Download Chapter IV- Unemployment

4 Unemployment
Patrick Lam
Real Wage
4 Unemployment
Disequilibrium
unemployment
SE
SR
11.1 Voluntary & involuntary
unemployment
iv
v
W'
Replacement ratio:
v
low
replacement
W*
The amount one get out of work
v
Wc
ratio
The amount one get in work
Voluntary unemployment is the
minimum unemployment given market
high replacement
imperfection.
D
ratio
The market does not clear at qcwc
q3 qc1q* qcq2q*' q1
QL
 remaining U (qc-qc1). The voluntary
(equilibrium) unemployment is caused by alternative social security incomes which
discourage workers from accepting wage rates at market clearing levels. This is the
minimum unemployment obtainable given SE. It is also known as the natural rate of
unemployment.
Solutions:
 Shift the SR curve to the left(government’s hiding method) by not counting U (those
on re-training program). i.e. redefining the eligibility of unemployed.
 Neo-classical solution of shifting SE to the right by reducing attractiveness of
alternative social security incomes.
Keynesians emphasise the role of AD in this situation  advocate raising D to
absorb U. Supply-side economists reply that raising D will raise both money wages &
prices  real wage not changed  demand for labour will not change.
The natural rate of unemployment or the
Phillips' Curve
LR
P
NAIRU is the MIN level of unemployment
SR
possible at constant inflation. ‘Full employment’
is a controversial concept. To Keynesians, U can
be lowered permanently along the Phillips’
curve, provided a price is paid in terms of higher
& accelerating inflation.
Neo-classical
economists argued that U cannot be lowered
permanently in the LR. Attempts to do so
provide accelerating inflation  the LR Phillips’
will be vertical.
U
Causes of Disequilibrium unemployment
1. Government setting too high wages for civil wages.
2. Minimum wages legislation.
3. Wage/Labour determination: centralised wage bargaining.
4. Immobility of labour.
5. Taxation.
6. Anti-discrimination legislation.
- Where national unions with a lot of members in different industry/
Centralised
regions may bargain for its members.
wage bargaining
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4 Unemployment
Geographical
immobility
Occupational
immobility
T revenue
Taxation
Patrick Lam
- Takes place in where it is the most prosperous  wage fixed does
not reflect market conditions (supply & demand) in other areas,
including unemployment in those area.
- This also include public sector pays, which are structured on an
national basis.
- The solution is to decentralised wage bargaining.
- Housing problem for the unemployed to move to new area.
- No jobs  no mortgage  cannot buy new homes in new areas
- No jobs  prejudice against them in the house rental market
- People do not want to move north even with a promotion  HQs
are in the SE where people want to move back eventually.
Diverging house price differentials in the north/south (House price
in the north, house price in the south) in the 80s  people
could not afford to move north for a while  they cannot move
back.
- Negative equity in the recession  mortgage worth more than
what the property worth  people cannot sell property & move
elsewhere.
- Improved rights of landowners with legislative changes 
encourage people to buy property & rent them.
- Training mechanism is required for switching labours from 1 form
of obsolete industry to another form of growing industry,
- A particular problems at management levels: problems of firms
training employees(expensive) who may leave for other firms later.
- Governments do not want to be involved to cut T. Firms are the
best bodies to train labours.
- Diamondnism, entrepreneurship respond to incentives, according
to supply-sidists  most of the revenue should be allowed to be
kept  lower rate of marginal tax.
Laffe Curve: lower tax rate  higher economic
output  higher total tax revenue.
Supply sidist solutions:
 cut personal taxation for employers  allow
lower money wages while disposable wages stay
the same for employees.
 cut corporation tax  more incentives to make
, more firms set up, established firms could pay
more dividends(more people invest on it) &
reinvest (less borrowing)
T rate
- Tax cut: greater micro-economics effects for
the economy to work better.
- market forces work better than government regulated ones which
are poor, inefficient.
- the greater is the proportion of resources allocated/reallocated by
market forces/price mechanism, the better is the economy 
greater consumer sovereignty(resources are allocated to maximise
consumers’ interest), greater efficiency.
-minimise state involvement (cut T  cut G)
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4 Unemployment
Employment
protection
Legislation
Non-wage
benefit
Patrick Lam
- LR discrimination costs money  deter discrimination(bigger
wage bill, e.g. cheaper to employ coloured labourers)  bigger D
for the discriminated groups  wage for the discriminated goes up
 no discriminated
- Health & safety, acceptable working conditions, leave, sickness
pay, paid holiday.
- got to be reduced to reduce unemployment
11.2 Keynesians’ view on unemployment
In Keynes’ ‘the General Theory of Employment, Interest and Money’ he wrote
that unemployment with brief intervals on excitement is intolerable, and that they are
associated with today’s capitalistic individualism.
11.3 Unemployment in the UK
Keynesian Aggregate Demand Management policies secured nearly 2 decades of
low unemployment after the WW2. Recently, although the government commitment to
full employment (first stated in the 1944 White Paper on employment policies) is not
revoked, there appeared to be no tool do the job. The reflation solution of Keynesian is
impractical due to its adverse effects of inflation. Import controls/incomes policies are
rejected as they adversely affect resource allocation. The current government’s emphasis
on supply-side economics has little impact. The depressing forecast of unemployment
(U) of over 2 M for the 1990s is inevitable. It is argued that the low U for the 50s & the
60s was an exception rather than the rule.
The level of post-war unemployment
The objective of a ‘high & stable level of employment’(the 1944 White Paper)
was within reach during the 50s & early 60s, during which period, U rarely exceeds 2%.
This period ended in the mid-60s when an upward trend in U rate started. Each
successive U cycle(peaks to peaks) in recent years leave the UK economy with a higher U
rate than the previous one. The severe recession of 1980/81 conspired to give the UK an
absolute level of U higher than even in the 1930s Depression. U fell sharply in Summer
1986, but rise again in 1990 due to anti-inflationary measures. U peaks of in mid-93 at
10.5%, which is the first time since 1954, where the peak of U is below that of the
previous maximum. However, the data is questioned over its reliability due to the
frequent re-definition of the unemployed.
Methods of measuring unemployment
Labour Force - This survey method provide information about the labour force.
- The UK government does this quarterly.
Survey (LFS)
- It uses the International Labour Office (ILO) definition of U:
i)people without a job,ii) who were available to start work within 2
weeks and had either iii)looked for work within 4 weeks prior to
interview or iv)were waiting to start a job.
- Advantage: the internationally standardised ILO definition of U
allow inter-country comparisons.
- Disadvantage: costly, time-consuming in processing/publishing the
data, possible for sampling/response errors
Since October 1992, the UK government provide U figures monthly
Administrative
based on this.
records
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- Based on the no. of people claiming U related benefits:
Unemployment Benefit, Income Support & National Insurance
Credits at the Employment Services local offices.
- Less costly  by-products of administrative benefits system, and are
available speedily, giving details of small geographical areas.
- Based on pay benefits  highly susceptible to changes in the rules
governing people’s eligibility for benefit. (30 changes since 1979 to
reduce the official U).
Comparing the survey & administrative methods
The majority of the unemployed on the ILO definition are also included in the
claimants, but it also includes some non-claimants, who were not eligible for benefits(e.g.
married unemployed women who were looking for a job immediately after a period of
full time ‘occupation’ at home  not eligible for means tested income support).
The majority of the claimants, on the other hand, would also be U on the ILO
definition., but also includes some which are not ILO unemployed as they may either be
economically inactive(not seeking jobs/unavailable to start a job) or have done some [aid
work during the survey week.
The two measures of unemployment, however, show similar trends over the past
decades, and the gaps are narrowing. U for women is, however, consistently higher on
the ILO definition, as many are ineligible for benefit despite actively looking for a work,
while the case is in reverse for men.
The differences in the two measures are resultant from: i)changes in eligibility
conditions for claiming benefits or ii)movements in the economic cycle, where in the
downturn with fewer jobs available, people were discouraged, and whilst claiming
benefit are less likely to respond that they are actively looking for work in the LFS
questionnaire (ILO measure)  rise in claimant count not matched by a corresponding
rise in the LFS/ILO measure of U.
By mid-1994, registered U fell by 310 000 from its 1993 peak, while employment
fell by around 58 000. The 368 000 workers who are no longer employed but are not
claiming benefits are classified as inactive in government statistics. The main reasons for
the fall in registered U are: i)increase in inactivity, esp. mid - late middle age men who
took early retirement, ii)reclassification of many U as invalid & iii)growth in student
numbers in further/higher education.
Disaggregating unemployment statistics
Regional unemployment
There used to be a feature of disparity between regions for the unemployment
pattern. U in the South & the Midlands have been below the national average, whereas,
U elsewhere have been above the national average.
Traditionally, the reasons for the disparity are that the depressed regions have
been over-reliant upon declining industries like coal. Forthergill’s and Gudgin’s study in
1982 suggests that this is true until mid-1960s, when the problems seemed to be that the
N and Scotland have been dragged down by the disproportionate no. of big cities whose
U is high. Although U elsewhere are not so bad, there is a trend in the UK where jobs
shift from the cities to smaller towns/rural areas. Fothergill & Gudgin suggest that the
main cause of this is the shortage of space in urban areas.
The rise in U accompanying the 1990 recession was, however, concentrated in the
regions that have previously experienced lower rates of U than the national average(the
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4 Unemployment
Patrick Lam
South-East, Greater London, the South-West, West Midlands) convergence in regional
U rates. Those areas that were hit worst in the 1990 recession relied heavily on the
service sector/manufacturing which have experienced a sharp downturn in the recession
for the provision of employment.
Evans’ and McCormick’s work in 1994 related the housing market and the
convergence of U rates. The big increase in mortgage lending in the 1980s means that
there was a greater implications for consumer expenditure when the I is raise in 1990.
Higher I are unlikely to have a neutral impact on regional consumption, as geographical
locations of borrowers/lenders is regionally biased. Higher I  force borrowers to
reduce consumption to finance higher mortgage repayments, lenders may not spend the
additional I-related U on consumption expenditure. The narrowing of regional U in the
1990-93 recession is due to the inability of households in the SE to sustain high levels of
mortgage repayment without reducing their consumption  reducing AD in the SE raise
U. U varies within regions more than they do between regions.
Industrial and occupational unemployment
Different industries/occupations suffer disproportionately from unemployment
Some have an extreme cycle, like the construction industry(>25% in early 80s, 11.9% in
Spring 1986, 17% in Autumn 1993). For occupations, un/semi-skilled manual worker
are twice as likely as skilled ones to be unemployed. Manual workers are twice as likely
as no-manual ones to be unemployed. The U rates for non-manual, manual and general
labourers in Spring 1994 were 3.1, 6.4 & 16.3% respectively.
Female unemployment
Since 1975, the rise in female employment has been about 3 times as fast as than
for men, due to: new labour-saving technology in office, equal pay/opportunities
legislation encouraged employers to substitute males/capital for female labour,
Demographic & social factors. The recession may place more strain on a UK workforce
which as the highest activity rate of any country in the EU, although in May 1994, the
female U rate was 5.0%, compared with 12.8% for males. In all EU & OECD countries,
except the UK, women have higher U rates than me.
Age-related unemployment
Age particularly affects the duration of unemployment. In April 1994, the agegroup 50+ accounts for 47% of the male unemployed than has been out of work for over
a year, whereas the corresponding figure for 18-24 age group was 27%.
U is also concentrated in the 18-25 age-group, although it is mainly in the SR.
The 20- accounted for c.5% of the total unemployed in the 1960s, and in April 1991, it
was 13%, which would be worse if the government did not have schemes aimed at the
young unemployed(fallen 8% by April 1994). In nearly all OECD, young people
experience a much higher U rate than do adults. The Department of Employment
estimates, e.g., that for every 1% increase in male unemployment, there is a 1.7%
increase in male youth unemployment  proportion of youth in the total unemployed
increases. It also found no systematic relationship between the proportion of youth U and
their earnings. However, employers’ attitudes to them have moved adversely. A
Manpower Services Commission’s study found that 31% of employers thought that there
had been deterioration in the quality of young workers.
Ethnic unemployment
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The U rate of each ethnic group as a proportion of the total economically active
for that group would be high if it has a high proportion of older/younger people. Even so,
people of ethnic minority origins were more likely to be unemployed than whites of the
same age-group. sex & educational qualifications.
Length of unemployment
The pool of unemployed workers is a stock whose instantaneous size depends on:
i)the rate of flow into unemployment, ii)duration of the spells of unemployment
individuals experienced. U could increase as more join the register or by an increase in
the average time an unemployed spends out of work.
In the UK and most EU countries, the proportion of workers becoming
unemployed at any time is small, as compared with the US where the flow into/out of
unemployment are substantially larger. The higher U rate in the EU is due to the
increased duration of U. In 1992, more than 40% of the unemployed in the EU had been
out of work for a year or more compared with 15% in EFTA & Japan and only 11% in
the US.
11.3 International Comparisons
UK, USA, France & Germany experienced high & rapidly rising average U from
1960 up to the mid-1980s  due to the adverse oil price shocks of 1973-74, 1979-80
together with the pursuit of tight monetary & fiscal policies aimed at eliminating
inflation. UK’s rise in U in the late 70s was, however, much sharper than in most other
countries.
Although the U rates was standardised to allow for the differences in national
definitions, care must be taken in making simple comparisons. Figures reflect labour
market practices. Low Japanese rate  life agreement between firms and workers.
11.4 Why did unemployment increase?
The increase in the NAIRU from 1.6-5.6% in 1966-1973 to 3.5-8.1% in 1989-90
is according to Layard, Nickell & Jackman the effects o trade union power + a more
generous & easily available benefits system in the UK. Trade unions through their
influence on the target real wage curve(shift it to the right) may cause the NAIRU to rise.
The increase in the replacement ratio may prolong job search(assuming benefits are paid
over a long period) increasing frictional unemployment. Generous benefits reduce the
fear of U  makes union wage bargaining more aggressive.
From 1974 to 79, the main influence appears to be the first oil shocks(1973-74).
That, together with the commodity price boom in 1972-73 led to a rise in the target real
wage relative to the feasible real wage  NAIRU increased  much larger impact in the
EU than in non-EU Europe & the US. EU lost 3.3% in her real purchasing power from
the terms-of-trade loss(rise in M prices relative to X prices). The US & non-EU Europe
losses from that were 2.2% & 2.3% respectively. Japan experienced a 6% loss in real
income & did not experience the same increase in U as the EU  trade unions were more
effective outside Japan protecting workers against the fall in real wages from oil/
commodity price rises, at the expense of higher U. Meanwhile, labour productivity in
most OECD countries decreases  workers have to accept a slowdown in the growth of
the target real wagenot accepted by workers  NAIRU rose. Trade unions prevented
the downward adjustments in target real wages  NAIRU rises.
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Vacancies (V) %
From 1979-mid-80s, U in the UK rise above 10%  demand-led by authorities to
control inflation(tighter fiscal/monetary policies  overvalued sterling  Q falls by 5%
between 1979 & 1981, while actual U was pushed above the equilibrium rate to reduce
inflationary pressure in the economy, the equilibrium was also raised. One cause is the
increase in skill mismatch  changes in the structure of demand & technology away
from traditional heavy manufacturing industries.
The Beveridge curve maps
U=V
out the vacancy rate (V) against the
unemployment rate (U). If the
unemployed increasingly have the
wrong
skills/in
the
wrong
geographical area  increasing U
associated
with
increasing
vacancies  outward shift in the
Beveridge curve, which is nonUV curves
linear & negative slope(no matter
45'
how high the vacancy rate is, U is
never 0). The outward shift of the
increase in
Unemployment (U) %
Beveridge curve occurred in Britain
mismatch
in the EU in the 80s. In the UK,
unemployment
vacancy rate was higher in 1987
than in 1980, but U was double that of the earlier year. This did not happen in the US,
where the curve moved out and then back again.
The outward shift in the UV curves in the EU is in line with an increasing skills
mismatch  could be the result of the unemployed searching for jobs less effectively,
being more choosy in accepting jobs or firms more choosy in filling vacancies(against
long-term U or to employment protection legislation).
U fell sharply in the 1980s. The NAIRU fell, and the AD increased. Financial
liberalisation  easier access to consumer credit + tax cuts  boost to demand. U fell
below the equilibrium rate  inflation rose to around 10% p.a. in 1990  UK
government curtailed demand using high interest rate mainly  actual U(10.9% in
January 1993) was pushed up above the equilibrium rate  inflation fall to 2.2%p.a. by
July 1994. Since then, U fell in the UK, but is still around 9%.
There appeared to be not a single cause for the 4 times rise in U from the 50s to
the 90s. It is caused by a no. of adverse developments(unfavourable movements as trade
associated with the oil shocks) and the counter-inflationary policies.
11.5 Why did these adverse developments have such an effect on unemployment
EU & the US were hit most from the supply & demand shocks in U  their real
wages are less responsive to U than in Japan/non-EU Europe. The U costs of disinflation
are higher in the EU & the US. The differing responses could be found by examining the
institutional characteristics of the labour market. Corporatist economies (e.g. Austria &
Sweden)tend to be characterised by a high degree of consensus on policy objectives
between workers. firms & government. Bean, Layard & Nickell(1986) found that they
tend to exhibit high elasticity of real wages in response to U, and adjust faster to adverse
shocks. Newell & Symons(1986) found that the impact on U of trade union induced
wage-shock or a government induced interest-rate-shock was smaller in a corporatist
economies. The more corporatist the economy, the lower the cost (from rising U) of
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Patrick Lam
reducing inflation  costs of disinflation depends on the credibility of the government’s
policy. In corporatist economies most economic agents shares policy makers’ beliefs
about the structure & working of the economy & their objectives.
A positive relationship between corporatism & economic performance suggests
that an economy with a competitive(con-corporatist) labour mkt. like the US should
perform well. Calmfors & Driffill(1988) suggested that the relationship between
centralisation in wage bargaining & U might be hump-shaped rather than linear. There
are the high centralised wage bargaining between national unions & employers’
association on the one hand, and wage-negotiation at the central level(the corporatist
model) on the other. Unions recognise that high-money wages  higher prices  weal
wages unchanged. Government use a non-accommodating demand management policy
 higher U. Hence, unions moderate wage demand. Wage bargaining is conducted at
firm-level at a decentralised wage bargaining, where unions realise that higher wages
reduce market share & jobs lost. Intermediate system of wage bargaining(e.g. UK,
Italy, France): highest wage demand  highest U where perceived union wage
bargaining power is the greatest. Unions could secure wage increases above the level of
inflation. Higher money wages  higher industry prices  limited substitutability
between industries  little U  increase in real wage secured by powerful unions.
11.6 Sources of persistence in EU unemployment
Although the real wage rigidity between the EU and the US are similar, leading to
a similar SR movements in U, the increases in U inIn the US seem to be less persistent
than those in the EU, with U usually falling back quickly to its trend level. The problem
is that the NAIRU does not behave like the theory would predict. The equilibrium level
appears to be not a unique rate, but one that is influenced by the actual rate of U.
Otherwise, U should fall once the inflationary pressures are eliminated. Hysteresis
models explain the rise in the NAIRU in line with the actual U.
One prominent early contribution to hysteresis was the insider-outsider
hypothesis where insiders are the unionised employed who pay little attention to the
welfare of the unemployed outsiders. The insiders do not fear to be replaced by
outsiders. D for labour falls  insiders lose jobs becoming outsiders  D recovers 
smaller pool of insiders exploit the relative scarcity negotiating for higher wages, instead
of restraining to create job opportunities for other workers  economy settles at a higher
wage, lower employment equilibrium. Only when supply-side measures have weakened
insiders’ power(job protection legislation) did the economy recovered from a high U
equilibrium. Another argument is that U erodes the skills of the unemployed & reduces
their work habits. If the outsiders’ MPP fall below their reservation wage(the minimum
wage inducing the U to take a job), they will drop out of the effective labour force. Also
firms may want to employ workers that have been U for a short period of time  fear of
U does not constrain the wage aspirations of the employed as they have a better chance to
be re-employed than the average unemployed labour  increase in target real wages 
increase in NAIRU, compared with where workers are hired irrespective of their duration
of U.
Another school of thoughts is the job search behaviour of the outsiders whose LR
U discouraged them from searching for jobs, while adjusting to live on benefits(available
for a long period in the LR)  effective labour force falls  U have a smaller impact on
the wage setting behaviour of the employed.
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A third reason for the persistence of U is due to the high firing costs. Expensive
to fire workers  firms become reluctant to take on extra workers unless the increase in
D is seen as long lived.
The final reason for the persistence in U is attributable to the effects of recessions
on the capital stock. By 1987, as compared with 70-74, there was a capital shortfall of
21% in the UK & 34% in Germany, while the US capital stock was on trend. Reduction
in capital stock in EU lowers MPP of labour  demand curve for labour shifted to the
left  Q picks up, employment does not return to original level  economy returns to
equilibrium with a higher level of U than before.
Measures to reduce unemployment
At least in the EU, U can hardly be reduced once started  incentive to prevent U
from rising. OECD’s recent study of U (OECD 1994) discounted causes of high U it
regarded as ill-founded: technology, imports from low-wage countries & increased
competition from globalisation.
Technology both destroys & creates jobs. It eliminates low wage & productivity
jobs and creates higher skilled & better paid jobs. The income generating effects are
more powerful than the labour displacing effects. Technology promotes economic
growth, wealth & employment. Technology leads to U only if D is limited.
Manufacturing in industrialised countries shows that technology creates jobs. Since
1970, employment in high-technology sectors expanded, while that in low/medium
technology sectors stagnated. There are job-losses in low-skill manufacturing. Countries
adapted best in new technologies & shifted production & X to high technology markets
tended to created most jobs.
Competition from low wage countries especially Asia is also not substantiated.
Only 1.5% of the total OECD expenditure go to M from low-wage countries. Although
the figure is increasing, low wage markets represent a potential market for OECD exports
and create jobs.
Increased competition due to globalisation is also not a good reason for U.
Declining transport/communication costs, liberalisation of trade, I & K flows & rising
R&D expenditures makes firms more efficient through merging, downsizing or reengineering  small loss of unskilled jobs to non-OECD countries  creation of jobs for
skilled workers.
Hence, the solution to U cannot be to slow down technological development, in
work-sharing or protectionism. The OECD(& UK) government believe in using supplyside measures to reduce NAIRU, improving flexibility of labour mkt, restoring the
capacity of economies to adapt to change:
1. Enhance the creation & diffusion of technological know-how.
2. Increase working time flexibility.
3. Nurture an entrepreneurial climate.
4. Increase wage & labour cost flexibility(reassess minimum wage’s role for
redistributing Y).
5. Reform employment security provision.
6. Expand & enhance active labour market policies(improving public employment
services & helping long-termed unemployed)
7. Reform U & related benefits systems(eliminate disincentive effects).
8. Improve labour w-force skills(improving school to work transition, encouraging
workers to invest in continuing education, training.
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These measures are medium to long term. The UK adopted them and received
little benefits on U. They need to be reinforced by a commitment to active labour market
measures, targeted particularly at the long-termed U. In Sweden, benefits run out after 14
months, which are followed by intensive retraining programmes, recruitment subsidies to
employers and the public sector acting as an employer as a last resort  expensive but
paid for itself in reducing benefit payments  in the 1970s & 80s, Sweden’s U was kept
below 3%.
The low U in the UK in the 50s & the 60s was argued as an exception, achievable
only by the post-war consensus in the UK  stable inflation through wage restrain 
entrenchment of restrictive practices  slowed the growth of the economy + feasible
wage  UK’s relative decline. In Sweden in the 70s & 80s, there is a similar period of
low U & productivity growth  the devaluation & rapid increase in public sector
employment are more useful than the active labour market policies. Sweden currently
suffered the worst U since the 1930s (9% in 1994). The labour policies might not have
failed, as it never worked in the way many economist believed. The earlier polices could
not be said to be functioning as they were not really tested, since employment was
sustained by devaluation & increased public sector employment. OECD’s Employment
Outlook(1994) argued that although increased flexibility is important, regulations
covering areas like minimum wages, health & safety have little influence on economic
performance. OECD sees an important role for unions, workplace consultation & free
collective bargaining in improving labour mkt. efficiency, providing economic agents
with more information, reducing labour turnover, stimulating training & investments in
skills  UK government’s policy of flexibility in labour mkt. and creation of more
temporary(low-skill) jobs is not a solution, if it ignores unions’ role & discourages
training.
ADM may not work as well, unless U is above NAIRU. Jobs may be created in
the SR, but the LR effects will be higher inflation & U (vertical Phillip’s Curve). Some
economists see ADM as risky, while the OECD sees it as good for providing a
macroeconomic environment encouraging structural changes for job creation.
REFERENCES


Economics 2nd by John Sloman
'A' Level economics course taught by P C T Monk, Esq., at Haileybury College
(http://www.haileybury.herts.sch.uk)
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