Efraim, Benmelech., Nittai , Bergman., & Amit Seru. Financing Labor. Retrieved from http://www.nber.org/papers/w17144
Terms
Absolute advantage - The ability of a country, company or individual to create products or services using fewer resources than other producers in the same field.
Capital resources- Goods that are made by individuals such as equipments and buildings, and are used to produce more goods and services
Determinants of demand –factors affecting purchase of goods, resources and services by consumers.
Economic system-a collection of laws, activities, institutions, human motivations and controlling that provide the foundation for economic decision making
Factors of production-resources/input in the production process
Full employment- economists use the concept of the rate of unemployment as an indicator for the highest level of employment that is sustainable.
Labor Market Institutions (LMI) – Organisations that are in existence to oversee activities of entities with regard to workers such as working environment, wages and fringe benefits among others
GDP growth- The overall growth of a entire country’s economy.
External finance- Funds that an entity has sourced from external parties such as banks or other lenders.
Macroeconomic variables- Issues such as demand and supply, which impact on the performance of a particular market
Working capital- The finances available to any given business entity for investments
According to the article, imperfections in the financial market have a significant impact on how firms decide to hire employees. Labor Market Institutions (LMI) tends to determine the rate of unemployment in the medium run. The Keynesian school of thought contends that periods of high real interest rates accompanied with insufficient capital accumulation result in high rates of unemployment. As such, any shifts in labor market institutions often cause unemployment and thus the rate of employment reflects how well the economy is utilizing labor. On the other hand, a healthy economy is indicated by a GDP growth for example in the united state in 2007, there was a 2 to 3 percent growth as unemployment remained below 5 percent. However, in 2008, GDP became negative even though the rate of unemployment remained low. Thus, GDP growth rebounded to positive territory in the middle of the year and at the same time unemployment rose rapidly.
The article relates to the real business cycle theory that relates to the difficulties in the economy. The rate of unemployment ranges form 3% to 7%, although it was at 10% or 25% during the great depression of the 1930s.As such, unemployment comes in three cycles, frictional, structural and cyclical depending on the Labor Force Participation Rate, and Labor Market Institutions. In this manner, availability of credit and financial constraints are vital elements in firm-level employment decisions, and they affect unemployment outcomes. If there are any frictions in the labor market then employment decision when labor is not the only variable factor in production will be rather fixed. As described in the article, the fixed cists are inclusive if investments that are associated to training and hiring activities within the firm. Facing an economic downturn, lack of external finances will affect the rate of employment directly since it also has a direct impact on investment. Most significantly, the rate of employment is adjusted by decline in capital specifically with the sensitivity of the investment cash flow (Efraim & Amit, 1).
Likewise, the article explains that labor market institution can also be affected by policy settings hence unemployment can be explained by macroeconomic variables used in analyzing changes in LMI. Therefore, the rise of unemployment is essentially caused by labor market inflexibility may result in wage-push factors in many countries. The fluctuating trends in labor markets can be determined by the cost and availability of external finances, which tend to have an impact on a firm’s employment decisions. Therefore, following a mismatch between labor, payment and generation of cash, firms find it necessary to finance their labor activity during the production process. When the firm’s financial ability to cater for working capital deteriorates, then the firm’s employment automatically falls.
Apart from that, variables that measure the availability of finance and potential fluctuations between cost of internal and external funds such as credit also correlate with the company’s Absolute advantage in production hence affecting its demand for labor. Thus, in simpler terms, the article suggests that employment is negatively related to financial constraints within a company and to the measure of external finance.
