Bill Mitchell and Joan Muysken on underemployment, macro-modelling and policy

Yesterday, I posted some graphs about underemployment in the EU, mainly to draw people’s attention to this important subject. The main takeaway:

Underemployment is high as well as cyclically sensitive.

And I stated that we should start to incorporate it in macro models. Well, Bill Mitchell and Joan Muysken are already doing this, I discovered. And incorporating underemployment in models turns out to make a large difference. In a prelude to a working paper Mitchell states the next things:

A motivation is that underemployment has become an increasingly significant component of labour underutilisation in many nations over the last two decades. In some nations, such as Australia, the rise in underemployment outstripped the fall in official unemployment in the period leading up to the financial crisis. Underemployment is now higher than unemployment in Australia. There is now excellent data available for underemployment from national statistical agencies, which makes it easier to examine its macroeconomic impacts.

The standard Phillips curve approach predicts a statistically significant, negative coefficient on the official unemployment rate (a proxy for excess demand). That is, when the unemployment rate falls, the labour market is said to tighten and workers are more able to demand money wage increases, which are passed on by firms with price-setting power (via their mark-ups) in the form of accelerating prices.

The “quality” of the unemployment pool is also considered. It is argued that “quality” (in terms of the disciplining capacity of unemployment to restrain worker wage demands) is related to unemployment duration and at some point the long-term unemployed cease to exert any threat to those currently employed.

Consequently, they do not discipline the wage demands of those in work and do not influence inflation. The hidden unemployed are even more distant from the wage setting process. So we might expect that the short-term unemployment is a better excess demand proxy in the inflation adjustment function.

While the short-term unemployed may be proximate enough to the wage setting process to influence price movements, there is another significant and even more proximate source of surplus labour available to employees to condition wage bargaining – the underemployed.

The underemployed represent an untapped pool of potential working hours that can be clearly redistributed among a smaller pool of persons in a relatively costless fashion if employers wish.

It is thus reasonable to hypothesise that the underemployed pose a viable threat to those in full-time work who might be better placed to set the wage norms in the economy.
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This argument is consistent with research in the institutionalist literature that shows that wage determination is dominated by insiders (the employed) who set up barriers to isolate themselves from the threat of unemployment. Phillips curve studies have found that within-firm excess demand for labour variables (like the rate of capacity utilisation or rate of overtime) to be more significant in disciplining the wage determination process than external excess demand proxies such as the unemployment rate.

It is plausible that while the short-term unemployed may still pose a more latent threat than the long-term unemployed, the underemployed are also likely to be considered an effective surplus labour pool. In that case we might expect downward pressure on price inflation to emerge from both sources of excess labour
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The equations shown are the simple regressions depicted graphically by the solid lines. The graph suggests the negative relationship between inflation and underemployment is stronger than the relationship between inflation and unemployment. More detailed econometric analysis (see later) confirms this to be the case.

(Alas no graphs, I did not manage to copy/cut/past/save the Mitchell graphs. To see these go to the source).