The Question of Unemployment
Economic considerations versus political/social
considerations
UNICERT IV
paper
S. Alison Careless
2
The Question of Unemployment
Economic considerations versus political/social
considerations
“ A man willing to work, and unable to find work, is perhaps the saddest sight
that fortune’s inequality exhibits under the sun. “ – Thomas Carlyle
Abstract:
The following research paper gives a comprehensive study of the causes of
unemployment seen from a macroeconomic standpoint, and later confronts them
with political approaches to the problem. In the first part, terms such as
frictional unemployment, wait unemployment and wage rigidity are explained in
depth in order to give a basis for the subsequent discussion which reflects some of
the paradoxes inherent in the subject.
3
Keywords:
•
Disguised unemployment
•
Efficiency-wage theory
•
Frictional unemployment
•
Minimum-wage laws
•
Seasonal unemployment
•
Structural unemployment
•
Unemployment Insurance
•
Unemployment rate
•
Wage rigidity
4
I.
Introduction
Unemployment is a situation which exists when members of the labour force
wish to work but cannot obtain a job.
It is therefore used in the sense of
‘involuntary’ unemployment, rather than the voluntary decision on the part of
someone to choose leisure rather than work. Most governments take it as a
prime object of policy to keep aggregate national unemployment at a minimum.
The rapid acceleration in the rate of inflation through the 1970s led to increased
emphasis on control of inflation, and rates of unemployment have risen sharply
in the U.K. and throughout the O.E.C.D. economies.
In a general sense
unemployment represents a waste of resources: the economy is producing below
its potential capacity and hence the total output of goods and services is less than
it could be – everyone is worse off than they need be. Keynes believed that the
mass unemployment of the inter-war years was not a problem of scarcity but of
incipient abundance.1 Further, the burden of unemployment tends to be
unequally shared: it bears particularly heavily on the youth of ethnic minorities
and particular localities and regions.
Arguably high rates of unemployment
create greater social tension and stress than high rates of inflation.
Several types of unemployment have been distinguished and will be discussed
throughout the course of this paper. After having dealt with the macroeconomic
theory behind this problem we will turn to politics and how this issue is
addressed there.
II.
Main part
A)
Explanations of the macroeconomic terms
1
Skidelsky
5
a)
Unemployment rate
Unemployment is probably the one macroeconomic problem that affects people
the most, due to its direct impact on their lives. Hence the reason that every
prospective political leader promises to reduce the unemployment rate.
Therefore a close look at the unemployment rate will quickly give one an idea of
the main problem. Defining the labour force as that part of the population which
is employed or available for work 2, then this labour force is composed of a
number of people who are employed and of those who are unemployed. If one
denotes ‘L’ as the labour force, ‘E’ as the number of people employed and ‘U’ as
the number of people unemployed, one then arrives at the following equation for
the potential labour force
L=E+U.
Þ
Rate of Unemployment =
[Equ. 1]
U
L
Now if we include the cycle of job separation (‘s’) and job finding (‘f’) in this
equation then we arrive at the following
fU = sE
[Equ. 2]
Given this, we can now postulate the steady state unemployment rate.
Reconsidering equation 1
Þ E= L – U
and substituting E in equation 2, we now have
fU = s (L-U)
[Equ. 3]
6
After a certain amount of restructuring (as demonstrated in the Appendix) we
can now derive the new expression for the unemployment rate in terms of job
seeking and job finding:
U=
s
f +s
[Equ.
4]
This expression clearly shows that the rate of unemployment depends only on the
rate of job seeking and job finding of the workforce. The higher the rate of job
finding the lower the unemployment rate and vice versa. This relationship has
important implications for public policy: “Any policy aimed at lowering the
natural rate of unemployment must either reduce the rate of job separation or
increase the rate of job finding. Similarly any policy that affects the rate of job
separation or job finding also changes the natural rate of unemployment.” 3 From
these results we can draw the conclusion that job finding is not instantaneous.
Albeit this is an important conclusion, it does not give us any explanation for the
nature of unemployment.
b)
Frictional Unemployment
Considering that job finding is not instantaneous, we should look at ‘why it takes
jobless people so long to find a workplace’. The intuitive answer to this is
probably that it takes time to match workers and jobs. Furthermore not all jobs
and workers are identical. Not every worker is equally well suited for a specific
job. If this were the case a worker who was laid off would immediately find a
new job, always supposing that the number of workers is equal to the number of
jobs available; but as every worker has different preferences, potentials, motives
and abilities and every job has different attributes and requirements job finding
cannot be instantaneous. Besides this, one should not forget the imperfect flow of
information.
Not every worker is informed of every vacant job, not every
employer is informed of every job seeker. This has to do with the geographic
2
Bannock, pg.257
7
situation and the resulting immobility of workers. Additionally every worker
might have his own utility function attached to his search. The offer might be too
demanding, or the pay too low. This type of unemployment is called ‘Frictional
Unemployment’; it is caused by the time it takes a worker to search for a new job.
A certain percentage of this frictional unemployment is inevitable in our
changing economy. As the demand for goods and services changes, so does the
demand for the labour producing it.
The invention of the car, for example,
reduced the number of horsemen, but increased the number of workers employed
in the car manufacturing industry. At the same time it increased the number of
workers in associated branches of industry, such as steel production and of course
the new branch of researchers. This shift in demand occurring in branches of
industry or regions is called sectoral shift.
In addition to those reasons previously discussed, there are some more important
reasons for frictional unemployment, such as the failure of a firm, unacceptable
performance of the worker and job dissatisfaction or as shown in the example
above the extinct need of skills. As long as the supply and demand for labour
among firms is changing, frictional unemployment is unavoidable.
c)
Wage rigidity
Having discussed frictional unemployment we now turn to another important
reason for unemployment which is wage rigidity. Wage rigidity occurs when the
economy is unable to adjust wages to current demand until labour supply equals
labour demand. In the equilibrium model of the labour market the wage rate
would adjust to balance supply and demand, however in reality instantaneous
adjustment does not occur, thus wages are occasionally above the marketclearing level.
This demonstrates that the inflexibility of wages is a great
inhibiting factor on the labour market.
The explanation for this lies in the
following: once the wage level is above the level balancing supply and demand,
the quantity of labour supplied will exceed the quantity demanded. Employers
3
Mankiw, pg. 135
8
will only be able to finance a small quantity of labourers at this high level of
wages and therefore many labourers will be left without work. Using the terms
introduced previously when talking about frictional unemployment we can say
that ‘real-wage rigidity reduces the rate of job-finding and raises the level of
unemployment’.4
Unemployment which is caused by wage rigidity and the
resulting job-rationing is called wait-unemployment. In this case workers are not
unemployed because of the time factor which arises when the worker is searching
for the job best suited to their individual skills and preferences, but because
supply simply exceeds demand. All they can do is to wait for a job to become
available.
Real wage
Supply
Amount of
unemployment
Rigid real
wage
Demand
Amount of
labour hired
Amount of
labour willing
to work
Labour
Real-Wage rigidity leads to Job Rationing
If the at
realthis
wageproblem
is tuck above
the equilibrium
level,
then themicroeconomic
supply of labour exceeds
Looking
bearing
in mind
general
theory, one
the demand. The result is unemployment
Source: Mankiw pg. 139
would assume that once the supply of workers succeeds demand and the real
wage exceeds the
4
Mankiw, p.g 138
9
equilibrium level, companies would lower the real wage.
There are several
reason why firms tend not to follow this microeconomic rule: minimum-wage
laws, the monopoly power of unions and efficiency wages.
d)
The impact of minimum-wage laws
In the case of minimum-wage laws it is the government, not the company, which
prevents the wages from falling to equilibrium levels. Minimum wage laws set a
legal minimum on wages which companies have to pay their employees. If one
considers the single hourly rate for the national minimum wage in England one
arrives at £ 3.60 (as of the National Minimum Wage Regulation (1999) which
came into force on 1st April 1999).
In the German building industry an employer has to pay at least DM 18,50. The
difference here is that every industry has its own minimum wage.
Many
workers earn well above this minimum wage but for some workers, especially the
unskilled and inexperienced, the minimum wage raises their wage above its
equilibrium level. And this again results in a reduction in the quantity of labour
demanded employers.
If one looks at the different unemployment rates across the whole population, one
notes that the minimum wage problem has its greatest impact on teenagers, as
they are the least skilled and least experienced. Teenagers tend to have a low
marginal productivity and therefore tend to accept ‘compensation’ in the form of
on-the-job training instead of pay. For these reason, supply of teenage workers
equalling the demand is low and therefore minimum wages are often more
binding on teenagers than on anyone else in the labour force.
Wage rigidity is also often caused by the monopoly power of unions. In many
European countries unions play a very important role (e.g. Sweden – 84%; UK41%; Germany – 33%; Source: Clara Chang and Constance Sorrentino, “Union
Membership Statistics in 12 countries”, Monthly Labor Review (Dec. 1991) : 4653 ). The difference between unionised workers and non-unionised workers is
that the wages of unionised workers are determined by the bargaining of the
10
union leaders and are equal across all unionised workers in that industry. In
most cases the agreement raises the wage above the equilibrium level but
therefore allows the firm to decide the number of workers to employ.
This
usually results in a reduction of the hired labour force and has an increasing
effect on job-finding and consequently to increases in wait unemployment.
Unions can have the same effect on workers wages, even if they are not
unionised, by just the threat of their becoming union members. Unions are very
much disliked by firms as they do not restrict their work to wage bargaining but
also increase the bargaining power of labour and many other issues, such as
working conditions and hours worked. By paying their workers higher wages
and therefore keeping them happy, firms try to discourage their workers from
joining a union.
Unionisation creates another conflict; the conflict between insiders and outsiders,
i.e. the workers already employed by the firm (the insiders) who will try to keep
the wages high, and the unemployed (outsiders) who have to bear part of the cost
of higher wages paid to the insiders as otherwise they would be hired.
The
interests of these two groups will always differ and the outcome of any
bargaining depends on the influence of either group. (cf. Mankiw)
e)
The efficiency-wage theory
The last reason for wage rigidity causing unemployment lies in the efficiencywage theory which maintains that highly paid workers are more productive.
Despite excess labour supply, companies therefore might be afraid to cut wages
which would make workers unhappy and would thus cause efficiency to decline.
Although a reduction in wages would lower a firm's wage bill, companies would
suffer – if these theories are correct, resulting in a lower worker productivity and
a reduction in the firm's profits.
In poorer countries, the efficiency wage theory argues that a higher wage
increases productivity as this would result in better nutrition of the workers, but
11
in most developed countries this should play no relevant role as most equilibrium
wages are above the subsistence level.
A second theory which again can be applied to developed countries states that the
higher the wages the lower the frequency of workers quitting their job for
personal reasons. This reduces the amount the company has to spend on the
hiring and training of new workers.
The third theory attached to the efficiency wage theory propounds that by paying
a higher wage employees are more likely to work with greater effort. Employers
do not have the possibility to monitor their employees constantly, but employees
who are paid a higher wage are more likely not to behave inappropriately as their
regret at losing their job is higher.
All these theories may differ in detail but have the common thread that
employees work better at a higher wage and the company profits from paying a
wage above the equilibrium level. In terms of unemployment this incorporates a
lower rate of job-finding and greater wait unemployment.
f)
Seasonal unemployment and structural Unemployment
Besides frictional and wait unemployment there are also other kinds of
unemployment, which nevertheless only make up a small proportion of total
unemployment.
One of these occurs as a result of the seasonal nature of some jobs and is
therefore called ‘Seasonal Unemployment’. (‘A concise dictionary of Business ‘)
One example for this is the building trade which employs more people in the
summer months than in the winter months.
Some governments adjust their
unemployment figures seasonally, in order to flatten the peaks and troughs of
unemployment in certain seasons.
‘Structural Unemployment’ is caused by changes in technology or tastes. One
example for this is increasing automation in the manufacturing industry,
encouraged by recent developments in computer technology.
The closure of
military bases may result in a whole community becoming unemployed.
12
g)
Disguised unemployment
One last kind of unemployment which should not be forgotten, although it has no
effect on the unemployment statistics, is that some potential workers choose not
to work.
Therefore ‘Disguised Unemployment’ can be defined as ‘a potential
addition to the labour force which does not reveal itself unless opportunities are
actually available’ (Dictionary of Economics). A large group which falls under
this criterion are married women, who might take jobs of various kinds, but only
if opportunities exist. Unlike the rest of society who are jobless, these people do
not register as unemployed; even though they do not work (viewed in terms of
paid work) they do not consider themselves as job seeking.
h)
Minimum wage
Prior to the following discussion on what the political approach to this problem
may look like, one needs to recall what John Maynard Keynes used to propose
when talking about economic management. In his view, the task of economic
management ‘was to bring forward the day when enjoyment of life could replace
saving up for enjoyment’.5
Before continuing our discussion of the above, we need to redefine minimumwage, as politicians usually believe that workers need this minimum wage in
order to live as part of society. They tend to be more concerned about the social
aspect of this question as they always have to bear in mind that the unemployed
also have a vote at the next election.
A)
Political debate about the unemployment insurance
When the question of unemployment arises in political debate, probably the first
issue raised is concerned with unemployment insurance. Besides the publicly
funded retraining programmes, which are designed to ease the transition of
workers from declining to growing industries, and therefore accelerate the rate of
5
Skidelsky
13
job-finding, to decrease the amount of frictional unemployment, other
governmental
unemployment.
programmes
tend
to
increase
the
amount
of
frictional
Under these programmes, unemployed workers can collect
fractions of their pay.
Additionally, they will be entitled to collect the
appropriate welfare (if we take Germany as an example) in order to sustain their
standard of living or at least not to sink below the subsistence level. The problem
arising from these programmes, albeit socially responsible, is that many
unemployed do not search for a new job as they consider their unemployed
situation to be very comfortable, seeing no reason for rejoining the hardship or
earning money for this comfort.
In macroeconomic terms this means that frictional unemployment and the
natural rate of unemployment increase because of unemployment insurance.
After having been unemployed for a longer period many unemployed workers do
not see the need to search for a new job or accept unattractive offers. Even if
they should find a job, because of the security of unemployment insurance they
are less likely to bargain for stable employment prospects and job security.
But this does not mean that the programme is ill-conceived, as in the beginning
at least the income of the worker is at least guaranteed at a fraction of his former
income, i.e. the family associated with this worker is not forced to suddenly leave
its accommodation or to suffer from hunger.
And if the worker does reject
unattractive job offers he unknowingly contributes to a better matching of worker
and job, but on the other hand, if he shows no initiative to contribute to his
subsistence at a later state and continues to live off the taxes of employed
workers, social tensions may easily arise.
Many employed workers who have to pay their taxes in order for the unemployed
to sustain their standard of living often appeal to politicians to reduce
unemployment benefits in order to give the unemployed an incentive to rejoin the
labour force.
Some people believe that the government could reduce
unemployment by employing the workers themselves and therefore obtaining
something in return for the money paid to them. This is partially founded on
14
Keynes' argument of initiating a policy of public works in housing, transport and
building roads, thus attempting to create mass or full employment. With full
employment, the standard of living would increase through the growth of the
consumer industry, while the state could reinvest in industry as a result of the
savings it would gain through unemployment benefits. “The full-employment
policy by means of investment”, he wrote to T.S. Eliot at the end of his life, “is
only one particular application of an intellectual theorem. You can produce the
result just as well by consuming more or working less.”
6
Keynes argued that
unemployment was not only costly to the state, but is also hardly beneficial to
society. This is why he argued that governments should concentrate their efforts
on fighting unemployment by overcoming periods of recession in which private
investment is cut heavily which leads inevitably to unemployment. Governments
are asked to create an investment-friendly environment.
This is one of the greatest criticisms aimed at the German government.
As
companies are always concerned about being economical, rising costs are the
main incentive in their trading. This phenomenon is one of the reasons for the
high unemployment rate in Germany, which itself mirrors the disadvantages of
the German economy.
Frequent criticism is made of
the following factors:
production costs are too high, direct wages are too high, inflexible working hours,
fringe benefits are too high, inflexible bureaucracy, etc.
Besides this, governments should encourage investment in research and
development programmes as qualified workers are needed for this purpose who
are more likely to be found in Germany than in one of the ‘wage-dumping’
countries. This means discouraging the hiring of foreign specialists and
simultaneously reducing fringe benefits in order to encourage new employment.
At present the national social system (again seen from the German standpoint)
calls for companies to lay off workers if they find themselves in economic
difficulties. One proposal to change this is to adjust the employer's contribution
to social security to total added value instead of to the wages of the workers,
6
Skidelsky
15
although this will result in the total opposite from what was proposed a few lines
above.
Some politicians propose the reallocation of labour and a resulting cut in working
hours in order to employ new workers as the solution to cutting unemployment.
A reduction in working hours is presumed to create new jobs. However, this
usually does not result in new jobs but in some workers working longer, as
overtime is sometimes less expensive than employing an additional worker.
Another impact is a reduction in that product range which hardly has any
negative effect on profit. Despite this possible consequence, the proposal might
well have a positive effect on companies. They could experience an increase in
productivity, because more workers generate higher productivity since the less
productive hours caused by, say, tiredness are reduced.
Unions therefore advise the government to cut reduction in working hours
without full compensation for lost wages as they maintain that a reduction in pay
would result in a reduction in consumption, which in turn would result in a
decrease in demand and this would ultimately lead to an increase in
unemployment. This is why they advocate a reduction in working hours with full
compensation for lost wages as they believe that this will not have any influence
on purchasing power.
The question nevertheless remains whether productivity would suffer.
An
increase in productivity can be achieved by a collation of work but also by
rationalisation, i.e. by the purchase of new machines.
One question the
significance of which is usually not recognised is whether the company needs to
increase its number of machines by expanding its workforce.
This of course
would entail a high increase in costs for the company but would also bring about
a possible increase in profits.
One interesting proposal to solve this paradox is for the government to enhance a
newly employed worker's wage by reimbursing his former unemployment
16
insurance to his new employer. This would lower the employer's costs and would
therefore encourage him to increase his workforce; and the government would be
paying for actual work instead of for unemployment.
The only question
remaining is whether the presently unused labour force can actually supply the
skilled workers that will be needed to implement this policy.
(cf. Mankiw)
One very important factor, namely the increase in flexibility on the part of the
individual worker, should at least be mentioned in this context. Flexibility easily
entails an extension of opening hours, though it does not necessarily increase
demand but only increases prices. The government could foster demand by e.g.
reducing taxes on private households; this would increase consumption, which
would in turn increase production and create jobs. But the companies could just
as well simply increase prices to create higher demand which would have the
opposite effect from what is our intention, as exports would decrease but imports
would increase. This spiral is hard to resolve.
III.
Conclusion
If we evaluate all these different proposals, we can see that it is much easier for
economists to propose changes in tackling unemployment than it is for
governments, as governments have to bear in mind the social consequences these
changes could bring with them.
We can see that changes are necessary; maybe society has to contribute more
than it currently believes to finding a final solution to this problem, as this might
otherwise become an even greater burden than it is at present.
17
18
Appendix:
Explanation of how to equate the formulae:
Plug E = L – U
[Equ. 1]
Þ
fU=s(U–L)
Þ
f
U
U
=s(I)
L
L
Þ
f
U
U
=ss
L
L
Þ
U
(f+s)=s
L
Þ
U
s
=
L
f +s
into
fU = sE
[Equ. 2]
[Equ. 3]
19
Bibliography:
Printed Material:
Bannock Graham, R.E. Baxter & Ray Rees (1984). Dictionary of Economics.
3rd edition, Penguin Reference
Isaacs Alan BSc, PhD ed. et alii (1990). A Concise Dictionary of Business.
Oxford Reference
Mankiw N. Gregory (2000). Macroeconomics. 4th edition, Worth Publishers
Skidelsky Robert (23/11/2000). ‘Ideas and the world’, The Economist
Sorrentino Constance, Chang Clara. “Union Membership Statistics in 12
countries”,
Monthly Labor Review (Dec. 1991) : 46-53
Internet sites:
http://www.hmso.gov.uk/si/si1999/19990584.htm#1
http://www.economist.com/PrinterFriendly.cfm?Story_ID=431717
http://www.economist.com/PrinterFriendly.cfm?Story_ID=443380
http://www.economist.com/PrinterFriendly.cfm?Story_ID=555453
http://www.economist.com/PrinterFriendly.cfm?Story_ID=498547
http://www.york.ac.uk/student/su/essaybank/politics/state_social_reformism.html
Resolutions:
EYP, Stockholm (March 2001). Motion for a Resolution by the Committee on
Social Affairs “ On the question of unemployment. Which solution to the
increasing need for non-skilled workers (often immigrants) and effective
education providing equal opportunities? What hope for young people?”
EYP, Stockholm (March 2001). Motion for a resolution by the committee on
economic and monetary affairs and industrial policy “On the question of
enlargement: the free movement of persons versus inflexibility of the
workforce and immigration from non-EU member states.”
20
Corral Luis Manuel, Presentation by Trade Union Congress of the Philippines
(TUCP) at the ADB-WB Social Policy Forum, 9-12
November 1999, Manila, Philippines