Financial market regulation and job creation      Insights from the recent ILO Global Employment Trends Report            ...
Overview of the GET report   What is the GET?The ILO Global Employment Trends Report                                      ...
Overview of the GET report   Key messagesKey messages from the GET report   Global unemployment        has increased by 27...
Overview of the GET report                Motivation of today’s talkInvestment is key for employment recovery             ...
Overview of the GET report   Motivation of today’s talkFinancial market returns and investment                            ...
Financial markets and unemployment flows   Research strategyHow do financial markets affect jobs?    E. Ernst (ILO)          ...
Financial markets and unemployment flows   What drives unemployment dynamics?An overview of the model flows I  Decomposing u...
Financial markets and unemployment flows   What drives unemployment dynamics?An overview of the model flows II  Job creation...
Financial markets and unemployment flows   What drives unemployment dynamics?Putting the pieces togetherSubstituting the flo...
Financial markets and unemployment flows   Financial market development and unemployment flowsFinance and unemployment flows:...
Financial markets and unemployment flows   Financial market regulation and unemployment flowsFinancial market regulation    ...
Finance and jobs   Data and methodologyA word on the data  Unemployment flows come from Elsby et al. (2008)       Construct...
Finance and jobs   Data and methodologyEstimation methodology IStep-by-step estimation      Step 1: Identify base-line equ...
Finance and jobs   Data and methodologyEstimation methodology II    Step 3: Estimate macro model          Introduce macro-...
Finance and jobs      Financial development and unemployment flows: EvidenceFinancial determinants of outflows              ...
Finance and jobs   Financial development and unemployment flows: EvidenceFinancial determinants of inflows                  ...
Finance and jobs       Financial reguation and unemployment flows: EvidenceFinancial regulation and unemployment flows I    ...
Finance and jobs       Financial reguation and unemployment flows: EvidenceFinancial regulation and unemployment flows II   ...
Finance and jobs   Financial reguation and unemployment flows: EvidenceA first summaryFinancial market developments and unem...
Reform scenarios and employment dynamics   A macro-model to assess employment effects of financial reformsSetting up the mac...
Reform scenarios and employment dynamics   Financial reform scenariosReforms are not being implemented in isolation   Refo...
Reform scenarios and employment dynamics   Financial reform scenariosWhat shapes financial market regulation?    E. Ernst (...
Reform scenarios and employment dynamics   Financial reform scenariosFour broad reform scenarios emerge... 1   Business-As...
Reform scenarios and employment dynamics   Financial reform scenarios...and their expected macro consequences XXX         ...
Reform scenarios and employment dynamics                 Financial reform scenariosWhat happens to jobs?                  ...
Concluding remarksLessons learned and outlookWhat have we learned so far?    Financial markets have significant effects on l...
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Financial regulation and employment growth

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What will be the impact of changes in financial market regulation on employment? Based on insights recently published in the ILO's Global Employment Trends 2012, this presentation provides empirical results on the impact changes in banking regulation, international financial transaction taxes and regulation of securities markets might have on job creation, job destruction and employment growth.

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Financial regulation and employment growth

  1. 1. Financial market regulation and job creation Insights from the recent ILO Global Employment Trends Report Ekkehard Ernst1 1 Employment Trends Unit International Labour Organization Geneva ernste@ilo.org http://ekkehard.ernst.free.fr ECB Feb 10th, 2012 E. Ernst (ILO) GET presentation Frankfurt, 2012 1 / 26
  2. 2. Overview of the GET report What is the GET?The ILO Global Employment Trends Report ILO’s annual flagship study. Discusses global and regional employment trends. Medium-term projections on the basis of consensus GDP forecasts (up to 2016). Analyses of particular key macro and policy developments. This year: Financial market crisis and its consequences. Available at: http://www.ilo.org/get E. Ernst (ILO) GET presentation Frankfurt, 2012 2 / 26
  3. 3. Overview of the GET report Key messagesKey messages from the GET report Global unemployment has increased by 27 million since the start of the crisis could reach up to 210 million next year will only gradually decline by 2016 Working poverty 1 in 3 workers is either poor or unemployed Declining trend in working poverty has been stopped by the crisis Global investment An increase by 2 pp could absorb global unemployment Corresponds to $1200 billion. E. Ernst (ILO) GET presentation Frankfurt, 2012 3 / 26
  4. 4. Overview of the GET report Motivation of today’s talkInvestment is key for employment recovery 220 7.0 Unemployment (in million) 210 Unemployment rate (in %) 6.5 200 6.0 190 180 5.5 170 5.0 160 150 4.5 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total unemployment Total unemployment − downside scenario Unemployment rate Unemployment rate − downside scenario Unemployment rate − Unemployment rate − upside scenario boosting investment E. Ernst (ILO) GET presentation Frankfurt, 2012 4 / 26
  5. 5. Overview of the GET report Motivation of today’s talkFinancial market returns and investment 4.0 2010 2006 2007 Annual average productivity growth 2000 2004 3.0 2005 2011 2.0 2003 (in percent) 2008 2002 1.0 2001 0.0 −1.0 2009 −2.0 −1.0 0.0 1.0 Changes in investment shares (in percentage points) E. Ernst (ILO) GET presentation Frankfurt, 2012 5 / 26
  6. 6. Financial markets and unemployment flows Research strategyHow do financial markets affect jobs? E. Ernst (ILO) GET presentation Frankfurt, 2012 6 / 26
  7. 7. Financial markets and unemployment flows What drives unemployment dynamics?An overview of the model flows I Decomposing unemployment dynamics Ut = Lt − ETt = INt − OUTt Labour force growth Lt = α3 + β31 Lt −1 + β32 ut −1 + β33 Taxt Employment growth ETt = JobCreationt − JobDestructiont E. Ernst (ILO) GET presentation Frankfurt, 2012 7 / 26
  8. 8. Financial markets and unemployment flows What drives unemployment dynamics?An overview of the model flows II Job creation JobCreationt = β11 ETt −1 + β12 wt + β13 ADt + β14 Ut + β15 Vt + β16 Financet −1 Job destruction JobDestructiont = β21 TFPt +β22 Financet +β23 εt +β24 IMPt +β25 wt +β26 ADt Wage determination: wt = α4 + β41 Kt + β42 CBt + β43 ut −1 + β44 Taxt E. Ernst (ILO) GET presentation Frankfurt, 2012 8 / 26
  9. 9. Financial markets and unemployment flows What drives unemployment dynamics?Putting the pieces togetherSubstituting the flow equations: OUTt = JobCreationt INt = JobDestructiont + ∆Lt −1Hence: OUTt = β11 OUTt −1 + β12 INt + β13 XtJobCreation + β14 ut −1 + β15 Financet −1 INt = β21 INt −1 + β22 OUTt + β23 XtJobDestruction + β24 Lt −1 + β25 Financetwhere: Share prices Interest rates Finance = Financial development Market volatility E. Ernst (ILO) GET presentation Frankfurt, 2012 9 / 26
  10. 10. Financial markets and unemployment flows Financial market development and unemployment flowsFinance and unemployment flows: Hypotheses Mount-Pelerin-Hypothesis Financial development positive for labour dynamics Reduces unemployment inflows Increases unemployment outflows Schumpeter-Hypothesis Financial development leads to more turnover Increases both U inflows and outflows Attac-Hypothesis Financial development comes at the expense of the real economy Destroys jobs without creating new somewhere else E. Ernst (ILO) GET presentation Frankfurt, 2012 10 / 26
  11. 11. Financial markets and unemployment flows Financial market regulation and unemployment flowsFinancial market regulation Regulation of international capital flows e.g.: FTTs, capital controls reduce availability of foreign capital lower financial market competition but also reduce volatility Banking sector regulation e.g. macro-prudential regulation reduces credit growth ambiguous effect on interest rates, expected to reduce volatility Regulation of (securitized) financial products e.g. CCPs reduce diversity and availability of (securitized) products ambiguous effects on volatility E. Ernst (ILO) GET presentation Frankfurt, 2012 11 / 26
  12. 12. Finance and jobs Data and methodologyA word on the data Unemployment flows come from Elsby et al. (2008) Constructed on the basis of information regarding unemployment duration at different duration lengths Information on financial market development is based on updated data by Torsten Beck Size of financial sector assets and liabilities (banking, bond markets, stock markes) Financial sector reforms has been provided by Abiad et al. (2008) Information on interest rate ceilings, credit growth restrictions, entry barriers for banks, (financial sector) privatisations and security market reforms Information on international capital flows has been used from Lane and Milesi-Ferretti (2006) Importance of internationally traded assets and liabilities, such as foreign direct investment, portfolio equity and debt flows, and financial derivatives Macro indicators come from the OECD Economic Outlook database and the OECD Main Economic Indicators (vacancies, share prices) E. Ernst (ILO) GET presentation Frankfurt, 2012 12 / 26
  13. 13. Finance and jobs Data and methodologyEstimation methodology IStep-by-step estimation Step 1: Identify base-line equations Macro variables to affect unemployment flows Reduced-form panel estimates GMM used to control for endogeneity Results published in Ernst (2011) Step 2: Identify relevant financial variables Use baseline specifications and add financial market variables Separately for financial development and regulation Identify preferred specification E. Ernst (ILO) GET presentation Frankfurt, 2012 13 / 26
  14. 14. Finance and jobs Data and methodologyEstimation methodology II Step 3: Estimate macro model Introduce macro-economic closure: Okun’s law Introduce endogenous policy rules Estimate using GMM Step 4: Design reform scenarios Develop reform scenarios Take into account feedback loops from financial community Analyse impact on employment growth E. Ernst (ILO) GET presentation Frankfurt, 2012 14 / 26
  15. 15. Finance and jobs Financial development and unemployment flows: EvidenceFinancial determinants of outflows Dependent variable: Unemployment outflows (1) (2) (3) (4) (5) Unemployment outflows 0.750*** 0.847*** 0.646*** 0.638*** 0.810*** (lagged) (3.6e-2) (3.0e-2) (4.3e-2) (4.0e-2) (3.3e-2) Employment rate 0.517 0.065 0.700 0.969** (lagged) (1.2e-1) (1.1e-1) (9.1e-2) (1.1e-1) Output gap 1.8e-2*** 1.9e-2*** 2.6e-2*** 2.2e-2** 1.6e-2** (7.0e-3) (7.0e-3) (7.0e-3) (6.0e-3) (7.0e-3) User cost of capital -1.4e-2** -1.6e-2*** -1.7e-2*** -1.5e-2** -1.6e-2** (7.0e-3) (7.0e-3) (6.0e-3) (6.0e-3) (7.0e-3) Wage-interest rate -9.1e-2*** -8.6e-2*** -8.7e-2*** -8.3e-2*** -1.1e-1*** ratio (3.1e-2) (3.2e-2) (3.3e-2) (2.8e-2) (3.7e-2) Real share price growth 1.3e-1*** 1.2e-1** 1.3e-1*** 1.4e-1*** 1.4e-1*** (4.8e-2) (5.2e-2) (4.7e-2) (4.5e-2) (5.5e-2) Gross fixed capital 2.473*** 1.516* 1.992** 2.872*** 1.540 investment (8.8e-1) (9.1e-1) (8.8e-1) (8.2e-1) (9.8e-1) Real household disposable 2.206*** 2.435*** 2.132*** 2.012*** 2.510*** income growth (6.2e-1) (6.6e-1) (6.1e-1) (5.8e-1) (6.9e-1) Financial market 0.131*** 0.127*** development (3.9e-2) (3.4e-2) Banking sector -0.127*** -0.094** leverage (3.6e-2) (3.7e-2) International financial -0.001*** -2.9e-4*** openness (lagged) (0.000) (1.1e-4) Real growth in liquid 0.459*** 0.398** liabilities (1.4e-1) (1.6e-1) Observations 191 192 179 190 176 Number of countries 8 8 8 8 8 Note: All estimates performed using Arellano-Bond System GMM estimator. Standard errors in parentheses. The number of asterisks indicate the statistical significance level *** p<0.01, ** p<0.05, * p<0.1 E. Ernst (ILO) GET presentation Frankfurt, 2012 15 / 26
  16. 16. Finance and jobs Financial development and unemployment flows: EvidenceFinancial determinants of inflows Dependent variable: Unemployment inflows (1) (2) (3) (4) (5) Unemployment inflows 0.965*** 0.966*** 0.958*** 0.962*** 0.956*** (lagged) (1.0e-2) (1.0e-2) (1.1e-2) (1.0e-2) (1.1e-2) Output gap -2.9e-2*** -2.8e-2*** -2.7e-2*** -2.1e-2*** -2.4e-2*** (5.0e-3) (5.0e-3) (5.0e-3) (5.0e-3) (5.0e-3) TFP growth 2.8e-1*** 2.8e-1*** 3.1e-1*** 3.2e-1*** 2.7e-1*** (5.2e-2) (5.3e-2) (5.5e-2) (5.3e-2) (5.6e-2) Labour force growth 1.179** 1.146** 1.238** 1.626*** 2.170*** (lagged) (5.0e-1) (5.0e-1) (5.6e-1) (5.2e-1) (5.8e-1) User cost of capital 6.0e-3** 6.0e-3** 5.0e-3* 5.0e-3* 7.0e-3** (lagged) (3.0e-3) (3.0e-3) (3.0e-3) (3.0e-3) (3.0e-3) Financial market 3.3e-2** 4.8e-2** development (1.5e-3) (2.0e-3) Banking sector 3.2e-2* 8.4e-2*** leverage (1.8e-2) (2.2e-2) International -1.4e-4** -2.6e-4*** financial openness (6.9e-5) (8.0e-5) Real credit -2.3e-1*** -2.6e-1*** growth (5.5e-2) (6.0e-3) Observations 304 305 273 303 270 Number of countries 12 12 12 12 12 Note: All estimates performed using Arellano-Bond System GMM estimator. Standard errors in parentheses. The number of asterisks indicate the statistical significance level *** p<0.01, ** p<0.05, * p<0.1 E. Ernst (ILO) GET presentation Frankfurt, 2012 16 / 26
  17. 17. Finance and jobs Financial reguation and unemployment flows: EvidenceFinancial regulation and unemployment flows I Dependent variable: Unemployment outflows (1) (2) (3) (4) Unemployment outflows 0.857*** 0.860*** 0.823*** 0.886*** (lagged) (0.0273) (0.0248) (0.0291) (0.0288) Financial derivatives liabilities -2.851*** -2.532*** -3.238*** -2.736*** (in % of GDP, lagged) (0.711) (0.634) (0.659) (0.751) Removing directed credit 0.0536** provisions (lagged) (0.0219) Loosening of interest rate controls -0.0431* (lagged) (0.0251) Lifting of entry barriers -0.0417*** (lagged) (0.0159) Bank privatization 0.0228 (lagged) (0.0165) Deregulation of international capital flows 0.0685 0.174*** (lagged) (0.0455) (0.0530) Capital account openness 0.0350** 0.0220 (lagged) (0.0156) (0.0170) Securities markets deregulation 0.123*** 0.116*** 0.135*** 0.135*** (lagged) (0.0345) (0.0398) (0.0358) (0.0383) Prudential regulation of banks 0.0376*** 0.0348*** 0.0298*** 0.0265** (lagged) (0.00911) (0.0119) (0.0108) (0.0127) Banking sector distance to default 0.00626* (0.00323) Financial stress index -0.0131** (lagged) (0.00654) Observations 145 152 149 139 Number of countries 8 8 8 7 Note: All estimates performed using Arellano-Bond System GMM estimator contain a (significant) constant. Standard errors in parentheses. The number of asterisks indicate the statistical significance level *** p<0.01, ** p<0.05, * p<0.1 E. Ernst (ILO) GET presentation Frankfurt, 2012 17 / 26
  18. 18. Finance and jobs Financial reguation and unemployment flows: EvidenceFinancial regulation and unemployment flows II Dependent variable: Unemployment inflows (1) (2) (3) (4) Unemployment inflows 0.939*** 0.936*** 0.933*** 0.943*** (lagged) (0.0184) (0.0196) (0.0199) (0.0203) Removing directed credit 0.0308** provisions (lagged) (0.0121) Financial derivatives liabilities 0.194 -0.0601 0.197 0.236 (in % of GDP, lagged) (0.406) (0.439) (0.394) (0.423) Loosening of interest rate controls -0.0199 (lagged) (0.0138) Lifting of entry barriers -0.00659 (lagged) (0.0108) Bank privatization 0.0244*** (lagged) (0.00850) Deregulation of international 0.0169 capital flows (lagged) (0.0283) Capital account openness -0.0530*** -0.0629*** -0.0579*** -0.0567*** (lagged) (0.00939) (0.0115) (0.00926) (0.0107) Securities markets deregulation 0.0546*** 0.0467** 0.0659*** 0.0768*** (lagged) (0.0152) (0.0222) (0.0155) (0.0258) Prudential regulation of banks -0.0123** -0.0218*** -0.0116** -0.0119* (lagged) (0.00547) (0.00730) (0.00589) (0.00646) Change in financial stress index 0.00656** (lagged) (0.00258) Change in banks’ distance -0.00378* to default (lagged) (0.00228) Observations 211 211 192 192 Number of countries 12 12 10 12 Note: All estimates performed using Arellano-Bond System GMM estimator. Standard errors in parentheses. The number of asterisks indicate the statistical significance level *** p<0.01, ** p<0.05, * p<0.1 E. Ernst (ILO) GET presentation Frankfurt, 2012 18 / 26
  19. 19. Finance and jobs Financial reguation and unemployment flows: EvidenceA first summaryFinancial market developments and unemployment flows Financial market development raises labour market turbulence by increasing both unemployment out- and inflows. Credit growth promotes employment growth unambiguously by decreasing inflows and raising outflows. Banking sector leverage depresses labour market dynamics. International openness lowers labour market turnover.Financial market regulation Prudential regulation of banks strengthen labour market dynamics. Deregulation of securities market increase labour market turnover. Ambiguous effects of credit controls. E. Ernst (ILO) GET presentation Frankfurt, 2012 19 / 26
  20. 20. Reform scenarios and employment dynamics A macro-model to assess employment effects of financial reformsSetting up the macro-model Labour market flows and matching: OUTt = αOUT + β11 OUTt −1 + β12 INt + β13 XtJobCreation INt = αIN + β21 INt −1 + β22 OUTt + β23 XtJobDestruction + β24 XtLabourForce ETt = αET + β31 OUTt − β32 INt Okun’s law: Gapt = −δ1 INt −1 +δ2 OUTt −1 +δ3 INVt −1 +δ4 GovConst −1 −δ5 Taxt −1 +δ6 ∆NetExportst −1 Philipps curve: πt = γ b πt −1 + γ f E πt+1 + Gapt −1 + TOTt −1 Taylor rule: itm = (1 − ϕ) itm 1 + ϕ [b1 E πt+1 + b2 Gapt + b3 (GovConst −1 − Taxest −1 )] − Investment dynamics: INVt = ∆RSharet −1 + Rtl −1 + ∆ETt −1 + GovInvt −1 − GovConst −1 + ∆Prodt −1 E. Ernst (ILO) GET presentation Frankfurt, 2012 20 / 26
  21. 21. Reform scenarios and employment dynamics Financial reform scenariosReforms are not being implemented in isolation Reform debates in different countries and at different levels Banking sector reforms (e.g. Basel III) Reforms of derivative markets (e.g. central clearing houses) International reforms (e.g. tax on international transactions, capital controls) Financial market problems are multi-faceted Credit growth and leverage has been too high Systemic interconnections have been too frequent Lack of transparency has prevented better appreciation of risks by investors Different actors pursue different political agendas Policy makers care about access to funds and economic stability Workers care about job stability and wage increases Financial investors care about diversification and investment opportunities Managers care about empire-building and earnings growth Political compromises involve multi-dimensional agendas to satisfy all four actors E. Ernst (ILO) GET presentation Frankfurt, 2012 21 / 26
  22. 22. Reform scenarios and employment dynamics Financial reform scenariosWhat shapes financial market regulation? E. Ernst (ILO) GET presentation Frankfurt, 2012 22 / 26
  23. 23. Reform scenarios and employment dynamics Financial reform scenariosFour broad reform scenarios emerge... 1 Business-As-Usual (BAU): No or ineffective reforms No (major) changes in financial market regulation and continuous high market volatility Profit sharing between CEOs and financial investors; pressure on wages and further increase in inequality 2 Brakes on (financial) globalization Managed international flows but no domestic reforms Less international volatility but few(er) possibilities for diversification Moderate improvements in wage developments and inequalities 3 A new compromise: Domestic reforms with open international capital markets Substitution of domestic by international financial liquidity Stonger pressure by international financiers for favourable regulation 4 Full-scale regulation: Both international and domestic (re-)regulation Reduced international and domestic volatility at the expense of higher user cost of capital Profit sharing at the firm level between workers and managers and improved wage-productivity linkage Less reliance on public debt but larger role of the state (at least in the form of higher taxes) E. Ernst (ILO) GET presentation Frankfurt, 2012 23 / 26
  24. 24. Reform scenarios and employment dynamics Financial reform scenarios...and their expected macro consequences XXX International XXX XXX capital flows Unreformed Tightened Regulation Domestic XXX financial markets XX X Scenario I : Scenario III : Permanent increase in Moderate reduction in financial financial stress stress Return to highly value shares Moderate reduction or stable share Unreformed Continued export and import prices growth Further export and import growth High international capital Moderate increase in international flows capital flows Scenario II : Scenario IV : Moderate increase in Permanent reduction in financial financial stress stress Tightened Stable share prices Lower real share prices regulation Slower trade growth Slower growth of world trade Reduced international capital Reduction in international capital flows flows E. Ernst (ILO) GET presentation Frankfurt, 2012 24 / 26
  25. 25. Reform scenarios and employment dynamics Financial reform scenariosWhat happens to jobs? 2.5 Annual employment growth 2.0 (in percent) 1.0 1.5 0.5 0.0 Baseline International Domestic Fully coordinated scenario reforms only reforms only reforms After 1 year After 3 years After 5 years Note: The chart compares employment growh rates of different reform scenarios with the baseline. The bars represent differences in annual employment growth rates in percentage points. E. Ernst (ILO) GET presentation Frankfurt, 2012 25 / 26
  26. 26. Concluding remarksLessons learned and outlookWhat have we learned so far? Financial markets have significant effects on labour dynamics. This holds for both financial market development and regulation. Reform scenarios yield substantially differences in employment growth.Avenues for future research Derive financial market interactions from first principles Introduce different forms of financial frictions Specify the political economy interactions E. Ernst (ILO) GET presentation Frankfurt, 2012 26 / 26

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