Structural unemployment, labour market dynamics and the transmission of monetary policy in South Africa

Abstract

This thesis begins by raising the following question: what is the relationship between the labour market structure in South Africa and the ability of the monetary authority to keep control of macroeconomic dynamics? The answer to this question is threefold. First of all, we investigate the empirical evidence of the existence of wage rigidities in the South African labour market. Second, we assess the impact such frictions may have on the conduct of monetary policy. Finally, we introduce public employment to analyze the e¤ects it may have on labour market dynamics in the peculiar case of South Africa. This thesis is therefore divided into three main chapters. Chapter 2 estimates a New Keynesian Wage Phillips Curve for South Africa to determine the respon- siveness of wages to employment conditions. First, we estimate the model using aggregate data. The aggregate estimation results show that private sector wages are not quite responsive to employment con- ditions, while they also reveal a certain sensitivity to in‡ation and quite a good correlation with in‡ation expectations. The relationship between private sector nominal wage in‡ation and employment is clearly weak for the whole sample, and it becomes insigni…cant at the end of the sample, indicating an increase of wage rigidities in the post-apartheid South Africa. On the other hand, the relationship between nominal wage in‡ation and price in‡ation is quite strong and robust for the whole sample but it becomes quan- titatively weak for the in‡ation targeting period. In this period, trade unions in‡ation expectations are instead strongly correlated to nominal wage in‡ation. In the second part of the chapter we look at the relationship between nominal wages, productivity and the reservation wage. The …ndings con…rm that nominal wage in‡ation has consistently outpaced the growth in productivity, even after correcting for price in‡ation. Furthermore, the results suggest that employment conditions had little e¤ect on wage dynamics. We also …nd that for the community, social and personal services sector which, mainly consist of public …rms, the response of wages to market conditions is remarkably strong. The overall picture that comes out from the analysis is that of a wage formation mechanism that is very insensitive to overall macroeconomic conditions. Chapter 3 therefore investigates the implications this picture may have on conducting monetary policy. Therefore, we use a DSGE model with unemployment and labour market frictions following the work of Blanchard and Gali (2010) to answer this crucial interrogation. In an economy with ‡exible wages, the divine coincidence holds since stabilizing in‡ation automatically leads to a stable unemployment (output gap). However when we account for wage rigidities and further labour market frictions, the results show that pursuing an objective of a stable in‡ation leads to undesirable and persistent ‡uctuations in unemployment; with a sacri…ce ratio that is typically higher the more ‡uid the labour market. The estimation of the model using South African data displays two main results. First, labour market parameter estimates present a picture with pervasive wage rigidities which thus con…rms the …nding in chapter 2. Second, the labour market appears to be characterized by large ‡ows in job creation and job destruction rates, with the latter dominating the dynamics. Finally, chapter 4 revisits the …nding in chapter 2 of a strong response of wages to market conditions in the public sector. Furthermore, the public sector in South Africa is for the most part skilled workers intensive, and has been expanding since the 2008 …nancial crisis while private …rms experienced massive turbulences. This chapter thus raises two questions: what could be the impact of public employment on overall labour dynamics? Moreover, could these features of public employment contribute in part in explaining the rigidities in wages observed in the private sector? To answer this question, we use a DSGE model with two sectors and two types of workers (depending on their level of skills), which is essentially a modi…ed version of the framework …rst introduced by Gomes (2013). In particular, we mainly investigate the e¤ects of a positive public sector wage shock on a calibrated South African labour market. For comparison purposes, we also assess the impact of a positive private sector productivity shock. We further take into account the di¤erent level of bargaining power and how the di¤erence in productivity between public and private sectors both a¤ect the responsiveness of variables. The …ndings show that an increase in private sector productivity produces more desirable results with an increase in employment for both skilled and unskilled workers which translates into a decrease in overall unemployment. Public sector wage shock on the other hand mainly crowds out private skilled labour which the …rms react to by substituting it with unskilled workers. Ultimately, the increase in public wages raises overall unemployment as supplementary skilled unemployed individuals queue for public jobs. Altogether, the e¤ects are more pronounced when the bargaining power of unskilled workers is raised.the more ‡uid the labour market. The estimation of the model using South African data displays two main results. First, labour market parameter estimates present a picture with pervasive wage rigidities which thus con…rms the …nding in chapter 2. Second, the labour market appears to be characterized by large ‡ows in job creation and job destruction rates, with the latter dominating the dynamics. Finally, chapter 4 revisits the …nding in chapter 2 of a strong response of wages to market conditions in the public sector. Furthermore, the public sector in South Africa is for the most part skilled workers intensive, and has been expanding since the 2008 …nancial crisis while private …rms experienced massive turbulences. This chapter thus raises two questions: what could be the impact of public employment on overall labour dynamics? Moreover, could these features of public employment contribute in part in explaining the rigidities in wages observed in the private sector? To answer this question, we use a DSGE model with two sectors and two types of workers (depending on their level of skills), which is essentially a modi…ed version of the framework …rst introduced by Gomes (2013). In particular, we mainly investigate the e¤ects of a positive public sector wage shock on a calibrated South African labour market. For comparison purposes, we also assess the impact of a positive private sector productivity shock. We further take into account the di¤erent level of bargaining power and how the di¤erence in productivity between public and private sectors both a¤ect the responsiveness of variables. The …ndings show that an increase in private sector productivity produces more desirable results with an increase in employment for both skilled and unskilled workers which translates into a decrease in overall unemployment. Public sector wage shock on the other hand mainly crowds out private skilled labour which the …rms react to by substituting it with unskilled workers. Ultimately, the increase in public wages raises overall unemployment as supplementary skilled unemployed individuals queue for public jobs. Altogether, the e¤ects are more pronounced when the bargaining power of unskilled workers is raised.