Unemployment

 

As we noted in the previous units, the control of unemployment is a key target of macro-economic policy.

Indeed, following the widespread mass unemployment of the inter-war period, the control of unemployment

was at the top of the political agenda in the hey-day of most governments all over the world in the post-war

period.

As this time and up until the mid-1970s, 1990s, economists and politicians spoke glibly about full

employment as an objective of macro-economic policy.

In the 1980s, worldwide unemployment rose to levels that were unprecedented since the end of the

Second World War. Not only was the overall level of unemployment wastefully large, the structure of unemployment

was highly varied. Currently, the most serious problem of localized unemployment is the very high

rates among the many unskilled residents of the decaying inner cores of large industrial cities. The effects of

high long-term unemployment are still serious. Disillusioned workers give up trying to succeed within the

system and sow the seeds of social unrest. The existence of two-worlds the affluent employed and the

unemployed - strains the social fabric, and offends many people’s sense of social justice.

Unemployment is a hazard of an industrialized economic system. Primitive communities were usually self-sufficient

and had no unemployment problems, though they had to accept a very low standard of living. The

people shared the work that had to be done, and if any time remained afterwards they enjoyed their leisure.

Industrialization, with division of labor and specialization brought about a higher standard of living than

communities had ever previously enjoyed, but it also brought with it the risk of unemployment. In fact, some

unemployment can be attributed directly to industrial progress. That is why, perhaps rather belatedly, it was

the leading industrial nations that were the first to introduce schemes of social security.

There are a number of different causes of unemployment. Clearly, before plans can be formulated for

maintaining full employment, it is necessary to distinguish between these different causes, for only after an

accurate diagnosis has been made can the appropriate remedy be applied.

Objectives

At the end of this unit, you should be able to:

(i) specify the meaning of unemployment.

(ii) put current levels of unemployment into an appropriate perspective;

(iii) understand that some individuals in the population choose to be economically inactive;

(iv) distinguish between various types of unemployment – Frictional, Structural, demand deficient and classical;

(v) understand the Keynessian view that unemployment results from a deficiency of demand in the economy;

(vi) appreciate the classical view that unemployment is the result of a disequilibrium in the labor market

and a failure of real wages to fall sufficiently to equate the demand for labor with the supply;

(vii) know the effects of unemployment;

(viii) define the policies that can reduce the unemployment;

(ix) established that there is a trade off between inflation and unemployment.

Problems of Definitions

The causes of these phenomena are of course, the subject of considerable disagreement among economists.

First of all, there are problems of definition which are by no means trivial.

To begin with, unemployment cannot be equated with ‘not working’ since in our society there are many

people who are not working – such as babies and young people, the elderly, house wives and so on. These

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individuals should not be regarded as unemployed. Economists use the term economically inactive to refer to

those people who are neither in employment nor actively seeking work.

The economically inactive will comprise

- those below employment age ( babies, and school-age children);

- those above employment age (65years old for men and 60 for women);

- those who for some other reason are unfit or unable to work (e.g chronically sick and disabled people);

- those in prisons

- those in full time further education or on government training scheme;

- those who for reasons other than those above choose not to enter the labor market (e.g. the very

wealthy or mothers who stay at home to look after children).

In contrast, the economically active part of the population consists of both those who are in employment

plus those who indicate their willingness to work by registering as unemployed. The activity rate also known

as the participation rate refers to that proportion of the population of working age who are economically

active. This can be expressed as

Activity Rate = Total Employed plus registered unemployed

Total population of working age

Causes / Types of Unemployment

In analyzing the causes of trend in unemployment, it is helpful initially to distinguish different types of unemployment.

This classification of unemployment into different types is also of course, in part an explanation

of why unemployment occurs.

The unemployed can be classified in various ways: by age, sex, occupation, degree of skill and even by

ethnic groups. We may classify by location, e.g. unemployment in the South East, North West, South West,

etc. We may also classify by the duration of unemployment between, say, those who are out of jobs for long

periods of time and those who suffer relatively short-term bouts of unemployment. Finally, we may classify

the unemployment by the reasons for their unemployment.

In the present unit, we concentrate on the reasons for unemployment. Different economists find it convenient

to identify different causes, in what follows we take one common scheme for classifying unemployment

by types:

- Financial Unemployment

- Structural Unemployment

- Real wage or classical Unemployment

- Demand – deficient Unemployment

- Seasonal Unemployment

- Regional Unemployment

- Technological Unemployment

- General Unemployment

Frictional Unemployment

Overtime the pattern of consumer demand in the economy will change, both as a result of changes in

incomes and tastes and in response to a changing set of relative prices. The change in the pattern of demand

will in turn lead to a change in the amounts and the types of goods and services produced. This will then lead

to a change in the type of labor required. Moreover, technical improvements will bring about changes in the

way in which goods and services are produced, and this will alter the demand for the various types of labor.

In short, all of these changes will lead to a change in the pattern of the demand for labor.

Frictional unemployment results from this change in the pattern of demand for labor as some workers will

not find that their skills are no longer required. These workers will become unemployed for a period until they

eventually become re-employed either in a similar or in a different occupation. The use of the term “Frictional”

to describe such unemployed suggests that is results from frictions in the Labor Market. If there

were perfect information - so that workers knew that jobs were on offer and employers knew what labor

was available - and if labor were perfectly able and willing to move, there would be little or no unemployed

of this type, since the unemployed workers would be immediately redeployed in a new occupation.

Unemployment that is associated with the normal turnover of Labor is called Frictional unemployment.

People leave jobs for many reasons, and they take time to find new jobs, young persons enter the labor force

but new workers do not often fill the jobs vacated by those who leave. This movement takes time and gives

rise to a pool of persons who are “Frictionally unemployed.” They are moving between jobs. Frictional

unemployed would occur even if the occupational, industrial and regional structure of employment were

unchanging. ‘

Frictional unemployment is therefore defined as the irreducible minimum amount of unemployment caused

by the Labor turnover when new people enter the labor force and look for jobs and existing workers

change jobs.

Structural Unemployment

In contrast to frictional unemployment, which in theory at least is of short duration, structural unemployment

is of a longer-term nature. However, it too results from the dynamic nature of an economy in which the

changing pattern of consumer demand and changes in the way in which goods are produced lead to a decline

in the demand for certain types of labor. For example, in the U.K. from the 1960s onwards there was a

decline in the demand for certain types of labor. For example, in the U.K. from the 1960s onwards there

was a decline in the demand for British built ships and hence a decline in the demand for ship-builders.

Equally noticeable in the last decade has been the decline in the demand for coal miners brought about, first

by labor saving technical progress, which has enabled coal to be minded using more capital-intensive and

hence labor-saving techniques, but more importantly by the decline in the demand for U.K. produced coal,

as power stations have opted to buy cheaper imported coal or switch to gas.

By its very nature, structural unemployment tends to be concentrated in certain geographical areas. For

example, ship-building was concentrated in the north east of England, so this area was severely affected by

the decline in ship-building. This led to a further decline in the region because of regional multiplier effect.

Thus structural unemployment and regional unemployment tend to go hand in hand.

Structural changes in the economy can cause unemployment. As economic growth proceeds, the patterns

of demands and supplies change constantly. Some industries, occupations and regions suffer a decline in the

demand for what they produce while other industries, occupations and regions enjoy an increase in demand.

These changes require considerable economic readjustment. Structural unemployment occurs when the

adjustments are not fast enough. Severe pockets of unemployment then arises in areas, industries and occupations

in which the demand for labor is falling faster than its supply.

Structural unemployment is defined as the unemployment that exists because of a mismatching between

the unemployed and the available jobs in term of any relevant dimension such as regional location or required

skills.

Structural unemployment occurs because changes in the regional, occupational and the industrial structure

of the demand for labor do not match the changes in the structure of the supply of labor.

Structural unemployment can increase because either the pace of economic change accelerates or the

pace of adjustment to change slows down. National forces and social policies that discourage movement

among regions, industries and/or occupations can raise structural unemployment. Policies that prevent firms

from replacing labor with new machines may protect employment in the short-term. If, however, such policies

lead to the decline of an industry because it cannot compete with more innovative foreign competitors,

they can end up causing severe pockets of structural unemployment.

Demand – Deficient Unemployment

We expect the demand for labor and therefore, the level of unemployment to be correlated with the business

cycle. When the economy is in a recession, the demand for goods and services falls. Consequently, there will

also be a fall in the demand for the labor that produces those goods and services. Hence unemployment will

rise. Because the level of such unemployment will vary with the business cycle, it is termed cyclical unemployment.

It is also sometimes referred to as demand-deficient or Keynesian unemployment.

One of Keyne’s great contributions was to argue that demand-deficient unemployment could be removed

by bringing about the increase in the level of aggregate demand. For example, the government could bring

about a budget deficit thereby injecting spending power into the economy and raising the overall level of

demand. This increase in the demand for goods and services would bring about an increase in demand for

labor and hence unemployment would fall.

The term demand-deficient unemployment or cyclical unemployment refers to unemployment that occurs

because aggregate desired expenditure is insufficient to purchase all of the output of a fully-employed labor

force. It is the main subject of the national income theory. This theory seeks to explain the unemployment that

is caused by variations in the total demand for the nation’s output.

The feature of a trade depression is a general deficiency of demand. Consumers’ wants may be as great

and extensive as ever but people do not have the means to satisfy them. The result is that nearly all industries

are affected at one and the same time - though not all to the same extent - and there is wide spread mass

unemployment. Unemployment arising from a general deficiency of demand is known as cyclical unemployment

on account of its association with the nineteenth century trade cycle.

Classical Unemployment – Real Wage Unemployment

In the previous units, we described the foreign exchange market as an example of a perfectly competitive

market. In such a market, we argued, price would be determined by relatively scarcity and the market would

be in equilibrium when demand equaled supply. Some economists believe that this same analysis can be

applied to the workings of the labor market.

This view is variously known as the classical view, the neo-classical view and (sometimes) the monetarist

view. It stands in contrast to a Keynesian analysis which suggests that, as a matter of observable fact, the

market for labor does not function in the same way as the textbook model of a perfectly competitive market.

The demand curve for labor will be downward sloping indicating that the higher the wage, the less labor

will be demanded, and the lower the wage, the more labor will be demanded. This is explained by the fact

that labor is a factor of production, which is combined with other factors of production to make goods and

services. The higher the price of labor, the more incentive to economize on its use and to substitute other

factors such as capital.

A real wage that is held above its free market level causes unemployment in that market. Setting wages

above their equilibrium levels in some markets can cause unemployment in those markets.

Seasonal Unemployment

Seasonal factors may cause unemployment in some industries. Many building workers are temporarily unemployed

in January and February when weather prevents outside working. The tourist industry employs

most of its labor during the summer holidays and, for a much shorter period, at Christmas. Much of the

labor force is not required for the rest of the year and may be regarded as seasonally unemployed.

In some occupation such as planting agriculture and building, there is a demand for labor only at certain

periods of the year. For instance, fruit gathering and building construction demand labor at certain periods of

the year. In Sweden, for instance, building constructions are usually stopped in winter, and hence some

workers become unemployed. In West Africa those who work on harvesting crops often become unemployed

after the harvesting period.

In some outdoor occupations, such as building and road making, bad weather often causes a suspension of

work, so that temporary unemployment occurs. The weather, too, may prevent a fishing fleet putting out to

sea. In some occupations, there is a demand only at certain periods of the year – hop-picking, potato-lifting,

fruit-gathering, entertaining at holiday resorts, etc.

Technological Unemployment

Whereas structural unemployment results from a change in the pattern of demand, technological unemployment

is a result of a change in the methods of production. In the dock industry, the introduction of containers

have enabled a given volume of cargo to be handled by a much smaller work force. Dockers who leave the

industry in consequence may be considered to be unemployed because of changes in Technology. One of the

dilemmas of economic efficiency, which normally involves substituting capital for labor, actually generated

technological unemployment.

The introduction of office machinery – typewriters, computers, book-keeping machines, etc., has resulted

in the employment of fewer clerks. This kind of unemployment may result from the invention of a new

machine or an innovation which may reduce the demand for labor concerned.

Residual Unemployment

This includes all those people who, on account of physical or mental disability are of so low a standard of

efficiency that few, if any, occupations are open to them. Payment of standard rates of wages, too makes it

more difficult for people so handicapped to find work.

Regional Unemployment

This type of unemployment occurs when the basic industries of an area go into decline without being replaced

by others. One way of reducing regional unemployment is to increase the geographical mobility of

labor so that the work force migrates towards areas of high economic activity, but as we have seen, the

general policy is to move industry and jobs to the regions of high unemployment.

Unemployment and Inflation – Is there a Trade-off?

Newspaper editorials and public discussions about economic policy often refer to the “trade-off” between

inflation and unemployment. The idea is that to reduce inflation, the economy must tolerate high unemployment

or alternatively that to reduce unemployment, more inflation must be accepted.

Unemployment, and inflation – sometimes referred to as the “twin evils” of macro-economics are among

the most difficult and politically sensitive economic issues that policy-makers face. High rates of unemployment

and inflation generate intense public concern because their effects are direct and visible: almost everyone

is affected by rising prices.

Moreover, there is a long standing idea in macro-economics that unemployment and inflation are related.

This was discussed in detail under the concept of the Phillips curve – that there is an empirical relationship

between inflation and unemployment. The Phillips curve suggested that it was possible to reduce inflation,

but only at the cost of higher unemployment. According to the Phillips curve, inflation tends to be low

when unemployment is high and high when unemployment is low.

The origin of the idea of a trade-off between inflation and unemployment was a 1958 article by Economist

A. W. Phillips. Phillips examined 97 years of British data on unemployment and nominal wage growth data,

he found that historically, unemployment tended to be low in years when nominal wages grew rapidly and

high in years when nominal wages grew slowly. Economists who built on Phillips work shifted its focus

slightly by looking at the link between unemployment and inflation that is, the growth rate of prices – rather

than the link between unemployment and the growth rate of wages. During the late 1950’s and the 1960’s

many statistical studies examined inflation and unemployment data for numerous countries and time periods,

in many cases finding a negative relationship between the two variables. This negative empirical

relationship between unemployment and inflation is known as the Phillips curve.

In the following decades, however, this relationship between inflation and unemployment failed to hold. i.e.

the 1970s, 1980s, 1990s. During those years, unlike the 1960’s, there seemed to be no reliable relationship

between unemployment and inflation, and this applied equally to other European countries. From the perspective

of the Phillips curve the most puzzling periods were the mid-1970s and early 1980s during which many

countries experienced high inflation and high unemployment simultaneously. High unemployment together

with high inflation, is inconsistent with the Phillips curve.

The Effects/Problems of Unemployment

There are two principal costs of unemployment. The first if the loss of output that occurs because fewer

people are productively employed. This cost is borne disproportionately by unemployed workers themselves,

in terms of the income they lose because they are out of work. However, because the unemployed may stop

paying taxes and instead receive unemployment benefits or other government payments, society (in this case,

tax payers) also bear some of the output cost of unemployment.

The other substantial cost of unemployment is the personal or psychological cost faced by unemployed

workers and their families. This cost is, especially important for workers suffering long spells of unemployment

and for the chronically unemployed. Workers without steady employment for long periods lose job skills

and self-esteem and suffer from stress.

Policies to Reduce Unemployment

Many people would argue that, for both economic and social reasons, economic policies should be used to try

to lower the natural unemployment rate. Although no certain method for reducing the natural rate exists,

several strategies have been suggested

 (i) Government support for job training and worker relocation

Thus a case can be made for policy measures such as tax breaks or subsidies for training or relocating

unemployed workers. If these measures had their desired effect, the mismatch between workers and

jobs would be eliminated more quickly and natural unemployment rate would fall.

(ii) Increased Labor Market Flexibility

Currently, government regulations mandate minimum wages, working conditions, workers’ fringe

benefits, conditions for firing a worker, and many other terms of employment. Such regulations may

be well intentional but they also increase the cost of hiring additional workers, particularly workers with

limited skills and experience. New and existing labor market regulations should be carefully

reviewed to ensure that their benefits outweigh the costs they impose in higher unemployment.

(iii) Unemployment Insurance Reform

Although unemployment benefits provide essential support for the unemployment, they may also increase

the natural unemployment rate by increasing time that the unemployed spend looking for work

and by increasing the incentives for firms to lay-off workers during slack times. Reforms to benefit

systems that preserve the function of supporting the unemployed but reduce incentives for increased

unemployment are needed. For example, taxes on employers might be changed to force employers that

use temporary layoffs extensively to bear a greater portion of the unemployment benefits that their

workers receive.

(iv) Monetary and Fiscal Policy

These are used aggressively to keep unemployment as low as possible, the natural rate of employment

will eventually fall.

So, for example, if current employment is stimulated by monetary expansion, workers may be able to

acquire more on-the-job training which reduces mismatch and lowers the natural unemployment rate in

the long-run.

(v) Labor Turnover Causes Frictional Unemployment

In so far as frictional unemployment is caused by ignorance, increasing the knowledge of labor market

opportunities can help.

(vi) Frictional unemployment

This is inevitable part of the learning process. Policy changes that make it easier for youths to find jobs from

which they can learn and hence raise their productivity could help. Youth training, and schemes aimed at

subsidizing the wage rate for young workers have also helped.

Conclusion

Unemployment is inability to obtain work although work is actively sought. It excludes those who are seeking

work even if they have refused work at some derisory wage. It has been an aim of governments to intervene

in the economy with fiscal and monetary policies to ensure a low level of unemployment.

Unemployment may be broken down into smaller components of which some of the most important are

Frictional unemployment, Structural unemployment, disguised unemployment, seasonal unemployment.

The costs of unemployment include output lost when fewer people are working and the personal or

psychological costs for unemployed workers and their families. Policies to reduce the unemployment rate

include government support for job training and worker relocation, policies to increase labor market flexibility

and unemployment benefit reform.

Following the famous 1958 article by A. W. Phillips, empirical studies often showed that inflation is high

when unemployment is low and low when unemployment is high. This negative empirical relationship between

inflation and unemployment is called the Phillips curve. Inflation and unemployment in European

economics conformed to the Phillips curve during the 1960s but not during the 1970s and 1980s. Economic

theory suggests that in general, the negative relationship between inflation and unemployment should not be

stable.

Summary

In this unit, we have succeeded in establishing that all people who could work choose to do so. Some such as

married women may be economically inactive in the sense that they have no paid employment.

Various explanations for the existence of unemployment can be offered. These are sometimes described

as different ‘types’ of unemployment. They consist of frictional unemployment, structural unemployment,

demand-deficient unemployment and classical unemployment, frictional and structural unemployment result

from a mismatch between the type of labor being offered and that being demanded. Demand-deficient

employment is correlated with the business cycle, rising in recessions and falling in booms. The classical

explanation for the existence of unemployment is based on an analysis which views labor as a commodity to

be bought and sold in the market. In this analysis, unemployment can only be understood as a disequilibrium

situation brought about because the price of labor (the real wage) is too high to allow the market to clear.

Finally, unemployment is the number of people who are available for work and are actively seeking work

but cannot find jobs.

THE END

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