The long- and short-term relationships between labour supply and employment

A key success criterion for economic structural policy in Denmark has been increasing the labour supply, such as through tax, labour, and welfare reforms. The ultimate goal of increasing the labour supply is greater employment, thereby increasing economic prosperity and strengthening public finances. There are significant theoretical arguments to support the idea that long-term growth of the labour supply determines growth in employment. For example, in the short term, an increase in the labour supply will put pressure on real wages, in turn increasing the demand for labour and thus increasing employment. There is also a large series of empirical examples that show how increased labour supply causes employment to also increase in the long term. In this research paper, we prove this using a systematic, statistical analysis of Danish quarterly data from 1996 – 2016. Although this period was also characterised by a strong economic shock — the financial crisis — the data nonetheless confirm the clear, long-term association between labour supply and employment.

We also find that the labour supply has only temporary effects on real wages. This is due to the fact that in the long term, real wages are determined by productivity. It is shown that, after a 1 per cent increase in labour supply, the economy will reach a new equilibrium after 4 – 6 years, slightly slower than predicted by the Ministry of Finance (4 – 5 years).

Additional structural reforms to increase the labour supply can also contribute to future economic growth.