Labour Market Model

The LMM uses actual economic data to estimate how an economy might react to changes in labour market policies, reforms or external factors. It provides results for each EU Member State as well as for the EU aggregate. The model has been developed by external experts from EcoAustria.

The LMM is a dynamic computable general equilibrium model with a detailed description of the labour market and the public sector (tax- and public social system). It can be used for comparative-static (comparing an initial equilibrium to a new equilibrium after a change) and dynamic simulations (observing an economy’s transition over time from one equilibrium to the other)It is based on an in-depth micro-foundation for the actors involved, namely households and firms. The specific structure of the model allows for results to be split by 8 age groups (based on overlapping generations, starting from 15-19 to 85+). and 3 skill groups (low-, medium- and high skilled). Based on an Overlapping Generations approach, household behaviour and all labour market variables are modelled for eight different age groups.

The LMM is used to provide a theoretical and empirical basis for identifying the possible direction and intensity of the effects of policies, rather than to make forecasts/projections of future developments. For instance, such policies can comprise changes in direct and indirect taxation, active and passive labour market policies, employment protection legislation (EPL), training subsidies, pension regimes, direct support to vulnerable groups (such as low-income employment), and demographic shocks (e.g., migration). Simulation results indicate the effects of policy reforms on macroeconomic and labour-market specific variables (such as GDP, investment, private consumption, unemployment, employment, and wages). Household-specific variables can either be presented on an aggregate level or on a more disaggregated level, such as age- and/or skill-dependent. Based on the model, inter- as well as intra-generational and inter-temporal effects can be analysed.

Based on an Overlapping Generations approach, household behaviour and all relevant labour market variables are modelled for eight different age groups. Four of these groups belong to the working-age population, three have already reached retirement age and do not participate in the labour market, while the so-called mixed age group includes people of working age who are already eligible to retire. Importantly, the model features three different skill groups (low-, medium-, and high-skilled persons), endogenous skill choice, as well as complementarity between capital formation and skills.

Decisions of households and firms are the result of an optimisation of lifetime utility and firm value, respectively. Households decide on the allocation of private consumption over the life cycle, labour supply along several margins (participation in the labour market, the intensity of job search if unemployed, number of hours worked if employed, and retirement age) and investment in human capital (educational decisions at the beginning of a lifetime and lifelong learning decisions during active life). Firms choose the optimal amount of physical investment, the number of vacancies, the lay-off rate, and the amount of investment in firm sponsored training. The model applies a static search model. The specific structure of the model allows for age- and skill-specific labour markets and unemployment rates. Wages are the result of a bargaining process between firms and households. The model captures a detailed description of public revenues and expenditures, as well as relevant institutions (e.g., passive labour market policies or EPL).

The model derives firms’ and worker’s labour market and economic behaviour from some general intertemporal utility/profit maximisation problems. Most of the resulting equations are assumed to be similar across the different Member States, while country-specific differences are implemented via different values of the same parameter.

• EU SILC
• LFS
• HBS
• MISSOC

To calibrate the model, a considerable amount of data input from various data sources is required. To the extent possible, we use harmonised data. Basically, part of the calibration procedure is based on methods that are similar across countries (e.g., age- and skill-specific labour market variables derived from disaggregated household micro data or macroeconomic indicators), while other parts of the calibration method (e.g., institutional settings) require considerable additional effort for each country.