0.05 0.10 0.13 0.13 0.13 0.12
Wage lna 0.01 0.04 0.07 0.10 0.13 0.24 0.28 0.26 0.24 0.22
Consumption price pcp 0.00 0.01 0.02 0.03 0.05 0.10 0.13 0.13 0.13 0.12
Terms of trade bpe 0.00 0.01 0.02 0.02 0.03 0.06 0.07 0.07 0.07 0.06
    Percentage-point
Consumption ratio bcp -0.04 -0.02 -0.01 0.00 0.00 0.00 0.00 0.01 0.02 0.02
Wage share byw -0.02 -0.01 0.01 0.02 0.03 0.05 0.05 0.03 0.02 0.02

(See details)

 

The increased labor supply is not automatically employed at once as there is no demand side response, so unemployment increases. The higher unemployment reduces the growth of wages and prices. The decline in prices relative to the baseline improves competitiveness, as a result production and exports increase and gradually pull the extra labor force into employment. Employment increases until the additional labor force is employed and the rate of unemployment is back at its structural level.

 

The positive effect on employment, the negative effect on wages and the positive effect on exports is permanent. Private consumption rises in the short run as the unemployed people receive unemployment benefits and other social benefits. The long term impact on private consumption is negative due to the negative real wage effect. Real wage effect arises because wages increase/decrease more than the general price levels due to the deadweight from the non-responding exogenous import prices. This creates a positive/negative real wage effect, terms of trade and real disposable income and private consumption increase/decrease permanently. When domestic demand falls the export needs to increase even more for the extra supply of workers to be soaked up in the economy. For this to happend, terms of trade need to be even better. Thus, wage will have to decrease more.

 

Overall, there is a positive effect on production in the long run because of the permanent increase in employment. There is also a permanent change in the relative prices of production factors, as labor becomes relatively cheaper compared to the partly imported capital. This implies a substitution effect. A substitution effect arises when a change in the relative prices of factors induces producers to use more of a relatively cheaper factor and less of a relatively more expensive factor. Consequently, the substitution of labor for capital making production more labor intensive and reducing labor productivity. The substitution effect offsets part of the increase in production.

 

The wage share falls permanently, i.e. the distribution of income changes permanently in favour of capital. Wage relative to user cost falls in the long run because investment prices fall less than wages due to the deadweight from import prices.

 

There is a significant positive effect on public budget in the long term, because the nominal fall in revenues is less than the nominal fall in expenditures. Transfer payments and public wage-expenses decline as hourly wages fall. Other public expenditures also fall as prices fall. On the revenue side, taxes on personal income fall when hourly wages fall. But the number of tax payers increases and this offsets some of the fall in tax revenue.

 

Figure 10a. The effect of a permanent increase in labor supply with 27000 people

 

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fig_10_5a_zoom38fig_10_6a_zoom38

 

 

fig_10_7a_zoom38fig_10_8a_zoom38

 

In general, a permanent increase in the labor force has a permanent positive effect on employment and output. The higher tax revenues provide a potential for higher public spending or lower taxes, which could boost domestic demand and moderate the need for higher exports.

 

hmtoggle_arrow1B. Number of workers - balanced budget

 

Increasing the labor supply has a permanent positive effect on the public budget balance. The additional public savings can be used to increase spending or to reduce tax rates in order to create expansionary effects in the economy. Table 10b presents the effect of a permanent increase in labor supply accompanied by a permanent decrease in income tax rates. As in section A, the number of people outside the labor force not receiving transfers is reduced by 1 percent of total employment - approximately 27.000 people and, in contrast to section A, central government income tax rates are reduced permanently by 6.16 percent (e.g. from 15 to 14.08 per cent) to balance the public budget in the long run. (See experiment)

 

Table 10b. The effect of a permanent increase in labor supply, balanced budget

    1. yr 2. yr 3. yr 4. yr 5. yr 10. yr 15. yr 20. yr 25. yr 30. yr
    Million 2010-Dkr.
Priv. consumption fCp -610 -912 -1232 -1529 -1773 -2348 -2507 -2656 -2833 -3016
Pub. consumption fCo 1748 1785 1815 1845 1875 2032 2197 2373 2561 2763
Investment fI 277 180 -267 -554 -711 -794 -506 -334 -302 -319
Export fE -38 -58 -78 -97 -110 -35 182 305 255 105
Import fM 459 342 61 -124 -229 -288 -101 25 62 53
GDP fY 914 651 176 -210 -487 -857 -541 -351 -393 -531
    1000 Persons
Employment Q 0.71 0.73 0.46 0.16 -0.10 -0.56 -0.13 0.23 0.27 0.15
Unemployment Ul -0.38 -0.37 -0.22 -0.07 0.06 0.28 0.06 -0.12 -0.14 -0.08
    Percent of GDP
Pub. budget balance Tfn_o/Y 0.03 0.03 0.02 0.00 -0.01 -0.03 -0.01 0.00 0.01 0.01
Priv. saving surplus Tfn_hc/Y -0.06 -0.06 -0.02 0.00 0.02 0.04 0.02 0.01 0.01 0.00
Balance of payments Enl/Y -0.03 -0.02 -0.01 0.00 0.01 0.02 0.01 0.01 0.01 0.01
Foreign receivables Wnnb_e/Y -0.06 -0.08 -0.07 -0.05 -0.02 0.10 0.16 0.18 0.20 0.21
Bond debt Wbd_os_z/Y -0.05 -0.07 -0.08 -0.07 -0.06 0.06 0.12 0.10 0.06 0.02
    Percent
Capital intensity fKn/fX -0.09 -0.07 -0.05 -0.04 -0.04 -0.08 -0.12 -0.14 -0.14 -0.14
Labour intensity hq/fX -0.07 -0.05 -0.04 -0.03 -0.03 -0.03 -0.03 -0.03 -0.03 -0.03
User cost uim 0.00 0.01 0.01 0.02 0.02 0.02 0.01 0.01 0.02 0.03
Wage lna 0.01 0.02 0.03 0.04 0.04 -0.01 -0.04 -0.03 -0.01 0.01
Consumption price pcp 0.00 0.01 0.01 0.01 0.01 -0.01 -0.03 -0.03 -0.02 -0.01
Terms of trade bpe 0.00 0.00 0.01 0.01 0.01 0.00 -0.01 -0.01 -0.01 0.00
    Percentage-point
Consumption ratio bcp 0.03 0.02 0.01 -0.01 -0.02 -0.05 -0.05 -0.04 -0.04 -0.04
Wage share byw -0.01 0.00 0.01 0.02 0.02 0.00 0.00 0.01 0.02 0.02

(See details)

 

The lower income tax rates reduce government revenues and public savings fall. In the short run, the negative effect on the public budget dominates, but in the long term, public budget and debt constitute the same ratios of GDP as in the baseline.

 

The higher labor supply is not immediately employed, so unemployment increases in the short run. The higher unemployment exerts a downward pressure on wages and prices which improves competitiveness. This makes exports stimulate production and employment. The expansionary effect is reinforced by higher private consumption, which peaks after five years. The higher consumption reflects that the lower income tax rates have increased disposable income. The stronger domestic demand makes unemployment fall more sharply than in section A. Employment keeps increasing until the additional labor force is employed and the rate of unemployment has returned to its baseline. The higher production increases the capital stock and investments permanently. Imports also increase permanently to meet the higher domestic demand.

 

When the government budget is unchanged as a share of GDP, the balance of payment is also unchanged in the long run as indicated in table 10b. Moreover, in this balanced-budget experiment net exports remain fairly unchanged implying that the volume change in net exports is balanced by the price change. This balancing of nominal exports and imports is illustrated in figure 10a, where the percentage increase in real exports minus the percentage increase in real imports, cf. first diagram on the left hand side, is equal to the percentage deterioration in the terms of trade, cf. last diagram on the right hand side.

 

In the long run, the need for lower wages to boost competitiveness will moderate the increase in real income and private consumption. The initial consumption boom raises the demand for dwellings, housing investment and house price increase, and the higher housing wealth has a certain feed-back effect on private consumption. Moreover, the short-run expansion of the housing capital is stronger than the long run effect. The excess supply of houses created in the medium run reduces house prices and the housing investment is adjusted downwards before the housing market reaches its equilibrium.

 

Figure 10b. The effect of a permanent increase in labor supply, balanced budget

 

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fig_10_7b_zoom38fig_10_8b_zoom38

 

 

Taking this section B together with section A, illustrates the importance of the budget constraint. Spending the supply-driven improvement of public finances on fiscal easing makes employment increase faster in section B than in section A, and the long-run need for higher exports and improved competitiveness is lower in section B. In section A, the additional supply was used to boost public finances and net exports. In section B, it is primarily used to increase domestic consumption. Making the public sector spend its additional revenues resembles an introduction of Say’s law.

 

In a closed economy, spending the full-structural-employment GDP on consumption and investment would be enough to secure full structural employment. However, in an open economy a share of domestic demand will be met by higher imports, and exports will have to increase accordingly. Consequently, we still get an export increase in section B, but as we have seen, the export increase is smaller than in section A. In real terms, the long-run increase of exports in ADAM will always match full-structural-employment GDP plus imports minus domestic demand. And in section B, the increase of exports will also match the increase of imports in nominal terms, because the constant public budget plus the private consumption function makes the impact on domestic demand match the impact on GDP in nominal terms.

 

The negative long-term impact on consumption in section A can also be seen in relation to the size of the foreign trade elasticities. The price elasticity of foreign trade in ADAM is not estimated with a view to permanent expansions of the labor supply. Permanent expansions on the supply side can lead more firms to introduce more products to the foreign market. Much in line with the traditional gravity model that makes Danish exports a function of not only the GDP of our trading partners but also of Danish GDP. ADAM’s estimated price elasticity reflects the average relation between relative prices and market shares in the estimation period, and this average elasticity may be too small to reflect the impact on exports of a permanent expansion in labor supply.

 

 

hmtoggle_arrow1C. Number of workers - large export price elasticity

 

Consequently, in this section we repeat the experiment of section a on an ADAM version with higher export price elasticities. The specific example is to increase the price elasticities of exports by a factor 2 (from an average of approx. -2 to approx. -4). As in section A, the exogenous shock reduces the number of people outside the labor force not receiving transfers by 1 percent of total employment - approximately 27.000 people. (See experiment)

 

Table 10c. The effect of a permanent increase in labor supply, large export price elasticity

    1. yr 2. yr 3. yr 4. yr 5. yr 10. yr 15. yr 20. yr 25. yr 30. yr
    Million 2010-Dkr.
Priv. consumption fCp 1409 4892 8403 11421 13995 21816 29670 43698 62998 85095
Pub. consumption fCo 0 0 1 1 1 -8 -25 -42 -56 -67
Investment fI 5980 12007 15770 18703 20855 23362 22437 26411 33575 40249
Export fE 13309 21881 30221 37531 43842 61640 65867 70738 79577 88321
Import fM 9347 16661 22607 27785 32357 48738 62793 82736 108318 136092
GDP fY 11228 21877 31393 39360 45735 57493 55336 59365 70415 81940
    1000 Persons
Employment Q 8.83 20.11 31.96 43.32 53.37 76.43 69.91 62.60 61.38 60.57
Unemployment Ul 9.72 2.99 -2.97 -8.63 -13.61 -24.83 -21.45 -17.84 -17.27 -16.86
    Percent of GDP
Pub. budget balance Tfn_o/Y -0.01 0.27 0.58 0.88 1.14 1.64 1.44 1.35 1.46 1.55
Priv. saving surplus Tfn_hc/Y 0.18 -0.09 -0.29 -0.49 -0.64 -0.63 -0.20 -0.06 -0.15 -0.23
Balance of payments Enl/Y 0.17 0.18 0.28 0.39 0.50 1.01 1.24 1.29 1.31 1.33
Foreign receivables Wnnb_e/Y -0.09 -0.28 -0.43 -0.49 -0.45 1.25 4.44 7.57 10.21 12.58
Bond debt Wbd_os_z/Y -0.15 -0.53 -1.18 -2.09 -3.20 -9.87 -15.40 -19.36 -22.90 -26.33
    Percent
Capital intensity fKn/fX -0.87 -1.51 -1.96 -2.26 -2.42 -2.00 -1.08 -0.54 -0.16 0.34
Labour intensity hq/fX -0.62 -0.98 -1.19 -1.30 -1.33 -1.16 -1.15 -1.37 -1.63 -1.83
User cost uim -0.11 -0.22 -0.28 -0.29 -0.24 0.70 2.12 3.48 4.78 6.11
Wage lna -0.18 -0.36 -0.32 -0.08 0.35 4.30 8.96 13.04 16.89 20.83
Consumption price pcp -0.07 -0.13 -0.12 -0.04 0.10 1.57 3.58 5.58 7.57 9.61
Terms of trade bpe -0.03 -0.06 -0.06 -0.01 0.08 0.96 2.09 3.14 4.14 5.14
    Percentage-point
Consumption ratio bcp -0.44 -0.42 -0.32 -0.21 -0.13 -0.11 -0.31 -0.31 -0.14 0.08
Wage share byw -0.27 -0.46 -0.50 -0.44 -0.31 0.83 1.72 2.18 2.53 2.90

(See details)

 

The higher labor supply is not immediate employed, so unemployment increases in the short run. The higher unemployment exerts a downward pressure on wages and prices, which improves competitiveness. Then exports stimulate production and employment. Compared to section A the stronger impact of prices on exports implies that prices and wages need to decrease less in order to increase exports and production sufficiently to employ the additional labor force. In the long run, we still have a negative effect on the real wage, but the effect is smaller than in section A. Actually, the long-run impact on total real income and on private consumption is now positive and not negative as in section A. The stronger domestic demand makes unemployment fall more sharply than in section A. Employment keeps increasing until the additional labor force is employed and the rate of unemployment has returned to its baseline.

 

The higher production increases the capital stock and investments permanently. Imports also increase to meet higher domestic demand.

 

The initial consumption boom raises the demand for dwellings. housing investment and house price increase, and the higher housing wealth has a certain feed-back effect on private consumption. Moreover, the short-run expansion of the housing capital is stronger than the long run effect. The excess supply of houses created in the medium run reduces house prices and housing investment is adjusted downwards before the housing market reaches its equilibrium.

 

Taken together, experiment 10c and 10a illustrates that the higher the price elasticity of foreign trade, the less negative is the long-run impact on wages and on terms of trade, and the more positive is the long-run impact on private consumption.

 

Figure 10c. The effect of a permanent increase in labor supply, large export price elasticity

 

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