A Theoretical Growth Model for Ireland

THE ECONOMIC AND SOCIAL REVIEW

We subject this model to three shocks: a shock to total factor productivity
A, a labour-market shock D and a capital market shock S. Noting that
Equation (5) allows us express r in terms of w, we can then employ Equations
(1), (2) and (4) to find the effects on K, L and w. It can easily be shown that K
and L (and thus GDP, GDP per head of population, and labour productivity)
rise in response to each shock, while w rises in response to the technology and
capital-market shocks but falls in response to the labour-market shock. (Even
in this latter case, however, GNP - which in our simple model corresponds to
the total wage bill - rises.) Since K and L respond together to each of our
shocks, we will concentrate on GNP, where some of the effects might be less
obvious.

The model can be presented graphically, in wage-employment space, as
follows. The labour-market equilibrium locus LL, is upward sloping, with
slope (1⅞2). LL is steeper the less mobile is labour (i.e., the lower is €2). The
capital-market locus KK is derived from Equations (2), (4) and (5) and is
downward- sloping with a slope of:

- cr Φ2 K/L / [cw + cr Φ2 (L/AFL')] < 0

The elasticity of KK lies between zero and minus one. KK is steeper the
less internationally mobile is capital (i.e., the higher is Φ₂). Now consider a
beneficial labour-market shock D which shifts LL to the right. This reduces w
and raises L, with the slope of KK ensuring that GNP rises. Furthermore, the
rightward shift of LL does not depend on the degree of capital mobility. Thus
the impact on GNP is higher the greater the mobility of capital.

An interesting result arises if the rightward shift of LL is independent of
the degree of labour mobility, as it may be under some formulations of the
labour-market shock. In this case, the flatter is LL (i.e., the higher the degree
of labour mobility, denoted LL_HLM in Figure 1), the smaller the fall in wages
and the lower the increase in employment and national income. A low degree
of labour mobility causes wages to fall more in response to labour-market
liberalisation, giving rise to a larger increase in the return to capital, which
triggers strong capital inflows and ultimately higher employment than in the
case where labour is more mobile. This can be seen by comparing the
equilibria at points 2 and 3, corresponding to high and low labour mobility
respectively, in Figure 1.

The other two shocks, the capital-market shock and the shock to TFP,
leave LL unchanged and instead shift the KK curve. Thus w and L move in the
same direction in these cases. The impact on GNP of both the capital-market
and the TFP shock is rising in €2 and falling in Φ2. Thus the greater the degree

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