U16 - Technological Progress, Employment and Living Standards in the long-run

Capital Intensity

*Making greater use of capital goods* (for example machinery and equipment) as compared with labour and other inputs. • Capital intensity of production: capital goods per worker.

Long-run unemployment rate and new technology (4)

*New technology can increase both real wages and employment in the long-run*. The adjustment process takes time, and may involve *job destruction in the short-run*. 1. A new technology means that fewer workers can produce the same output. 2. The new technology initially displaces a substantial number of workers from their jobs → the wage is the same but there are fewer jobs 3. Economic profits are high. New firms will be attracted to the economy and investment will rise. Unemployment eventually falls. 4. Wages rise. With lower unemployment, firms have to set higher wages to secure adequate worker effort. *Short-run*: A → D. Employment down. Wage share down. Inequality up. *Long-run*: A → B. Employment up. No change in wage share. Inequality slightly down.

Innovation Rents

*Profits in excess of the opportunity cost of capital that an innovator gets* by introducing a new technology, organizational form, or marketing strategy. • Firms can earn innovation rents by introducing new technology.

Lorenz curve diagram to show the effects of a new technology on inequality (4)

1. *Old technology*: the economy starts in long-run equilibrium before the new technology, with a share *A* of the population being unemployed. 2. *New technology*: This displaces some workers from their jobs so that unemployment now increases to *D*. 3. *Economic profits are high*: new firms will be attracted to the economy and investment will rise, so existing firms will expand. *Unemployment eventually falls to the level shown by point B*, the new long-run equilibrium. 4. Technological change *increased inequality in the short run* but *reduced inequality in the long run*: • employees' share of output returned to initial levels due to an increase in real wages • the higher real wage motivated employees to work hard at a lower level of unemployment.

Technological Progress over time (3)

1. Countries that are rich today have had labour productivity rise over time as they became more capital intensive. 2. Unlike the concave production function, capital productivity remained roughly constant over time in the technology leaders. 3. This is because these countries experienced a combination of capital accumulation and technological progress.

Modelling Technological Progress (4)

1. The production function is characterized by *diminishing returns to capital*. 2. The magnified section (A) shows how the *marginal product of capital* is calculated: it *is the slope of the tangent to the production function* at A. 3. The *marginal product of capital is falling* as we move along the production function to higher capital intensity. 4. *Technological progress* rotates the production function upwards: • this increases the APL and offsets the *diminishing marginal returns to capital* • makes it profitable to invest domestically, leading to increased capital intensity

Concave Function

A function of two variables for which the line segment between any two points on the function lies entirely below the curve representing the function (the function is convex when the line segment lies above the function). IOW: *A production function that exhibits diminishing returns to capital*. • Concavity captures the fact that output per worker increases with capital per worker, but less than proportionally.

Diminishing Marginal Product

A property of some production functions according to which *each additional unit of input results in a smaller increment in total output than did the previous unit*.

Stock Variable

A quantity measured at a point in time. Its *units do not depend on time*.

Flow Variable

A quantity measured per unit of time, such as annual income or hourly wage.

Inclusive Trade Union

A union, representing many firms and sectors, which *takes into account the consequences of wage increases for job creation* in the entire economy in the long run.

Industry

Goods-producing business activity: agriculture, mining, manufacturing, and construction. Manufacturing is the most important component.

Taylorism

Innovation in management that seeks to reduce labour costs, for example by dividing skilled jobs into separate less-skilled tasks so as to lower wages.

Net employment change

Job creation - Job destruction

Creative Destruction

Joseph Schumpeter's name for the process by which *old technologies and the firms that do not adapt are swept away by the new*, because they cannot compete in the market. In his view, the failure of unprofitable firms is creative because it releases labour and capital goods for use in new combinations. • New technologies require new machines • Technological advance is required to sustain the process of capital goods accumulation • Technological progress shifted the production function up • Firms that cannot keep up with innovation eventually fail

Employment Protection Legislation

Laws making job dismissal more costly (or impossible) for employers.

Long-run equilibrium in the labour market

Long-run equilibrium in the labour market is *when wages, employment level, and the number of firms are constant*. • in the long run, firms can enter/exit (so capital stock can change) • long-run employment rate depends on how well policies and institutions deal with: • work incentives - → *wage-setting curve* • investment incentives - → *price-setting curve*

Job Destruction | Acyclical (characteristic)

No tendency to move either in the same or opposite direction to aggregate output and employment over the business cycle.

Job Destruction | Countercyclical (characteristic)

Tending to *move in the opposite direction to aggregate output and employment over the business cycle* → rises during recessions: • firms post fewer vacancies and lay off more workers due to lower demand

Job creation | Procyclical (characteristic)

Tending to *move in the same direction as aggregate output and employment over the business cycle* → firms post more vacancies and need more workers to cope with rising demand: • rises in booms, and falls during recessions • labour-saving technological progress can also create jobs - e.g. reallocation of work from low- to high-productivity firms

How long is the long run? (US v. China example)

The *economy can go through a long adjustment process before reaching the new long-run equilibrium*. *Example*: adjustment of the US labour markets to the Chinese import shock: • Many economists thought that this shock would not have a major negative effect on wages or employment, because workers in import-competing sectors could easily relocate to other regions. • However, they underestimated the size of the shock and overestimated the degree of labour mobility - 2.4 million jobs were lost, and the labour market is still adjusting.

Capital Goods

The *equipment, buildings, and other durable inputs used in producing goods and services*, including where applicable any patents or other intellectual property that is used. Technological progress and capital goods accumulation are complementary: • New technologies require new machines • Technological advance is needed for increasingly capital-intensive methods of production to be profitable. • This process allows a sustained increase in average living standards.

Beveridge Curve

The *inverse relationship between the unemployment rate and the job vacancy rate* (each expressed as a fraction of the labour force) → curves slope downward. William Beveridge noticed that when unemployment was high, the vacancy rate was low; and when unemployment was low, the vacancy rate was high. The Beveridge curve can shift over time due to changes in the *labour market matching* efficiency: • German Beveridge curve shifted closer to the origin due to reforms that helped unemployed workers find jobs. • US curve shifted away from the origin due to a skill-based mismatch and limited worker mobility.

Adjustment Gap

The *lag between some outside change in labour market conditions and the movement to the new equilibrium*.

Diffusion Gap

The *lag between the first introduction of an innovation and its general use*. → takes time for whole economy to adopt the innovation

Draw and explain a diagram of increased productivity in goods production raises the fraction of workers in services

The *solid red line is the feasible frontier* and shows the amounts of goods and services that can be produced given the existing technologies and labour available. 1. *We assume equal amounts of goods and services are consumed*: at A, the amount consumed of each equals 1/2. 2. *The productivity of labour in the production of goods doubles*, but productivity remains unchanged in services. The new feasible frontier is shown as the dashed line. 3. *More goods, more services*: if people continue to consume equal amounts of goods and services, the economy will be at point B with production and consumption of 2/3 units of each. 4. *Employment shift*: At B, labour has shifted from the production of goods to the production of services: 1/3 of the labour produces goods, and 2/3 produces services. • productivity increases in some services reduces the shift • substitution of goods for services reduces the shift • an increase in relative demand for services increases the shift: as incomes rise, people choose to spend more of their budget on services.

Labour Market Matching (4)

The *way in which employers looking for additional employees (that is, with vacancies) meet people seeking a new job*. Newly posted vacancies are not filled instantly because of issues with *labour market matching*: 1. *Mismatch*: unemployed workers may not have the skills required for the job; jobseekers and vacancies may be located in different parts of the country. 2. Jobseekers and/or employers *may not know about each other* or not have relevant information. 3. *Policies and technology* can improve efficiency. 4. Industry-specific shocks or *shocks that prevent workers from moving increase the mismatch* (lower efficiency).

Marginal Product

The additional amount of *output that is produced if a particular input was increased by one unit*, while holding all other inputs constant.

Global trends: The changing nature of work

The amount of labour devoted to agriculture declines as countries get richer, first moving to manufacturing (after the Industrial Revolution), then from manufacturing to services.

Wage-setting curve

The curve that gives the real wage necessary at each level of economy-wide employment to provide workers with incentives to work hard and well. *In the long-run*: unemployment does not continuously fall with technological progress because the wage-setting curve can shift upwards. • depends on productivity of labour *Technological change can indirectly shift the wage-setting curve* due to: • fair shares bargaining by unions • policies to help those affected → employment protection laws • greater disutility of effort • improvement in the reservation wage

Price-setting curve

The curve that gives the real wage paid when firms choose their profit-maximizing price. *In the long-run* real wage depends on productivity *(λ)* and equilibrium profits (*μ#*) → Long-run price-setting curve: *w = λ(1 - μ#)* The *price-setting curve depends on incentives to invest*: • expected long-run tax rates • competition • risk of expropriation • quality of human capital/infrastructure • opportunity cost of capital • expected material costs

Bargaining Power

The extent of a person's advantage in securing a larger share of the economic rents made possible by an interaction.

Equilibrium profits

The profit rate determines the number of firms in the market: • high markup = firms enter. • lower markup = firms exit. It is a *self-correcting* process: → more firms → more competition → higher elasticity of demand → lower markup → fewer firms Equilibrium profits can change due to legislation e.g. property protection

Gross unemployment benefit replacement rate

The proportion of a worker's previous gross (pre-tax) wage that is received (gross of taxation) when unemployed.

Changing labour-market performance (insitutions/policies)

To achieve *good* economic performance, an economy must: 1. Ensure the *price-setting curve shifts up more than the wage-setting curve*. 2. *Adjust rapidly and fully* so the whole economy benefits from technological progress. These *cross-country differences* can be explained by: • *institutions* - *inclusive trade unions* (represent many firms and sectors) choose not to exercise maximum bargaining power because wage increases affect job creation in the long run. • *policies* - well-designed unemployment insurance schemes and job placement services can achieve low unemployment rates. *Institutions and policies used differ* across successful countries and over time. They make a big difference for employment and wage growth, but changing institutions or policies is difficult because it creates winners and losers. *Example*: The Netherlands and the UK both had increased unemployment rates in the 1970s due to the oil price shocks and the increased bargaining power of labour. Both countries managed to shift the wage-setting curve down: • Netherlands - institutions became more inclusive (as in Norway) • UK - policies reduced the power of non-inclusive unions

Labour Productivity

Total output divided by the number of hours or some other measure of labour input • *output per worker*