The Labour Market in CGE Models

In this chapter (written for the forthcoming "Handbook of CGE Modeling", edited by P. Dixon and D. Jorgenson), we review options of labour market modelling in the framework of numerical general equilibrium analysis. Our review is structured in three main sections: Modelling options for labour supply, labour demand and labour market coordination. On the labour supply side, two principal modelling options are distinguished and discussed: aggregated, representative households and microsimulation based on individual household data. Microsimulation is a forceful instrument, which has a number of clear advantages (direct link to modern labour supply estimation, explicitness in distributional questions) and avoids a number of typical problems that arise in determining the characteristics of representative households. Therefore, in our view, any labour-market related study should carefully check whether the microsimulation set-up can be made use of. On the labour demand side, we focus on the substitution possibilities between different types of labour in production. Labour supply analysis suggests a large number of potentially interesting labour subgroups. Except for a very small subset of these, the econometric basis for formulating labour demand in these categories is weak. We think that in general the assumption of perfect substitutability in demand (implying an efficiency-weighted additive treatment of individual labour quantities) is a plausible default. Demand for different categories of labour should only be differentiated if there is evidence that wages do not move in parallel. Modelling labour market coordination presents itself as a sharp trade-off. Ideally, we would like to have a theoretically founded, structural model of involuntary unemployment, which contains enough free parameters to be calibrated to empirical wage curve elasticity parameters. This is not easily available. Any reasonably simple structural model of unemployment has severe difficulty to be calibrated to empirically plausible wage curve elasticities. Working with these elasticities directly, without a structural foundation, is possible, but reduces our resources of providing an economic interpretation of changes in the wage as a response to policy shocks.

Boeters, Stefan and Luc Savard (2011), The Labour Market in CGE Models, ZEW Discussion Paper No. 11-079, Mannheim.