Low unemployment
Learning Objectives
- The meaning of unemployment
- Types and causes of unemployment
- Consequences of unemployment
The meaning of unemployment
What is unemployment?
For most people, an unemployed person is somebody who is not employed. However, there are many people in the UK who are of working age (between 16 and 65 for men, or 16 and 60 for women), and not working, but not "officially" unemployed. These "inactive" people of working age include people who stay at home, students without a part-time job and those who retire early.
How is unemployment measured?
The Office for National Statistics in the UK publishes two unemployment rate measures. There is the rate based on the claimant count, which includes all those who are unemployed and actually claiming benefit in the form of Unemployment benefit; and the government's preferred International Labour Organisation (ILO) total, which includes people not eligible for benefit.
ILO Unemployment Measure
The ILO count is taken from a survey of the population – this is called Labour Force Survey. In the UK 60,000 households with over 100,000 adults are surveyed. To be counted as unemployed, an individual has to be
without a paid job, be available to start a job within a fortnight and has either looked for work at some time in the previous four weeks or been waiting to start a job already obtained.
What is the definition of a claimant?
Claimants must be available to work, actively seeking work and able to work when the benefit is claimed. But this measure omits people who are out of work but who are not claiming benefit.
Which is the more accurate measure?
For international comparisons, the International Labour Organisation (ILO) measure is used. The government believes this one to be more accurate. The ILO total is based on a survey, so all those who are effectively unemployed, but do not claim the highly specific Unemployment benefit can be included.
This category covers the young unemployed who are not always eligible to claim, married women who can't claim if their husband earns over a certain amount, and those who claim sickness and disability benefits.
ILO Unemployment is likely to be above the claimant count figure because the claimant count excludes a number of key groups of unemployed workers
- Many female unemployed workers are actively looking for work (and therefore included in the ILO unemployment) but are not entitled to benefits for being unemployed. (not built up sufficient social security contributions or live in a household where partner earns too high an income.
- Older workers in their 50s and 60s may be collecting a pension from their previous employer or be supported financially by their spouse. They are therefore not entitled to benefits, but may be actively seeking work.
- Workers are not entitled to register as unemployed with the Department of Social Security until they have been out of work for a number of weeks.
The claimant count, however, may include some unemployed who would not be included in the ILO count. For instance, those working in the hidden economy may claim benefits for being unemployed but actually be in work, usually as a self-employed worker.
Defining the unemployment rate
Categories of Unemployment
The problem of unemployment is usually divided into two categories. The long-run problem and the short-run problem:
• The natural rate of unemployment
• The cyclical rate of unemployment
Natural Rate of Unemployment
The natural rate of unemployment is unemployment that does not go away on its own even in the long run. It is the level of unemployment that the economy normally experiences even at full employment.
Cyclical Unemployment
Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its natural rate. It is associated with short-term ups and downs of the business cycle.
Cyclical unemployment and natural rate of unemployment in the USA since 1950
Labour force participation rate is defined as the section of working population in the age group of 16-64 in the economy currently employed or seeking employment.
- What reasons were given in the video on Labour Force Participation rate for the decline in this variable in the USA since 2000?
- The Unemployment Rate
• The unemployment rate is calculated as the percentage of the labor force that is unemployed.
Task 1: What is the unemployment rate for the US in 2001?
Task 2: Questions on the unemployment rate
- The Bureau of Labour Statistics announced that in December 1998, of all adult Americans, 138,547,000 were employed, 6,021,000 were unemployed, and 67,723,000 were not in the labour force. How big was the labour force? What was the unemployment rate?
- Between 1997 and 1998, total US employment increased by 2.1 million workers, but the number of unemployed workers declined by only 0.5 million. How are these numbers consistent with each other? Why might one expect a reduction in the number of people counted as unemployed to be smaller than the increase in the number of people employed?
Task 3:
Task 4: Find out what is the difference between the different measurements of unemployment in the United States and why policy makers take U3 as its benchmark. See https://www.cbsnews.com/news/whats-the-best-way-to-measure-unemployment/
- Task 5: Explain the difficulties in measuring unemployment, including the existence of hidden unemployment, the existence of underemployment, and the fact that it is an average and therefore ignores regional, ethnic, age and gender disparities
Types and causes of unemployment
Types of unemployment
In a modern economy unemployment has a variety of causes. Some of them relate to the general level of economic activity, others are the result of a failure of the labour market in an economy to work optimally.
Among the main types of unemployment we can consider:
- Frictional unemployment
- Structural unemployment
- Seasonal Unemployment
- Real wage unemployment
- Demand deficient unemployment
Frictional unemployment
Frictional unemployment is transitional unemployment due to people moving between jobs: For example, newly redundant workers or workers entering the labour market (such as university graduates) may take time to find appropriate jobs at wage rates they are prepared to accept. Many are unemployed for a short time whilst involved in job search. Imperfect information in the labour market may make frictional unemployment worse if the jobless are unaware of the available employment opportunities.
Some of the frictionally unemployed may opt not to accept jobs if they believe the tax and benefit system will reduce significantly the net increase in income from taking paid work. When this happens there are dis-incentives for the unemployed to accept work.
Illustration of frictional unemployment in the US - Total NonFarm Hires & Total Separations
The net change in jobs added statistic masks the dynamic nature of the economy
Task 6: Why is some frictional unemployment inevitable in any market economy?
Seasonal unemployment
Seasonal unemployment is fairly self explanatory. Father Christmas tends to only be in demand for a short period of the year, and the rest of the year would certainly be classified as seasonally unemployed. Most other seasonal unemployment is less severe than this, and tends to occur in certain industries. Industries that suffer particularly are:
- Hotel and catering
- Tourism
- Fruit picking
- Father Christmases
The effects of seasonal unemployment are often highly regionalised
Structural unemployment
Structural unemployment occurs when people are made unemployed because of capital-labour substitution (which reduces the demand for labour) or when there is a long run decline in demand in their particular industry. Structural unemployment exists where there is a mismatch between their skills and the requirements of the new job opportunities. Many of the unemployed from heavy manufacturing industry (e.g. in coal, steel and heavy engineering) have found it difficult to gain re-employment without an investment in re-training. This problem is one of occupational immobility i.e. inability to move between occupations.
(a) Regional Unemployment: This is a form of structural unemployment. It arises when the declining industry is concentrated in one geographical area. The region dependent upon the industry may suffer particularly heavy unemployment because there will be a local downward multiplier effect from the decline in the income generated by the major industry.
The relative portion of the average unemployment rate that is accounted for by long-term unemployed
- Task 7: Take note of the reasons given for structural unemployment to exist in a country
Real wage (classical) unemployment
Real wage unemployment is a form of dis-equilibrium unemployment that occurs when real wages for jobs are forced above the market clearing level. Traditionally, trade unions and wages councils are seen as the institutions causing this type of unemployment.
Classical unemployment is thought to be the result of real wages being above their market clearing level leading to an excess supply of labour. Some economists believe that the introduction of the national minimum wage may create some classical unemployment in industries where average wage rates are closer to the NMW level and where international competition from low-labour cost producers is severe.
Task 8
1: Consider an economy with two labour markets, neither of which is unionized. Now suppose that a union is established in one market.
(a) Show the effect of the union on the market in which it is formed. In what sense is the quantity of labour employed in this market an inefficient quantity.
(b) Show the effect of the union on the non-unionised market. What happens to the equilibrium wage in this market?
2: It is shown that an industry’s demand for labour will become more elastic when the demand for the industry’s product becomes more elastic. Let’s consider the implications of this fact for the US automobile industry and the auto workers’ union (UAW)
(a) What happened to the elasticity of demand for American cars when the Japanese developed a strong auto industry? What happened to the elasticity of demand for American auto workers?
(b) A union generally faces a trade-off in deciding how much to raise wages, because a bigger increase is better for workers who remain employed but also results in more unemployment. How did the rise in auto imports from Japan affect the wage-employment trade-off faced by the UAW?
(c) Do you think the growth of the Japanese auto industry increased or decreased the gap between the competitive wage and the wage chosen by the UAW? Explain.
Demand deficient (or cyclical) unemployment
Cyclical unemployment is involuntary unemployment due to a lack of aggregate demand for goods and services. This is also known as Keynesian "demand deficient" unemployment and is associated with the transition of the economy through the business cycle. When there is an economic recession we expect to see a rising level of unemployment because of plant closures and worker lay-offs. This is due to a fall in demand leading to a contraction in output across many industries.
Although demand deficient unemployment is usually associated with economic recessions it can also exist in the long run when the economy is constantly run below capacity. As the economy recovers from a downturn, we expect to see the problem of cyclical unemployment decline.
The relationship between the unemployment rate and economic growth rate in the United States
Task 9 Questions on unemployment
1: These changes in unemployment will also have a significant effect on the government’s fiscal policy stance. Delete terms in italics as appropriate in the paragraphs below, to show the effect of higher unemployment on the government:
Lower growth in the economy often comes about because of higher / lower aggregate demand and as a result firms will tend to increase / reduce their work-forces. As unemployment rises / falls the government will find that there are more / fewer people paying tax and so their tax revenue rises / falls. At the same time there will also be an impact on government expenditure. With higher / lower unemployment there will also be an increase / decrease in the number of people claiming benefits. This will mean that government expenditure will rise / fall. The overall impact of both the tax and expenditure changes will mean that the PSBR rises / falls.
2: Identify what type of unemployment the following workers experience.
(a) A construction worker laid off because of bad weather during the winter months.
(b) A manufacturing worker who loses her job at a plant in an isolated area.
(c) A stagecoach-industry worker laid off because of competition from railroads.
(d) A cook who loses his job when a new restaurant opens across the street.
(e) An expert welder with little formal education who loses her job when the company installs automatic welding machinery
Consequences of Unemployment
Costs of unemployment
Perhaps the main cost of unemployment is a personal one to those who are unemployed. However, if they suffer then the whole economy suffers. Individuals may become dispirited by unemployment; they may lose their self-esteem and confidence. This may affect their motivation to work. The longer they are unemployed the more they may lose their skills and this has to be bad for the economy as well. On top of that these problems (and financial ones) often lead to the unemployed being less healthy, and then the health service is over-stretched. The whole economy suffers from people being unemployed.
Measures to reduce unemployment
1: Fiscal policy can decrease unemployment by helping to increase AD.
This involves cutting taxes and increasing government spending. Lower taxes increase disposable income and therefore help to increase consumption. With an increase in AD, there will be an increase in Real GDP (as long as there is spare capacity in the economy.) IF there is an increase in GDP there will be an increase in demand for workers and therefore lower demand deficient unemployment.
However,
- It depends on other components of AD. E.g. if Confidence is low, cutting taxes may not increase consumer spending because people prefer to save.
- Fiscal policy may have time lags. E.g. a decision to increase government spending may take a long time to have an effect on increasing AD.
- If the economy is close to full capacity an increase in AD will only cause inflation.
- In the long run expansionary fiscal policy may cause crowding out. i.e. the government increase spending but have to borrow from private sector, therefore, the private sector have less to spend and therefore AD doesn’t increase. (this is the Monetarist view)
2. Monetary Policy
Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing and encourage people to spend and invest. This increases AD and should also help to increase GDP and reduce demand deficient unemployment.
Also lower interest rates will reduce exchange rate and make exports more competitive.
Evaluation
- Similar problems as fiscal policy. E.g. it depends on other components of AD.
- Demand side policies can help to reduce demand deficient unemployment e.g. in a recession. However their effectiveness depends on the type of unemployment that occurs.
3. Supply-side Policies
The remedies supply-side economists put forward to reduce unemployment.
- Better job information to help reduce frictional unemployment.
- Lower unemployment benefits to increase the incentive to get a job. It is argued generous unemployment benefits create an unemployment trap, where those on benefits would not get any extra income after tax if they decided to work.
- Reduced Power of Trade Unions. Trade unions can cause real wage / classical unemployment. If you reduce the power of unions, wages will fall to equilibrium levels leading to less unemployment. Also reducing minimum wages
- Increased labour market flexibility. E.g. Make it easier to hire and fire workers; this should encourage firms to set up and hire workers.
- Better education and training.
Keynesian vs New Classical remedies for unemployment in the long run
Keynesians
Keynes believed that the achievement of a full and stable level of employment required active government intervention. This policy is called demand management and necessitated the use of fiscal and monetary policy.
According to Keynes such stimulation of the economy may not be inflationary – if the economy is on the perfectly elastic portion of the long run aggregate supply curve. It will become inflationary as the economy approaches full employment.
New Classical
New Classical economists believe that increasing aggregate demand will not in the long run reduce unemployment but will cause inflation to rise.
New Classicals argue that the only way to reduce unemployment without increasing inflation is to increase long-run aggregate supply (supply-side policies).
Consequences and solutions to unemployment
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