Unemployment - The Details

Unemployment - The Details

To a certain extent, these were covered in the topic called 'Macroeconomic objectives'. They are reproduced here in a little more detail.

  1. Implications for government spending and taxation. High unemployment is expensive for the government and, therefore, for the taxpayer. For every unemployed person, there are two costs to the government. First, the unemployed worker will be entitled to benefit, and if he/she is young, or older but remains unemployed for a long period of time, he/she will be offered training under the 'New Deal'. Secondly, there is the less obvious cost of the loss of income tax revenues the worker would have paid in work. These workers would have been paying VAT as well through their purchases. Put together, some economists have estimated that the cost to taxpayers of each unemployed person is up to £9,000 a year.
  2. Economic cost to the economy as a whole. There is the cost to the whole economy in terms of wasted, unused resources. The existence of any idle resources means that the economy will be at a point within its production possibility frontier (PPF).
  3. Social costs of unemployment. Unemployed workers (young men, in particular) may create other external costs in the economy, like crime for example. The governments of the 80s always dismissed the coincidence of rising crime figures and rising unemployment. Was it really a coincidence, given that many of the new unemployed were young school leavers with no experience in work?
  4. The cost of unemployment to the individual. In the short term the unemployed worker has to put up with the loss of earnings, although this may be balanced by redundancy payments. But in the long run, the long term unemployed will find it harder and harder to find a job, as they find that the skills they have become less relevant and they have had no new training.

Classical unemployment

This is unemployment that is caused by the real wage being higher than the equilibrium real wage. The following diagram should explain.

Classical unemployment

If you cannot remember why the demand and supply curves for labour look as they do, see the topic called 'Labour markets'. Classical economists (and their contemporary relatives, the neo-classical and monetarist economists) believe that the laws of supply and demand work in all markets, including labour markets. In the diagram above, they believe that the market will 'clear' at the equilibrium wage W1 giving a level of employment of L1.

This equilibrium can be disrupted, though, through the action of, say, a trade union, or the imposition of a minimum wage by the government. In both cases, the real wage rate is likely to be forced above the equilibrium real wage to W2. At this higher real wage, the number of workers prepared to offer their labour services increases (to L2) but the demand for labour by the firms falls to L3. This means there will be L2 - L3 workers unemployed involuntarily.

It is important to distinguish between those that are involuntary unemployed and those that are voluntarily unemployed. Remember that the supply curve in the diagram above only gives the number of people who are willing and able to work at any given wage. Some people may be unemployed simply because they are looking for a better job (frictional unemployment - see later). These people are voluntarily unemployed.

The solution to this problem of unemployment for classical economists, therefore, was to remove anything that distorts the labour market. The elimination of trade unions, any minimum wages or wage councils (who set wages at reasonable levels for the poor) would be suggested. In the UK, trade unions are now weaker than they were twenty years ago. The old wage councils were abolished in the 80s, but the Labour government has introduced the National Minimum Wage. Labour markets are now more flexible, so real wage rates will be more responsive to changes in the supply and demand for any particular sub-market. The real wage, therefore, is more likely to be at the equilibrium position.

Keynesian unemployment (or demand deficient unemployment)

Keynesian economists, on the other hand, believed that unemployment was not just a question of the labour market being in disequilibria. Labour, after all, is a derived demand, derived from the demand for the good that is being produced. If there is a big fall in the demand for products in the goods market (during a recession, for example) then the demand for labour will fall causing unemployment.

Keynesian unemployment

Using the same diagram as before, we see that the equilibrium wage is W1 giving a level of employment of L1. Keynesians now argue that in times of recession, the aggregate demand curve for the economy as a whole will shift to the left. This will cause the demand for labour curve to shift to the left as well (from DL1 to DL2). If the real wage rate stays at W1 then there will be L1 - L2 workers involuntarily unemployed.

Of course, the classical economists would argue that the real wage rate would fall to the new equilibrium (wage W2, employment L3). The level of employment would fall (from L1 to L3) but there would be no involuntary unemployment. At the time of the 1930s depression, Keynes argued that this would not necessarily happen because wages and prices were 'sticky downwards'. Even if the real wage rate did fall, the lower incomes of the workers would lead to lower spending in the economy, a further reduction in aggregate demand and a further reduction in the demand for labour. When would it all end?

Frictional unemployment

As was mentioned earlier, frictional unemployment is voluntary unemployment for workers who are looking for a better job. This all sounds very trivial, but the numbers involved are quite significant. When you hear the monthly unemployment figures announced on the news (a fall by 20,000; a rise by 10,000; etc.) what you may not realise is that the monthly change is dwarfed by the actual inflows of workers into jobs and outflows of workers into unemployment. Some months these figures can be as high as 300,000!

The bigger the imperfections in the labour market, the longer will be this period of unemployment for each worker, and the higher the 'search' costs for the individual. Of course, the worker could take the first job that comes his way, but it is probably better, for the individual and the economy as a whole, if he takes some time to find the right job, so that he is more productive in that job.

Some argue that this 'search' can become rather too 'long term' if, for example, the Jobseekers Allowance is too high. If out of work benefits are high, the unemployed worker might be tempted not to bother with work at all. The replacement ratio would be too high (the size of the unemployment benefit as a percentage of in work disposable income). But if benefits are too low, newly unemployed workers might take the first job that comes along, which might not be the best use of his skills. The economy's resources would not be allocated efficiently.

Structural unemployment

Structural unemployment is so named because it is unemployment caused by changes in the structure of the economy. The huge shift away from manufacturing to the service sector over the last twenty to thirty years (often referred to as deindustrialisation) has caused structural unemployment to be the largest component of the total unemployment figures.

Imagine working as a shipbuilder all your life, and then, at the age of, say, 53 your dock closes and everyone is out of work. You have been trained, thoroughly, for one job, but what else can you do? Some of the skills will be transferable, but retraining will be required. Employers would rather take on an 18 year old - young, fresh and open to new ideas - rather than a 53 year old with pre-conceived ideas of how to do things.

This was a common story throughout the 80s. A 53 year old man would often not get a job for a couple of years, and then it would be impossible to find work at the age of 55 with two years out of the market. He would spend the rest of his days up to retirement age (65) unemployed and virtually unemployable.

The problem of deindustrialisation would not be so bad if the expansion of the service sector creates enough jobs to employ those who lose their jobs in the manufacturing sector. This has happened to a certain extent, but the skills required in the service sector are often different to those required in the manufacturing sector. Occupational mobility has been improved through government training programmes, in particular, the 'New Deal' which helps the long term unemployed get back to work. Geographical mobility needs to be improved as well, through increased low cost housing for those who need to move to a more expensive area to get a job. Recent governments have not been quite so forthcoming with money to eradicate this problem. This may be because many people are reluctant to move from the area from which they came, regardless of financial inducements.

Technical unemployment

One can probably think of examples where 'technology' has put people out of work. A good recent example is the banking sector, where the introduction of phone and Internet banking has caused the big banks to close many of their traditional high street branches. Of course, it is not quite as simple as that.

If the improved technology reduces an industry's costs, and therefore prices, by a substantial amount, the increased demand for their product might involve an increase in employment. A substantial increase in output will require extra workers.

There is, therefore, a trade off. If, following improved technology, the increase in workers required outweighs the losses due to the more efficient capital employed, then there will be a net increase in employment. Otherwise, unemployment will rise. One important factor will be the extent to which new technology improves the productivity of the capital involved relative to the improved labour productivity. If all the reduction in costs is down to some new super machine, then the amount of labour required will probably fall.