New working paper

How Darwinian Should an Economy Be?

Abstract:
This paper studies aggregate dynamics in a cobweb model where learning takes place through a selection mechanism, by which more successful firms are replicated at a higher rate. The structure of the model allows to characterize analytically the aggregate dynamics, and to compute the effect on welfare of alternative levels of selectivity. A central aspect is that greater selectivity, while bringing the distribution of firm types closer to the optimal one at a given date, tends to make the economy less stable at the aggregate level. As in Nelson and Winter (1982), firms differ in their labor/capital ratio. They do not choose it optimally, rather it is a characteristic of a firm. The distribution of firms evolves over time in a way that favors the most profitable firm types. Selection may be inadequate because firms are being selected on the basis of incorrect market signals. Selection itself may reinforce such mispricing, thus generating instability. I compare economies that differ in the volatility and persistence of their productivity shocks, as well as the elasticity of labor supply. The key findings are as follows. First, a trade-off arises since greater selection allows to better track shocks and limits mutational drift in firm types; on the other hand, selection may strengthen cobweb oscillatory dynamics. Second, there seems to be a value in maintaining a diverse “ecology of firms”, in order to cope with future shocks. These observations explain the key results. Optimal selectivity is larger, the less “cobweb unstable” the economy, i.e. the more elastic the labor supply. Second, optimal selectivity is larger, the more persistent the aggregate productivity shocks. Finally, optimal selectivity is larger, the lower the variance of productivity innovations. The model can be extended to allow for firm entry and trend productivity growth, and a selection process with memory. Empirical evidence suggests that, in accordance to the model, countries with less regulated product markets exhibit lower aggregate inertia.

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New working paper

Can Active Labor Market Policy Be Counter-Productive?

Excerpt from the introduction:

This paper studies the effect of active labor market policies (ALMP) in a Mortensen-Pissarides style matching model. ALMPs are modelled as a subsidy to job search, and it is assumed that search activity is observed. A key feature of the model is that workers differ in their productivity, and that search takes place along an extensive margin. The model is used to study the effect of ALMP on the equilibrium, on aggregate welfare, and, equally importantly, on the distribution of welfare across worker types (productivity levels) and current labor market status (employed vs. unemployed).
It is shown that in addition to the usual job search externality, there is a “quality” externality. As search is not directed, an additional job seeker affects the average quality of the pool of unemployed, in addition to the job finding rate. As a result, the usual “Hosios” conditions for an efficient outcome — that the bargaining share of workers match their elasticity in the matching function — are no longer valid. For an efficient outcome, the decentralized equilbrium conditions must match the optimal ones for both the job creation margin of firms and the job search decision of workers, and these two conditions cannot be matched with a single instrument. It is shown, paradoxically, that to replicate the optimum one must select a worker share in bargaining which is larger than their elasticity in the matching function, and at the same time one must impose a tax on job search activity.
Clearly, this prediction does not validate the view that ALMPs are a desirable policy tool. The reason is that they raise workers’ outside option in bargaining, thus contributing to wage pressure, while at the same time reducing the average quality of job seekers. The optimal policy outlined above delivers an improved quality of job seeker, due to the search tax, while the bargaining share in excess of the Hosios level compensates for the implied reduction in the workers’ outside option.

Despite their negative effects on aggregate welfare, we can characterize a coalition in favor of ALMPs.┬áThese are favored by the least productive job seekers (or “short-term” unemployed”) and the least productive workers. The former gain directly from the subsidy, and the latter gain from an enhanced outside option in bargaining. On the other hand, more productive workers and job seekers lose from it. They are harmed due to the fall in the job finding rate, which reflects in particular the deterioration in average job seeker quality. Finally, the workers who do not search (or “long term unemployed”) only benefit if they are sufficiently close to the extensive margin of searching, that is, sufficiently productive. The least productive long-term unemployed are too far from the extensive margin of job search to benefit from the policy, and suffer from the financial burden of the search subsidy. Consequently, they oppose the policy. Note however that this analysis would be changed if ALMP were explicitly targeted at the least productive unemployed workers. Here, instead, by monitoring job search irrespective of productivity, the policy is implicity targeted at those workers whose productivity level is immediately below the critical search threshold.

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