Chapter 51: Types and causes of unemployment (2.3)

Transcription

1 Chapter 51: Types and causes of unemployment (2.3) Key concepts Types of unemployment o Structural unemployment o Frictional unemployment o Seasonal unemployment Equilibrium unemployment o Full employment and natural rate of unemployment Disequilibrium unemployment o Cyclical unemployment o Real wage unemployment Government policies to deal with unemployment Types and causes of unemployment Describe, using examples, the meaning of frictional, structural, seasonal and cyclical (demand-deficient) unemployment Distinguish between the causes of frictional, structural, seasonal and cyclical (demand-deficient) unemployment Explain, using a diagram, that cyclical unemployment is caused by a fall in aggregate demand Explain, using a diagram, that structural unemployment is caused by a fall in demand for a particular type of labour Evaluate government policies to deal with the different types of unemployment Since unemployment is a stock concept the level will change continuously as people enter and leave the labour force. An increase or decrease in population, school-leavers, and people simply returning to the job market after illness or paternity/maternity leave will serve to increase/decrease the size of the labour pool. Conversely, assuming a constant labour force, there will be people from the labour force gaining and losing jobs for any number of reasons, so if more people gain jobs than lose jobs unemployment will fall. Types of unemployment This ongoing process of in- and outflows into the labour market and available jobs will necessarily mean a degree of unemployment will always exist at any given point in time; this is equilibrium unemployment and consists of three main types; structural, frictional and seasonal unemployment.

2 (Smaller heading) Structural unemployment The most difficult type of unemployment to deal with is when it is built-in to society by forces inherent to the economy itself. Structural unemployment is basically the mismatch of available labour skills and the demands of the economy. The main forces affecting unemployment levels here are labour mobility, declining ( sunset ) industries and job redundancies resulting from technological advances in production. Any changes of these variables will give rise to structural unemployment since labour is configured to match certain demands in the labour market. There will be job losses when labour demands change, often resulting in very painful long run unemployment for large numbers of workers in a specific industry e.g. there is structural change in the economy whereby demand falls (permanently) for labour in a certain industry. Figure 51.1 Structural unemployment amongst coal miners, Northumberland UK, 1980s Figure 51.1 shows the resulting increase in unemployment as demand for coal miners fell in the UK during the 1980s. The deep mine pits in Northumberland region could not compete with far cheaper surface coal in China and Indonesia and as production shifted away from the UK and the newly elected conservative government of Margaret Thatcher stopped subsidising production, demand for coal miners plummeted (DL 0 to DL 1 ). In 1984 coal miners comprised about 1% of the total labour force and 20 years later less than 0.02%. 1 Structural unemployment is one of the most serious macroeconomic problems facing nations today, and three (often overlapping) types of structural unemployment can be identified. 1. Regional unemployment happens when a main industry in a region suffers from permanent loss of jobs, such as the fishing industry along the Norwegian coast (caused by depleted fish stocks); the steel industry in North America s socalled Rust Belt (caused by increased global competitiveness); and coal mining in the Northumberland region of England. 2. Very similar, and indeed often arising simultaneously, is sectoral unemployment. This is when a specific sector of the economy suffers from lengthy and often permanent decline. Industries producing horse-drawn buggies, mechanical adding machines and typewriters, and slide rules were all once commonplace but are now largely relegated to being part 1 See a very good article at

3 of history. In each case, skilled labour was made redundant. 3. In 1811 and 1812, during the first part of the Industrial Revolution, there was a great number of violent attacks on weaving machines in the Lancashire and Yorkshire districts of England. Men and women in the weaving industry destroyed textile machines that were replacing their labour during this transformation of English economy and society. 2 This violent reaction was to on-going technological unemployment, where new technology in textiles shifted the entire manufacturing base from labour intensive manufacturing to capital intensive. This is a continuous process in economies, since ever-improving technology will increase output per labourer and in many cases create large scale redundancies amongst professional groups. As one of many possible examples, just think of how computer technology has vastly increased the capacity of putting together a newspaper; thousands of highly trained professional typesetters were made redundant within a few years. Where have all the horse buggy makers gone? (Smaller heading) Frictional unemployment Labourers leaving/losing one job will mostly set out to find another. This is frictional (or search) unemployment and is mostly short term. The speed with which job seekers are able to find new employment depends on their work skills and education, plus the needs of the labour market. In addition to these market forces, there are a number of interventionist variables which will affect the ability/willingness of employers to hire and labourers to accept jobs. For example if labour law makes it difficult for employers to lay off workers then there will be greater care and time spent in hiring new workers. If unemployment benefits are high, the unemployed will have relatively low incentives in looking for jobs. (See Supply side policies in Chapter 60.) In addition to this, the availability and efficiency of job centres and unemployment agencies will affect time between jobs. (Smaller heading) Seasonal unemployment Waiters in holiday resorts; ski instructors; construction workers on North Sea oil platforms will all have to deal with longer periods of inactivity, giving rise to varying patterns of seasonal unemployment. Other than these workers finding backup jobs in off-seasons, there is little to be done about this type of unemployment. This type of unemployment will often overlap regional unemployment. 2 These became known as Luddites in reference to a fictitious General Ludd that the workers professed to follow. Today the term Luddite is used rather derogatorily as someone who is techno phobic and backward striving.

4 Definition: Structural, frictional and seasonal unemployment Structural unemployment is built into the very fabric of society labour immobility, declining industries and technological advances all contribute to structural unemployment. Three sub-types within structural unemployment are regional, sectoral and technological unemployment. When workers are between jobs and actively seeking employment, one speaks of frictional unemployment. (Also known as search unemployment.) Workers who are unemployed in industries subject to off-seasons such as tourism are seasonally unemployed. Equilibrium unemployment why we are different from chickens Chickens rarely if ever volunteer their services on the food market. 3 Labour is a little different from the market for chickens (or any other good, of course) in that the good on offer (e.g. labour) has a mind of its own and will therefore cause its own supply. In other words, there will be a difference between the total potential supply of labour the labour force and the actual supply of labour. While the illustration of the market for chickens simply shows the supply and demand at any given price, it is far more interesting when one is illustrating the labour market to show how many chic.eh, labourers are NOT part of supply. The difference between the people supplying their labour and the total labour force is of course unemployment. (Type 4 Smaller heading) Equilibrium unemployment the natural rate of unemployment Figure 51.2, diagrams I and II illustrate how structural, frictional and seasonal unemployment together make up the natural rate of unemployment. The aggregate supply of labour, ASL, shows the quantity of labour supplied at any given wage level, while the total labour force, TLF, shows the potential amount of labour available if everyone who offered their services had a job. (Think of the ASL curve as the job acceptance curve it shows the willingness of labourers to accept a job at a give real wage rate.) The TLF curve is upward sloping since higher wages would induce more people to enter the labour force, for example recent retirees and discouraged workers who would find it increasingly worth their while to offer their labour on the market. Notice that the TLF curve is steeper than the ASL curve, indicating that as the real wage rate increases, ever fewer people will spend time unemployed so the distance between the two curves decreases. 3 But the genetic modifiers are probably working on it. Kamikaze chickens, coming up.

5 Figure 51.2 Equilibrium in the labour market a: Supply and demand for labour b: Full employment on labour market P L (real wage rate) P L (real wage rate) ASL TLF ASL TLF U 0 U 1 U W* 2 W* NRU FE ADL ADL U* Q L /t FE U* Q L /t Equilibrium unemployment There will always be a degree of unemployment even when the labour market has cleared. Equilibrium unemployment is therefore the same as the natural rate of unemployment (NRU) shown as the difference between FEU*. The curves don t meet since there will always be someone unwilling to accept a job no matter what the wage level. 4 In figure 51.1a, the labour market is in equilibrium at the full employment level, FE. At the going wage rate of W*, there will still be a number of people in the labour force who are unemployed; the structurally unemployed (U 0 ), the frictionally unemployed (U 1 ) and the seasonally unemployed (U 2 ). The sum of unemployment at the market clearing real wage level W* is FEU*. This is the equilibrium level of unemployment. Diagram 51.1b (note; different scale) shows the sum of the three unemployment types. Structural, frictional and seasonal unemployment together comprise what rather contradictorily is called the full employment level of unemployment. A proportion, e.g. percentage, of the total labour force which chooses not to accept jobs at the going wage rate will vary but exist at all wage levels; thus it is also the natural rate of unemployment. 4 His name is Lars Swahn. I went to university with him.

6 Definition; full employment and equilibrium/voluntary/natural unemployment I know all the terminology gets confusing, so allow me to do the definitions via another syllogism: 1) If everyone in the labour force who wants a job at the going wage rate has a job, there is full employment. 2) Since these people accept the real wage rate, ASL equals ADL and the labour market is in equilibrium any existing unemployment is thus equilibrium unemployment. 3) Since there is always an element of voluntary unemployment in the economy, it is natural. The percentage of workers voluntarily unemployed is the natural rate of unemployment. Hence: Full employment = equilibrium unemployment = natural rate of unemployment. Disequilibrium unemployment When unemployment exceeds the rate at which the labour market is in equilibrium, there is disequilibrium unemployment. Economic theory identifies two main reasons for disequilibrium unemployment and the debate over which is a more accurate view is frequently rather high-pitched and politicised this is at the core of the Keynesian new-classical debate. The Keynesian/demand-side view is that disequilibrium unemployment is caused by too little demand in the economy. The new-classical/supply-side view is that disequilibrium unemployment is caused by market imperfections such as minimum wages and strong unions. (Smaller heading) Cyclical unemployment (or demand-deficient unemployment) We start off by looking at cyclical (or demand-deficient) unemployment. In this view, unemployment is strongly linked to phases in the business cycle, as the demand for labour is derived from the demand for goods and services. This is known as cyclical unemployment since it is connected to cyclical variations of economic activity. When total unemployment is higher than the natural rate of unemployment there is a cyclical addition to total unemployment caused by relatively low aggregate demand.

7 Figure 51.3 Disequilibrium unemployment cyclical or demand-deficient unemployment Diagram I in figure 51.3 utilises the aggregate demand and aggregate supply curves for labour to illustrate how a change in the demand for labour during a recessionary period causes disequilibrium on the labour market, i.e. a degree of cyclical unemployment. The decrease in the demand for labour from ADL 0 to ADL 1 adds U 0 FE unemployment to the previous (natural rate of) unemployment FEU* shown in diagram II. The question you should now be asking yourself is why the real wage rate doesn t fall to W 1 and create a new equilibrium level of unemployment lower than the rate at W*. Here s a clue; cyclical/demand deficient unemployment is also known as Keynesian unemployment! Recall that Keynesian economics views markets as imperfectly functioning in general, and that labour markets specifically suffer from downward stickiness. The concept of cyclical unemployment, in accordance with Keynesian assumptions, means that real wages will not fall in the short run and the market will be in disequilibrium. In other words, since labourers will be highly unlikely to accept lower wages (and firms will also be reluctant to lower them) the real wage rate will remain at W* and create an excess supply of labour at the going wage rate. While the labour market might ultimately clear, the proportion of people not accepting jobs at lower rates might last for some time, with unemployment rates above the market clearing level of W 1. Keynesian economics looks upon markets as inherently unstable/imperfect which explains the propensity towards government intervention. Definition: Cyclical (or demand deficient or Keynesian) unemployment Cyclical unemployment is the addition to equilibrium unemployment (full employment) resulting from a contractionary economy. Since the demand for labour is largely derived from the demand for goods and services, a fall in aggregate demand (and/or aggregate supply) during a recessionary period will decrease the demand for labour. The term derives its name from the cyclical variations in economic activity.

8 WARNING! Using labour market diagrams Here are a few common mistakes you will want to avoid plus a few comments on my labour market diagrams. Common errors: A common error in using labour diagrams is to mis-label the axes. (Rory, I m still confused about the plural form of axis.) Quite frequently when exam stress sets in students will use AD rather than ADL. Another common error is to put P on the P-axis rather than the correct P L or Real average wage rate. Include relevant assumptions! Here, you should include whether you are assuming real wages to be downward sticky or not. Comments on my use of diagrams to illustrate unemployment: I know of no secondary school textbook which consistently uses the TLF curve in diagrams seeking to illustrate changes in ASL or ADL. Commonly, textbooks briefly explain labour market equilibrium e.g. the natural rate of unemployment and then use a rather simplistic diagram omitting the TLF curve. My question is invariably: Right, now how can you see the quantity of unemployment?! Well no, as a matter of fact. A shift in ADL shows the change in people who have jobs not the amount of labourers who do not have jobs. Thus I have decided to retain the TLF curve in all diagrams. I am telling you the above simply to point out that you will NOT be penalised in your exams or IA by using the more common version without the TLF curve.

9 (Type 4 Smaller heading) Aggregate demand and demand for labour The relationship between aggregate demand and the demand for labour should be fairly clear cut; a rise in aggregate demand will lead to an increase in the demand for labour and vice versa the demand for labour is derived from the demand for goods and services. Figure 51.4 shows how a decrease in aggregate demand during a recession will affect the aggregate labour market. Figure 51.4 Disequilibrium During a recession (figure 51.4, red section in diagram I) aggregate demand falls which is shown in diagram II as a decrease in aggregate demand from AD 0 to AD 1. This will cause a decrease ultimately, remember that there are lags to take into consideration in the demand for labour, shown by the decrease in the aggregate demand curve for labour from ADL 0 to ADL 1 in diagram III. This creates a cyclical addition to unemployment of U 1 FE cyclical unemployment increasing total unemployment from FEU* to U 1 U*.

10 OUTSIDE THE BOX: THE KINKED SUPPLY CURVE FOR LABOUR (Smaller heading) Real wage unemployment By now you will need some revision. Here are three introductory points to real wage unemployment: 1. Disequilibrium unemployment e.g. where unemployment exceeds the equilibrium or natural rate of unemployment can be explained by a decrease in economic activity which leads to a decrease in the aggregate demand for labour. Since wages are downward sticky the labour market does not clear and the addition to total unemployment is called cyclical or demand-deficient unemployment. This is the Keynesian/demand-side view of disequilibrium unemployment. 2. There is another way to view disequilibrium unemployment, namely that the labour market does not clear at the real wage rate because there are structural hindrances which disallow the market to clear. This is known as real wage unemployment. In short, the real wage rate is too high. The real wage is too high since there are labour market impurities or rigidities disallowing the market to clear. For example, minimum wage legislation and union bargaining power helps keep wages too high resulting in non-market clearing real wages. This is the new-classical view. Here s another clue; real wage unemployment is also known as classical unemployment. Classical theory views labour markets as not entirely dissimilar to the market for goods such as, em, chickens.

11 Definition: Real wage unemployment (or classical unemployment) Real wage unemployment is the new-classical view that any addition to equilibrium unemployment is due to labour market imperfections such as minimum wage, union bargaining power, high social and unemployment benefits and other labour market rigidities. These imperfections keep real wages too high and disallow market clearing, leading to increased unemployment. The difference between cyclical and real wage unemployment is worlds apart since the former is based on Keynesian premises and the latter on new-classical but you d have a hard time discovering these differences by simply looking at the labour market diagrams. You see, the difference lies not so much in the fact that there is an excess of labour supply at a given wage rate but in why there is disequilibrium unemployment and what should be done about it. Figure 51.6 is virtually the same as in the diagram showing demand-deficient unemployment; real wage rates (W 0 ) are such that the market has not cleared, creating disequilibrium unemployment of U 0 U 1. Why is there disequilibrium unemployment in the economy according to real wage theory? Figure 51.6 Disequilibrium unemployment real wage unemployment U 0 U 1 : Real wage unemployment arises since at W 0, U 2 labourers are willing to work but only U 0 are demanded by firms. The real wage is too high and total unemployment is U 0 to U 1.

12 According to new-classical views, when the real wage rate is above market equilibrium wage, W* in figure 51.6, there will be more labourers willing to accept jobs than there is demand from firms. More labourers are willing to accept a job (e.g. there is a movement along the ASL curve) at W 0 but there is less demand from firms, shown by the quantity demanded for labour at U 0. There is now more labour willing to take jobs than there are offers of jobs. According to the new-classical view, disequilibrium unemployment (e.g. unemployment above the natural rate) exists because labour market forces have not been able to clear the market by lowering the real wage rate sufficiently. The wage rate of W 0 is above the market clearing rate of W*, creating real wage unemployment of U 0 U 2. Total unemployment is thus U 0 U 1, above what would be the level of unemployment if the labour market cleared at a wage rate of W* - the natural rate of unemployment of FEU*. How is the real wage rate set at above market clearing level (W* in figure 51.6) and why can it remain there? The new-classical view gives three main reasons: 1. One main reason is that the government might have instigated minimum wage legislation which sets the price of labour higher than the labour market would. 2. Another common argument is that social welfare states might have social/unemployment benefits which would decrease the propensity of people in the labour force to accept wages below a certain rate. High unemployment benefits mean that the opportunity cost of remaining unemployed is relatively low labourers lack incentives to take jobs at the going real wage rate. 3. Trade union power might serve the same purpose; by successful bargaining of wages, wages are bid up above equilibrium level. (Note that the concept of downward sticky wages is relevant here too.) All in all, these three factors are considered to build in market imperfections and hinder the labour market from clearing. The result of these structural impediments (= hindrances) is a higher level of unemployment than the full employment level. Government policies to deal with unemployment The two big policy areas are the Keynesian and new-classical approaches to disequilibrium unemployment and will be dealt with in further chapters. Here we will look at possible solutions to the three components of equilibrium unemployment; frictional, seasonal and structural. (Smaller heading) Decreasing frictional unemployment Frictional unemployment is conceptually based on the notion that a suitable job exists for the job-searcher and that it is a matter of finding that job. The basic issue in decreasing frictional (also known as search ) unemployment is to shorten the time workers spend between jobs. That narrows down the options in reality, it is a matter of creating a better match between seekers and employers and/or incentivising workers to take jobs that might not be at the top of the list. Yes, we are back to the able and willing concepts of supply and demand. Government run work offices with centralised computer systems linking employers to job searchers has worked very well in Sweden, Denmark and Germany. Worker programs aimed at increasing skill levels, such as apprentice programs and government run training schemes have been implemented in many European countries. A particularly Scandinavian attempt at lowering search unemployment for young people was to offer firms a discount on labour taxes when employing under-20s. (Yes, this met with some considerable criticism and it was finally dropped when it turned out that firms demand for over20s labour dropped more than new hiring of youths increased!) Lower income tax rates for low paying jobs can increase the net wage and thus incentivise workers to take second best options while continuing to search. Governments can also increase the opportunity costs of remaining unemployed during job searching by lowering social and unemployment benefits.

13 (Smaller heading) Decreasing seasonal unemployment Here too is the issue of getting labourers to accept jobs but often it means that labour has to move geographically and/or industrially. A lobsterman in the off-season will have to move elsewhere and an Alpine ski instructor might find herself having to work in a restaurant. It is worthy of noting that since seasons are rather regular and therefore predictable, one often finds that people in seasonal industries manage to earn enough over the course of the season to get by the rest of the year. For example, my favourite island in Greece, Sifnos, sees a population go from just over a thousand during the winter to well over 3,500 during the May to September high season. Barba Niko, my wonderful Syfnian uncle who lovingly chastises me for going on long distance runs in 40C heat, works 16 hours a day but can then spend a rather chilled-out off-season in Athens. Frequently market forces seem to take care of many cases of seasonal unemployment. Many regions simply rely on an influx of temporary labour during peak times and revert to back burner levels in the off season. Good examples of this are found in tourist areas (Greece), wine making regions (France) and extensive sheep farms (Australia). Central and regional government can offer various forms of regional incentives aimed at reallocating labour from areas with highly seasonal demand for labour to areas in need of labour, for example free train fare to job interviews and financial help in moving to another region. (Smaller heading) Decreasing structural unemployment Keep in mind that structural means build in to the fabric of society, e.g. unemployment arising from a permanent decline in the demand for certain types of labour. The problem is like a very difficult form of frictional unemployment where workers need to find alternative jobs in other fields. However, the time between jobs in the case of structural unemployment can be a very long time indeed since a coal miner (sunset industry) with 30 years experience losing his/her job will have a hard task getting a job as a computer programmer (so-called sun-rise industry ). Putting a harsh point on it, what needs to be done is increase the adaptability of the workforce so that time between jobs is cut down. Such policies, commonly referred to as structural reforms, take on both interventionist and market-based forms: Interventionist policies o Government-run retraining schemes and tax breaks to firms which supply re-education for redundant workers can increase labour market flexibility. o Several Nordic countries (Sweden and Finland for example) have outsourced government agencies to regions with high levels of structural unemployment. This also goes for universities and R&D institutions. Higher paid jobs create regional multiplicative effects and increases demand for labour in other areas such as services and recreation. o Subsidies and grants can help firms establish in areas with sectoral/regional unemployment. o.other supply-side policies, see Chapters Market-based policies o Lowering unemployment and social benefits can create incentives for workers to move geographically and/or take jobs at lower wage levels. This was a policy during the Thatcher era in the 1980s. o Labour market legislation making it easier to hire/fire can increase labour mobility between jobs. This was done in Denmark during the 1990s which has resulted in one of the world s most mobile labour force and also a consistently lower unemployment level than the rest of the EU. o other supply-side policies, see Chapters The overall aim of market solutions to unemployment is to alleviate supply and demand mismatches, i.e. to improve labour allocation. Proponents of market solutions point to the US and Great Britain as examples of how long run unemployment rates fell markedly during and after the Reagan and Thatcher reforms of the 1980s. This will be covered in depth in Chapters 60 62, supply-side policies.

14 Summary and revision 1. Equilibrium unemployment consists of structural, frictional and seasonal unemployment. a. Structural unemployment arises when there is a permanent decline in the demand for labour in certain industries. Three types of structural unemployment exist: sectoral, regional and technological. b. Frictional unemployment is the result of workers being in-between jobs they are actively seeking jobs, which is why this type of unemployment is also called search unemployment. c. Seasonal unemployment arises for workers in off-season in seasonal industries such as tourism. 2. Equilibrium unemployment is also known as the full employment level of unemployment which is also the natural rate of unemployment. 3. There are two types of dis-equilibrium unemployment: a. Cyclical (or demand-deficient) unemployment a Keynesian view that the disequilibrium is caused by low aggregate demand. b. Real wage (or classical) unemployment a new-classical view where unemployment above the natural rate of unemployment is caused by too-high real wages in the economy. 4. Government policies to reduce unemployment: a. Frictional examples include improved matching of available labour and firms via centralised job search agencies; training and education; and lower income taxes on low-paying jobs. b. Seasonal not a major policy issue, yet various regional incentives have often been implemented to reallocate labour from low to high demand areas. c. Structural interventionist policies focus on use of government subsidies and tax breaks to increase demand for labour in regions and industries, while market-based policies are intended to increase labour mobility by incentivising workers to move and/or take available jobs and ease the hiring of labour for firms.