Macroeconomics/Employment and Unemployment
Consequences of Unemployment
Governments are always trying to reduce the level of unemployment, but why? What is so bad about not working? Well, the effects of unemployment can be roughly split into direct and indirect effects:
- Fall in National Output - Labour, remember, is a factor of production. Hence, a fall in the overall supply of labour caused by higher levels of unemployment will result (cp) in a fall in national output. However, if the unemployment is caused by factor substitution i.e. labour is substituted by new machinery, then a fall in National Output may not necessarily result
- Loss of personal income - Those not working will encounter a fall in their living standards, as their income falls. The unemployed will have less purchasing power, and less disposable income. Of course, the dole may in fact provide more income than working, and the increased free time may be considered more valuable than working, though this is in the extreme minority
- Negative Multiplier Effect - Unemployed individuals, as mentioned above, are not able to spend as much money on goods and services, so a negative multiplier effect may result. For example, local businesses may suffer as a result of recent job losses in an area, meaning that purchases from suppliers will fall, and so on. Many areas where large job losses have occurred experience this effect, unless governments intervene.
- Loss of tax revenue - A fall in income results in a fall both in direct and indirect taxes. Why? Direct taxes come from wages, whilst indirect taxes come from the products those wages would have been spent on. As a result, governments must either raise the level of tax on existing wage earners, or reduce government spending (or borrow, which is unpopular but not necessarily always a bad idea). Both policies have a depressive effect on the economy.
- Society - Inequalities in wealth and income, and high unemployment have been shown to be linked to negative social effects, such as high crime rates in these areas. The lack of money to spend on private health care, healthy goods and living, means that those who are unemployed often lead less healthy lifestyles and have less backup when things go wrong. Also, children from unemployed households often have had poorer education and hold fewer skills than average, upon entering work, meaning that high unemployment levels can be self-perpetuating through time.
Policies to reduce Unemployment
Government policies to reduce unemployment must be based upon the types and causes of unemployment that are prevalent. It may be worth glancing back to that section to remind yourself of the major kinds of unemployment; however, we will go into more detail in this section. General policies such as cuts in direct taxes should be effective across any kind of unemployment, as it increases the appeal of any job to any potential employee.
Real Wage Unemployment
This is unemployment as a result of a kind of market failure, a failure of the labour market to respond to changes in demand. If demand for workers rises, it is logical that they will demand greater real wages (diagram). Similarly, if demand falls, workers should expect to suffer lower real wages for the same work. Unfortunate though it may seem, that is the way the market works! Real wage unemployment is usually caused by a combination of:
- Strong trade unions - giving employees greater power over deciding wage conditions with the threat of industrial action (strikes etc.) With strong unions, firms will not be able to reduce wages when demand is low, leading to bankruptcy (unemployment) or layoffs of workers (unemployment)
- Wage 'stickiness' - Employees on long term contracts will have a fixed wage over a long period of time. If a downturn in demand occurs, wages cannot fall immediately in response - they are 'sticky'
- Minimum wage - This is a characteristic of most modern economies, guaranteeing every worker a minimum standard of living. Whilst this is undoubtedly wonderful, if the minimum wage is set too high, the labour market is once again inflexible
Government policies to tackle this form of unemployment are invariably unpopular for workers, as their wage levels are threatened to the benefit of firms and businesses. However, it is largely appreciated that, for example, overly strong trade unions can utterly paralyse an economy (see Margeret Thatcher's time as Prime Minister in the UK). Policies to combat real wage unemployment include trade union reform (reducing their powers), increasing firms' ability to change wages and encouraging shorter term contracts and ensuring that the minimum wage level does not adversely impact the economy.
Remember, this is unemployment generated through incomplete information of the labour market. This can be solved in two main ways. Firstly, increasing the knowledge of the local vacancies through government funded 'job centres' could reduce time between jobs. Secondly, increasing the incentive to search for suitable jobs (such as reducing unemployment benefits and lower taxes on wages) could serve the dual purpose of increasing incentives to search for work, and making more vacancies acceptable to the unemployed individuals.
It is worth noting that this form of unemployment can also be known as Keynesian or demand-deficient unemployment. Over the economic cycle demand changes, and regardless of how flexible wages are, unemployment will rise or fall (diagram). There are clear links between the rate of economic growth and the level of unemployment. It is clear that in a depression, unemployment will rise, as demand for good and services falls. This could result in a negative multiplier effect, without government intervention. Policies to reduce the impact of Keynesian unemployment include:
- Increased government spending - this includes reductions in taxes. Increased G will cause an outward shift in AD, and may create a multiplier effect. Theoretically, government spending to pay workers to dig huge trenches and fill them in again will help, as it increases national income. However, targeted policies to increase the quality of infrastructure or levels of investment will be more effective. Also, reductions in direct taxes will encourage more people into work, and also increase the level of disposable income, hopefully leading to a positive multiplier effect
- Reduction of interest rates - remember that a fall in interest rates can also stimulate AD. Return to that section to remind yourself that a fall in interest rates encourages consumption and investment
Naturally, policies to reduce geographical unemployment will seek to decrease geographical immobility of labour. This is the inability of people to relocate from areas with low demand for labour, to areas with high demand for labour. Policies to reduce geographical unemployment include:
- Regional Incentives - this is regional policy to increase the incentives for new businesses to locate in areas of high unemployment, thus reducing regional variations in unemployment caused by geographical immobility
- Reducing geographical immobility - is the second and more direct method of combatting geographical unemployment. It aims to reduce geographical immobility by reducing barriers to free movement of workers (such as no border controls and cheap housing). This is more difficult within a country as the barriers are often social in nature, such as family ties.
This is the inability of workers to change the kind of employment (for example from manufacturing to IT) they are in. Left without intervention, this could lead to dangerous long term unemployment, whereby workers find it increasingly difficult to find jobs as they become less desirable the longer they are unemployed. Policies to reduce occupational unemployment include:
- Retraining - incentives for both companies to retrain and employees to take part in training to make them more attractive and useful to firms. Governments may also directly take part in retraining projects where unemployment levels as a result of structural unemployment are very high
- Reducing geographical immobility - could result in no need for retraining programs, as worker could simply move to an area in which their skills are in high demand. This works providing the costs associated with reducing geographical immobility are lower than those required for occupational-orientated projects such as retraining, and that their skills are in demand somewhere.
Definitions of Unemployment
Measuring and defining unemployment is often at least as difficult as, for example, determining the rate of economic growth within an economy, for several reasons. Firstly, economist may disagree over what unemployment is, and how to measure it. Secondly, individuals may either not wish it be known they are unemployed (i.e. not claim benefits) or alternatively, claim that they are unemployed when they are not.
Measurements of Unemployment
These include all the people that are nationally registered as claiming unemployment benefit from the government. This does not include those receiving a form of disability benefit, or those who do not claim unemployment allowance, only those that are willing and able to find work, and do claim.
Labour Force Survey
This is an internationally accepted measure used by the International Labour Organisation (ILO). This counts everyone without a job of any kind who have looked for a job in the past month and is willing to start working within the next fortnight. Of course since this is a survey and not a census (a survey is of a representative sample of a population, a census is of the entire population), there will always be inaccuracies and omissions in the data.
Generally, the ILO's LFS measure is higher than the claimant count, for the reasons mentioned above. When countries' unemployment levels are compared, the LFS is usually used.
To view recent data on unemployment figures for admittedly mostly European countries, see the OECD's report.
There are several different types of unemployment. One notable type is deficient demand unemployment. This occurs when there are simply not enough jobs to go around. Another type is structural unemployment. This occurs when the requirements of available jobs and the skills of available unemployed workers do not coincide. It is not clear whether location is a factor for this special case, or whether if the jobs are in a different area this is structural unemployment. It does seem clear that if the person could only become employed be accepting a rate of pay significantly below the going rate this it is structural unemployment. The other main type of unemployment is transactional or frictional unemployment, this is people between jobs. It can be very hard to classify unemployment between these groups. The classic example of this is if a major employer in a town closes. Many people are made unemployed in a small area. These people may be structurally unemployed because there are not enough jobs to go around, or they may fall within the special type of structural unemployment described above, because certain skills are required or the jobs are in a different area, or they may be transactionally unemployed if there are jobs for them but they have yet to find one.
Types and Causes of Unemployment
While looking at figures of unemployment is often useful, it is worth looking into what kind of unemployment is rising or falling, and how best to combat it. Unemployment is caused by a number of factors, detailed below:
This is caused by the time individuals spend searching for a suitable job, the time between jobs. For example, having left a job in a certain industry, it will take time to find and secure another suitable job (location, wage bracket, skills) even if there is a vacancy. Frictional unemployment is caused by:
- Imperfect information - an unemployed person cannot know the location and status of all vacancies in their area. This can be reduced through 'job centres' or similar state-funded operations aimed at increasing information available to jobseekers
- Disincentives - there may be government disincentives to seek work, as an apparently well-paid job will appear less attractive/suitable due to taxation and/or removal of benefits.
Occupational or Structural Unemployment
This is the result of changes in the economy over the lifetime of a worker. Many developed economies have moved from primarily manufacturing to primarily services orientated economies in the past thirty years. Similarly, a reduction in the percentage employed in primary activities (farming, mining, foresting for examples) has occurred. Those who are otherwise highly qualified in these areas may find it difficult to locate a suitable job. So, the causes of such structural unemployment include:
- Economic Change - that is, simply the changes an economy goes through as a result in the standard of living, technological change, and the associated economic growth
- Globalisation and Liberalisation of Trade - has caused changes in the structure of many economies, with lower costs of production causing much manufacturing and some services to move from some Western countries to primarily Asian 'tiger' economies
- Capital replacement - is the replacement of labour by capital, as a result of improvements in economies, leading potentially to unemployment
Ways to reduce structural unemployment include incentives for retraining and less popular, governmental protectionism.
This is revealed by a difference in the level of unemployment in an Geographical Unemployment is caused by geographical immobility of labour, the inability of workers to move easily from one area to another. Usually concerning difficulties within a country, it is affected by the rate of owner-occupation (owning one's own home, rather than renting for example), and barriers to free movement such as changes in the cost of living and family connections. Geographical unemployment can be reduced in two main ways:
- Alleviating levels of unemployment in the original area through incentives to invest by new companies (e.g. tax relief), government projects, or other targeted programs
- Reducing barriers to free movement of labour between areas. Notably, the European Union (EU) has reduced the barriers to free movement of labour between countries by reducing border controls. However, language difficulties will remain
When an economy experiences a downturn, or otherwise experiences a fall in AD, firms will respond with a fall in the demand for labour. This will result in a fall in the average wage level, and a fall in the level of employment. A fall in the level of employment usually leads to a similar rise in unemployment. Alternatively, an economic boom will most likely result in a fall in unemployment levels. This process is known as cyclical unemployment, variations in the levels of unemployment over the economic cycle.
Simply, this is unemployment caused by those who are able to work, but do not wish to. They have sufficient cash to have no need to work, and because of this, may not be cause for concern in unemployment figures.