ESTONIAN LABOR MARKET INSTITUTIONS WITHIN A GENERAL EQUILIBRIUM FRAMEWORK Marit Hinnosaar* October 2004 Working Papers of Eesti Pank No 5, 2004

The implications of the Estonian labor market policy reforms, such as changes to the minimum wage, social benefits and tax allowance, will be analysed using a simple applied general equilibrium model. The model used in the paper is from Bovenberg et al (2000), with the addition of an efficiency wage section based on Shapiro and Stiglitz (1984). The model integrates union bargaining and efficiency wage theory into a traditional CGE model framework.
JEL Code: D58, E62, J32, J50
Key words: computable general equilibrium models, unemployment, lowskilled labor, minimum wage, benefits, tax allowance

* The author thanks Aurelijus Dabusinskas, Toomas Hinnosaar, Reimo Juks, Rasmus Kattai, Märten Kress, John Lewis, Peeter Luikmel, David Mayes, Martti Randveer, Risto Vaittinen, Lenno Uusküla, and seminar participants in University of Tartu for helpful comments.

Authors' e-mail addresses: marit@hinnosaar.net

The views expressed are those of the author and do not necessarily represent the official view of the Bank.

Contents

1. Introduction

2. Wage Setting, Unemployment Benefits and Labor Taxes in Estonia

3. Description of the Model

3.1. General Overview

3.2. Households

3.3. Firms

3.4. Labor Market

3.4.1. Wage Bargaining

3.4.2. Efficiency Wage for High-Skilled Workers

3.5. Government

3.6. Foreign Trade

3.7. Equilibrium

4. Data and Calibration

5. Simulations

5.1. Description

5.2. Simulation Results

5.2.1. An Increase in Union Bargaining Power

5.2.2. An Increase in Replacement Rate

5.2.3. An Increase in Tax Allowance

6. Concluding Remarks

References

Appendices

Appendix 1. Main equations of the model

Appendix 2. Labor supply

Appendix 3. The impact of labor market institutions on labor supply

Appendix 4. First order conditions of CES function

Appendix 5. Ideal price index in case of CES function

Appendix 6. Profit maximisation

Appendix 7. The impact of wages on prices

Appendix 8. Labor demand

Appendix 9. Maximisation of Nash function

Appendix 10. The impact of labor market institutions on the low-skilled workers' wage

Appendix 11. Efficiency wage

Appendix 12. Data description

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