RDP 9801: Labour Market Adjustment: Evidence on Interstate Labour Mobility 2. Theory and Existing Evidence

The Australian states can be considered as a series of small open economies with a fixed exchange rate. Each state is subject to state-specific shocks, in addition to national or aggregate shocks. Because there is a fixed exchange rate between states, when a state is hit by an adverse idiosyncratic shock, the adjustment mechanism of a state-specific depreciation, or a state-specific easing in monetary policy is not available. Rather adjustment can be facilitated by federal (or state) fiscal policy or by changes in factor flows and factor prices. Here we are focusing on the latter adjustment mechanism.^[2]

Throughout we assume that there are no state-specific shocks to labour supply. That is, we are only concerned with changes in labour supply induced by interstate migration. Thus we abstract from the fact that a disproportionate number of overseas immigrants settle first in urban New South Wales (Migration, Australia, ABS Cat. No. 3412.0), from where they may then subsequently migrate to other states. Also, there seems to be some evidence that there has been an exogenous shift in preferences through time towards living in Queensland (Hagan and Mangan 1996).

Rather, we assume that any shock to the state labour market is in the form of a labour demand shock, related to changes in the demand for the state's product. These shocks may arise because of the different industrial structures of the states – for example, South Australia and Victoria have a higher share of employment in the manufacturing industry than the other states^[3] – or from state-specific financial shocks such as the difficulties of the State Bank of South Australia and the State Bank of Victoria in the late 1980s. Monetary policy may also have different regional impacts as certain states may have a higher concentration of more interest-sensitive sectors. Differences in state fiscal policy are another source of state-specific demand shocks.

Suppose there is an adverse state-specific shock, which generates a rise in unemployment relative to the national average. There are four possible avenues of adjustment which can eliminate this relative unemployment differential:

• Wage adjustment. The wage in the state falls relative to the wage rate in the rest of the country. This adjustment can be classified as a purely internal labour market adjustment.
• Firm (or capital) mobility. Firms relocate to the state to take advantage of the relatively larger pool of unemployed workers. This channel would be further enhanced by a fall in the relative wage.
• Labour mobility. Workers in the state migrate to a state where the unemployment rate is lower. Again, a fall in the relative wage would further encourage out-migration.
• Exit from labour force. Workers remain in the state, but leave the labour force.

Movements in the real wage therefore have an ambiguous effect on labour mobility. On the one hand, a fall in the wage will encourage out-migration because the return to working in the state is relatively lower. On the other hand, the lower wage will increase labour demand and encourage in-migration of firms, thereby reducing unemployment and hence, the incentive to move.

The wage adjustment mechanism depends on the definition of the ‘relevant’ labour market; for example, whether wages are determined at a suburban, state or national level. This issue has been addressed in a number of papers examining the existence of a ‘wage curve’. Blanchflower and Oswald (1994) find a significant negative relationship between the wage level in a region and the regional unemployment rate for a number of countries including Australia. For Australia, they find an elasticity of −0.19 for the effect of changes in the state unemployment rate on average weekly earnings in the state. This suggests that local wage changes may play a major role in the adjustment process.

Kennedy and Borland (1997) re-examine the evidence of a wage curve for Australia and find that it is not robust to the inclusion of state fixed effects. They present evidence that Blanchflower and Oswald's finding of a significant effect of the state unemployment rate on the state wage levels reflects the fact that the state unemployment rate is proxying for other factors that vary across states, particularly housing costs.

It is difficult to assess the role that firm mobility plays in reducing unemployment differentials in the absence of data on job creation and destruction by state. However, there are reasons to believe that this may not be a major part of the adjustment mechanism, and may in fact work in the reverse direction. The existence of demand spillovers (Diamond 1982) implies that a region that has been hit by a negative idiosyncratic demand shock is less likely to attract (say) service sector firms. This would be further enhanced by the negative income effect of decreased employment and lower wages.^[4]

Consequently, the mechanism we focus on here is labour migration. Harris and Todaro (1970) provide the seminal model of labour migration. In their model, the decision to migrate is dependent on a number of factors:

• Relative wages. The higher the wage in a particular location, the greater the probability of the worker moving to that location. However, even if the unemployment rate is relatively high in a particular location, a worker may still prefer to remain in that location if the wage there is high enough to compensate for the reduced likelihood of finding employment.^[5]
• Relative employment prospects; that is the probability of employment in the home state relative to that in other parts of the country.^[6]
• Housing costs. Housing is the largest non-tradeable good in the household's consumption basket, and hence, is likely to be the largest source of differences in the real consumption wage across locations. Oswald (1996) finds a positive relationship across countries between home ownership levels and unemployment rates, suggesting that the fixed costs of home ownership discourage migration.
• Other migration costs. These include the costs of physically relocating, as well as the less tangible costs of leaving an established network of friends and family.

Empirical evidence for the United States suggests that migration is a major part of the labour market adjustment mechanism. Blanchard and Katz (1992) find that in response to a state-specific increase in unemployment, labour migration plays the major role in reducing the interstate unemployment differential. A state returns to its trend rate of employment growth, but at a lower level of employment as workers leave the state. The migration response is strong even in the first year after a shock: if relative state employment falls by 10 workers, in the first year, unemployment rises by 3, the participation rate falls by 0.5, and 6.5 workers leave the state. In the long run (after 7 to 10 years), employment falls by around 13 workers, all of whom have migrated to other states. Thus there is an employment multiplier effect, consistent with Diamond (1982) demand spillovers.

Blanchard and Katz find that the regional nominal wage falls during the adjustment period, but does not contribute much to the adjustment process. However, they find that the regional consumption wage does not fall nearly as far, as house prices also tend to fall when a region is hit by a negative shock. The fall in house prices and resultant fall in household wealth should also reduce the incentive to move. These results suggest that the decision to migrate is driven by the state of the labour market rather than by the fall in the nominal wage. The fact that workers shift rather than firms is thus more surprising, given that the consumption wage is relatively unchanged (decreasing the incentive of workers to migrate out of a depressed region) while the nominal wage falls (increasing the incentive of firms to move in).

Decressin and Fatas (1995) find that labour mobility plays a considerably smaller role in the adjustment of European labour markets to region-specific shocks. They find that unemployment returns to trend after a region-specific shock because of changes in the participation rate rather than migration. That is, workers leave the labour force rather than the region. Bentolila (1997) finds that in Spain, there is evidence even of in-migration to depressed regions, rather than out-migration from depressed regions. This may be due to return migration or compensating differentials such as quality of life and housing prices. He also finds that the level of migration is negatively related to the national level of unemployment. This suggests that the workers perceptions of the probability of employment in other regions is significantly correlated with the national unemployment level. This negative correlation is also found by Faini et al. (1997) for Italy, and by Pissarides and Wadsworth (1989) for the UK. Faini et al. also attribute the declining rate of inter-regional migration in Italy over the past 20 years to high mobility costs, particularly caused by the lack of national co-ordination of job placement activities.

Pissarides and Wadsworth find that in the UK, the unemployed are more likely to move than the employed. However, Bentolila finds the converse is true for Spain. The employed may be more mobile because they are more likely to transfer states with their existing employer. Secondly, they may be less credit constrained in meeting the adjustment costs of shifting location. On the other hand, the unemployed may have more incentive to search for employment in other regions.

Pissarides and Wadsworth also find that an unemployed worker in a high unemployment region is no more likely to move than an unemployed worker in a low unemployment region. DaVanzo (1978) finds that the converse is true in the United States. McCormick (1997) finds that differences in regional unemployment rates in the United Kingdom are primarily the result of differences in the unemployment rate of manual workers. In response to an adverse region-specific shock, non-manual labour tends to migrate, whereas manual labour tends to leave the labour force.

In Australia, the Industry Commission (1993) analysed the impact of labour migration on relative unemployment rates in a framework very similar to the one used in Section 5 of this paper. Their empirical work employs a vector error correction model, based on unit root tests suggesting that all the variables used in their model are non-stationary. They find that changes in the participation rate are a major part of the adjustment mechanism to state-specific shocks and that migration has a relatively minor role in the adjustment process. The different stationarity assumptions, as well as the shorter sample period employed in their study accounts for the differences between their results and those presented in Section 5.

Borland and Suen (1990) analyse the interaction between labour mobility and unemployment differentials for Australia. They conclude that state-specific shocks exacerbate unemployment differentials in the short run, although labour mobility acts to equalise unemployment rates in the long run. The implication of this analysis is that long-run differentials in unemployment rates between states reflect compensating differentials (in terms of real wages or lifestyle factors).

Kilpatrick and Felmingham (1996) examine the issue of inter-industry labour mobility in Australia. They find that mobility varies significantly across states, and for males is dependent on the state of the cycle, and the length of job tenure. The likelihood of mobility is not affected by education levels or occupation (which may be seen as proxying for skill), counter to the results found for the UK. Their study is based on analysis of unit record data in the ABS survey of labour mobility (Cat. No. 6209.0). Unfortunately, the published survey contains little useful information about interstate labour mobility, and without access to the unit record files, we do not make much use of the survey in this paper. The most recent Labour Mobility survey (for the year ended February 1996) reveals that among interstate migrants who were marginally attached to the labour force, approximately half were employed both at the time the sample was taken and twelve months previously, while the other half were either unemployed, or out of the labour force, at either the start or the end (or both) of the year of their migration.

Finally, the definition of a region we are looking at in this paper is the state. We are implicitly assuming that the intra-state labour market functions relatively effectively and that the major barriers to mobility are at the interstate level. Gregory and Hunter (1995) suggest that this may not be so, in that labour may be relatively immobile between suburbs within a city, because of the importance of informal job placement and informal job networks. Intra-state immobility would further raise the natural rate of unemployment by increasing geographic mismatch between workers and jobs.

Footnotes

These issues are particularly relevant for the European Monetary Union. See Eichengreen (1990) for a comprehensive discussion in that context. [2]

17.3 per cent and 19.6 per cent respectively in February 1997, compared to a national average of 13.9 per cent. [3]

The recent decision by Bankers Trust to relocate some of its funds management operations to South Australia does, however, indicate that firms are willing to relocate to an area with an easily accessible pool of high quality unemployed labour. [4]

This is one of the key results of Harris and Todaro's model which was originally designed to explain urban migration in developing countries. The wage curve evidence of Blanchflower and Oswald provides counter-evidence to this proposition. [5]

One implication of the model is that if workers are risk averse, they will respond more to the relative employment probabilities than to the real wage. Treyz et al. (1993) provide evidence that supports this hypothesis. [6]