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INTERVIEWS
WITH ECONOMISTS
PROFESSOR
JOHN FREEBAIRN
John Freebairn is Professor of Economics at the University
of Melbourne. His previous appointments include Monash and La
Trobe universities and the Business Council of Australia. He researches
applied microeconomics, with special interests in taxation reform
and unemployment policy options.
High unemployment is a major economic and social problem in Australia.
At mid-1999 about 7.5 per
cent of the workforce, or over 700 000 people, were unemployed.
Several explanations for there being too few jobs on offer have
been made by economists. These include labour costs that are too
high, inadequate skills, insufficient aggregate demand, and an
overly regulated industrial relations system. With a knowledge
of the elasticity of demand for labour (that is, the responsiveness
of numbers employers would hire with respect to changes in wages
– the price of labour), we can estimate the increase in employment
and the effect on labour incomes (wage rate per employee times
numbers employed) of wage restraint.
Several studies of the demand for labour in Australia have reported
estimated labour demand elasticities. Estimates of the elasticity
for the short run, a period of about three months, where opportunities
to adjust are few, are between 0.1 and 0.2. After about eighteen
months, by which time employers can adjust the mix of machines
and people and the mix of labour intensive versus capital intensive
products, the long-run labour demand elasticity is estimated to
be between 0.4 and 0.8.
Suppose the growth of wages was to be reduced by 5 per cent relatively
to what otherwise might happen. This could be the result of a
government-imposed wages freeze, a tax cut for wage-restraint
trade-off, voluntary agreement between the ACTU and employers,
or enterprise bargaining recognising that lower wages could help
the unemployed.
What would happen to employment? Lower wages mean we move down
the labour demand curve and more people are employed. Within the
first three months employment would increase by between 0.5 per
cent and 1.0 per cent (being the short-run elasticity of 0.1 or
0.2 times the wage reduction of 5 per cent). By the end of eighteen
months the long-run employment increase would be between 2 per
cent and 4 per cent (being the long-run elasticity of 0.4 or 0.8
times the wage reduction of 5 per cent). Given current employment
of nearly 8 million people, this means an extra 160 000 to 320
000 people employed.
What about the effect on total labour income? Since the demand
for labour is inelastic, a wage reduction will result in a fall
in aggregate labour income, even though more people have jobs
and fewer are unemployed.
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