Notes on Unemployment

Aims: By the end of this chapter, you will be able to
(i) provide definitions to full employment, number unemployed, unemployment rate, and underemployment,
(ii) describe various types of unemployment with the help of appropriate diagrams whenever possible,
(iii) describe the cost of unemployment, and
(iv) evaluate measures to deal with unemployment.

  1. Labor force is the part of the total population that is either employed or unemployed. Some countries define this population to be the people between the age of 16 and 65 who are available for work at current wage rate. In the United States, there is a focus on civilian labour force which is the non- institutional (i.e. non-military) civilian population between the age of 16 and 65 who are willing and able to work and who are either employed or actively seeking for jobs.
  2. The number unemployed is the part of the total population that of working age who are without job but are available for work (i.e. willing and able to work) at current wage rate. However, this measure of unemployed people usually excludes people
    1. under the age of 16 and institutionalized (military, prisoners, mentally ill patients, etc) personnels.
    2. who do not wish to work (housemakers, retired, in schools).
  3. Thus, unemployment rate (U)= (number unemployed ÷ total labor force) x 100%. The unemployment rate is simply the number unemployed expressed as a percentage of the labour force in the economy.
  4. One simple measure of unemployment rate is simply the claimant unemployment which reports the number of recipients of unemployment-related benefits from government. This is usually understate the actual unemployment rate in the economy because (i) not everyone qualify for such a benefit (e.g. new school leavers) and (ii) some people prefer not to depends on hand-outs because of personal pride.
  5. Standardized Unemployment rate is the measure of the unemployment rate used by the ILO and OECD. The unemployed are defined as persons of working age who are without work, available for work within two weeks and either have actively searched for job in the last four weeks or are waiting to take up a job offer.
  6. Table 1 . The average unemployment rate for selected countries over periods corresponding to US business cycles (trough to trough)..
     
    US
    UK
    Hong Kong
    1971-1975
    6.30
    4.06
    1976-1980
    6.68
    5.74
    1981-1991
    7.14
    9.86
    2.53*
    1992-2001
    5.31
    7.52
    3.50
    2002-2007
    5.22
    5.13
    6.07
    Source: http://federalreserve.gov/ , http://www.statistics.gov.uk/statbase/ & http://www.censtatd.gov.hk.
    * This figure is actually the average for 1982-1991. Unemployment rate fluctuates within a country in the short run and changes in the long run. Unemployment rates are also differ from a country to another. The unemployment rate in US, UK and Hong Kong in 2011 were 9.1% (Jul), 7.9% (Jun) and 3.5% (Jun) respectively.

Types of Unemployment

There are two major types of unemployment in the form of Disequilibrium Unemployment and Equilibrium Unemployment.

Disequilibrium Unemployment: this is the unemployment due to the fact that the current real wage rate is above its equilibrium. The equilibrium wage rate in diagram 1 below is we where the quantity of aggregate demand for labour (ADL) equals the quantity of aggregate supply of labour (ASL). The ASL shows the number of people in the labour force who is willing and able to able to take up jobs at each wage rate. ASL slopes upward as higher real wage rate induces people who did not wish to work before like housemakers back to the market and the unemployed who are in between jobs to accept job offers. The ADL, on the other hand, shows the number of workers firms are willing and able to hire at each wage rate. This demand curve is downward sloping as real wage rate rises, firms will have incentives to substitute labours with other factors of production like machineries. If wage rate is raised to w1 for some reasons like the imposition of a minimum-wage regulation or from the successful demand of trade union then QB (number of workers associated with point B) people are now willing and able to take up jobs but firms are only willing to hire up to QA people (number of workers associated with point A). Thus, QB - QA number of people will be unemployed. This sort of unemployment is called real-wage unemployment. A real-wage unemployment is caused by real wages being driven above the market equilibrium level.

Diagram 1. Disequilibrium and Equilibrium Unemployment.
disequilibrium unemployment

Diagram 2: Shifts in the ASL and ADL.

If the disequilibrium unemployment is due to a fall in aggregate demand and sticky wage rate then this type of unemployment is named demand-deficient (cyclical) unemployment. It is also called Keynesian Unemployment. To Keynesians, a low level of aggregate demand could be so low that is such that the output is too low to sustain full employment. Cyclical Unemployment is caused by the recession phase of the business cycle. Sticky wage rate refers to a condition in which wage rate can rise quickly but has a lot of resistance to a downward movement. Demand for labour falls as the aggregate demand (AD) declines. In diagram 2, we could allow aggregate demand for labour, ADL to decrease to ADL1 due to a decline in AD. If the labour market clears then the new equilibrium is at point E' with a corresponding lower real wage rate but this is unlikely as wages are sticky downward. Given that wage rate is sticky at w0 then a "gap" develops between the quantity of new ADL and the quantity of ASL. This demand-deficient unemployment is represented by the difference E-A in diagram 2 above. In 1933 (During the Great Depression in US), the US unemployment rate stood at 25%. During the recessions in 1982 and 1991, US unemployment rates were 9.7% and 6.7% respectively which exceeded the averages in Table 1.

A disequilibrium unemployment can also develop from an increase in the labour supply, a shift of the aggregate supply of labour to the right as in diagram 2 above. If the labour market clears then the new equilibrium is at E" with a corresponding lower real equilibrium wage rate. If wage rate is sticky at w0 then a "gap" develops between the quantity of new ASL1 and the quantity of ADL. The difference B-E is the disequilibrium unemployment caused by a growth in labour supply.

 

Equilibrium Unemployment is the difference between those who would like to work and those who are willing and able to take up a job offer at current wage rate. If the current wage rate is we as in the diagram 1 above then those who like to work are represented by point F and those are willing and able to take up job offers are represented by point E. The difference F - E is the equilibrium unemployment. At a minimum wage rate of w1 as in diagram 1, the equilibrium unemployment is represented by C - B and disequilibrium unemployment is represented by B - A.

Equilibrium Unemployment could take three forms:

i. Frictional Unemployment.

a. Frictional unemployment occurs due to imperfect information in the labour market. This sort of unemployment consists of search unemployment and wait unemployment; for individuals who are either searching for jobs that are "in-between-jobs", or waiting to take up jobs in the future. Casual unemployment -e.g. opera singers, actors, script writers, commissioned artists etc.

b. Inevitable because at any moment in time, there will be individuals looking for jobs, and moving between jobs. The later case may be desirable because individuals are usually searching for higher-paying jobs or jobs with higher-satisfaction. Thus, productivity is increased because there is a better allocation of labour resources.

ii. Structural Unemployment.

a. Structural Unemployment is caused by permanent changes in the pattern of consumption and in the production technology (technological unemployment) in the economy. This in turn alters the total demand for labor (say the DL shifts to the right as in diagram 2 above and given that the real wage rate is unaltered, then quantity labor demanded will fall short of quantity supplied at that wage rate.) The people who are made redundant in one sector of the economy like blowing glass cannot immediately take up jobs in the IT sector.

b. This sort of unemployment often occurs in a regional setting and sometimes one hears the term "regional unemployment."

c. The change in technology of producing bottle caused firms to replace glass blowers with bottle-making machines. These glass blowers although possessed a wonderful skill were out of job because their skills were no longer in demand. Technological unemployment is a sort of structural unemployment caused by introduction of labour-saving technology to the economy. A coal or gold mining town could run out of its precious mineral which leads to widespread unemployment. This latter example is a case of regional unemployment. Sometimes, these towns were abandoned as ghost towns.

d. The level of structural unemployment depends on the degree of concentration of a "sunset" industry in a region (+), the rate of technological change (+), the rate of change in consumption pattern (+) and the mobility of labours (-). The level of structural unemployment in a coal mining town that has ran out of coal is very high if almost everyone is related to the mining industry. If textile industry had a fast rate of adopting automation in its production then larger will be the structural unemployment for hand weavers as more will be made redundant en mass. Similarly if people switch away from candles to electric bulbs quickly then candle makers will be made redundant en mass. We say the mobility of labour is higher if labour can easily and quickly change from one profession to another. However, this is not always the case. A coal miner who only knows mining all his life cannot be turned into a computer programmer overnight!

iii. Seasonal Unemployment is unemployment associated with industries that have lower demand for labour at certain time of the year. Usually affects farming, tourism and industries which outputs are related to seasons. Although this is a 'natural' occurrence, seasonal unemployment is often factored out from unemployment rate calculation (seasonally adjusted).

Residual Unemployment is not counted because these are the people who are unemployed at a permanent basis. (Look at the definition of unemployment rate.)

Let us go back to the definitions of Unemployment rate. These definitions are often criticised because:

a. Part-time unemployment. Part-time employees are counted as 'fully employed'. Some of these people may want to work full time and yet are only able to find part-time job. Underemployment occurs when people want to have full-time jobs but are only able to find part-time work. By including people who are underemployed in the fully employed category the measurement is understating the extent of unemployment. In the 1994 there were 6.5 million part-timers in the US. Diagram 2 below shows the underemployment rate and unemployment rate of Hong Kong from 1983 to 2007. In this period of time, the underemployment rate fluctuates around 2 percent of the labour force. If underemployment is counted as unemployment then the total unemployment in Hong Kong in 2007 exceeded 6 percent as opposed to the official 4 percent unemployment rate.
Diagram 2.
Source: http://www.censtatd.gov.hk.


b. Discouraged Workers. These people were out of work for such a long time that they may give up hope of ever finding a job thus stop seeking job. They will not be included in the labor force. This group is especially large during recession. There were 1.25 million of these people in the US in 1991.

c. Workers above the retirement age of 65. Unemployment rate also does not take into consideration of people who are above the retirement age, say 65, but who are unemployed or actively seeking for jobs.

d False Information. Very often the information is collected through questionnaire and respondents may be motivated to reply in a certain manner.

e. Disguised unemployment. Some firms may be reluctant to shed labour even when they are clearly overstaffed. If four people are employed to do the work of three, then it can be said that there is 'disguised' unemployment of one person. Disguised unemployment also occurs when skilled people are forced to take low-paid jobs that do not utilize their potentials. This was a major problem in the former USSR.

Disguised unemployment is a special case of underemployment.

Full Employment refers to a state of economy in which total unemployment is made up of solely frictional, seasonal and structural unemployment. Full employment is not having a zero unemployment rate but when there is an absent of disequilibrium unemployment in the economy.

That rate of unemployment is named the
"full-employment rate of unemployment(seasonally adjusted)" = frictional + structural unemployment rate
= zero cyclical unemployment rate
= natural rate of unemployment

The level of output produced when the economy is having the natural rate of unemployment is called the full employment level of national output, y*. We say then the economy is fully employed at this stage. This is a Keynesian concept at which there is no deficiency in aggregate demand in the economy.

The natural rate of unemployment for a country changes over time depending on demographic shift (more or less younger people), government's policies (war, unemployment compensation, etc.) and the structure of the economy. In the US this rate was believed to be around 4% in 1960s, 5.5-6% in the 1980s, and about 5% in the 1990s.

Monetarists sometimes refer to the "non-accelerating inflation rate of unemployment" (NAIRU) as the natural rate of unemployment (Un). NAIRU is basically the level of unemployment in the economy when the rate of inflation is stable but not necessary zero. NAIRU is not identical to having zero cyclical unemployment rate.
The Natural Rate (level) of Unemployment is the level of equilibrium unemployment in monetarist analysis measured as the difference between vertical N (the represents people who like to work) and the vertical LR AS of labour (that represents people who are willing to work). It measures the unemployment that is estimated to prevail in long-run macroeconomic equilibrium.

Composition of Unemployment.

Table 2: A snapshot of the labor markets of OECD countries in March 1997 using standardized unemployment rate.

Country Total
(all ages)
Women
(all ages)
Men
(all ages)
Total under 25 years old Women under 25 years old Men under 25 years old
Belgium
9.6
12.5
7.5
22.4
26.7
18.9
Germany
9.7
10.7
8.9
9.7
8.8
10.6
France
12.5
14.7
10.6
28.2
31.3
25.3
Ireland
11.1
11.8
10.7
16.3
15.8
16.8
Japan
3.2
3.3
3.2
6.4
6.3
6.6
Netherlands
5.5
7.1
4.3
9.0
10.1
7.8
Spain
21.0
18.2
16.0
39.5
46.3
33.7
UK
7.2
6.1
8.2
14.8
12.6
16.7
US
5.2
5.3
5.1
11.7
11.2
12.2
EU15
10.8
12.6
9.5
21.2
22.9
19.7
Source: Eurostastistics.

Geographical differences. Regional differences within a nation as well as differences among nations. In many countries inner city unemployment is higher than suburban or rural unemployment.

Gender. Women are more likely to be unemployed than men. Nevertheless the gap is closing due to introduction of labour-saving technology in offices (brawl is not so important), equal pay legislation, and the rise of unemployment in the service sector where a high proportion of employees are women. In March 1997, UK appeared to be the exception in Table 2 in which women unemployment was lower than men unemployment. In Dec 2002, women unemployment in UK was 4.5% against men unemployment 5.7%, and both Japanese and American women had slightly lower unemployment at 5.1% and 5.6% against men unemployment at 5.8% and 5.8% respectively.

Age. Younger people are more likely to be unemployed. Factors include qualification, work experience, the attitudes of employers to young people, and greater willingness of young people to spend time in job search. In the US, 20.2 % of teenagers were unemployed in 1992. In 1997, young people under the age of 25 have more than twice the unemployment rate compared to the total unemployment rate in the US. Similar phenomenon was observed from Table 2 above and the exception was Germany. Germany had an apprentice programme that successfully reduced unemployment among young people. Belgium, France and Spain made some progress by 2001 and were able to reduced unemployment for young people less than 25 years old to 17.5%, 21.4% and 24.8% respectively. However, German unemployment for young people less than 25 years old was 9.8% compared to total unemployment rate of 8.0% in December 2001.

Ethnicity. Lastly, minority groups are more likely to be unemployed. In the UK, the unemployment rate for Afro-Caribbeans is 2.5 times greater than that for White Caucasians. The figure is 3 times greater for people of Pakistani and Bangladeshi origins.

Occupation. The less skill-intensive jobs tend to have higher unemployment rate.

Costs of Unemployment. (Why is Full employment desirable?)

1. GDP Gap & Okun 's Law. When the economy fails to provide enough jobs for all who are able and willing to work, potential production of goods and services is lost for ever. (In the PPF diagram, one is then producing within the PPF and not on it.)
GDP gap = actual GDP - potential GDP .
Arthur Okun stated that for every 1% that the actual unemployment rate exceeds the natural rate, a 2.5% GDP gap occurs. If the unemployment rate is 7.4% and the natural rate is estimated to be 6% then GDP gap is 1.4 x 2.5 = 3.5%.
The inability to produce at the potential means firms lose the opportunity to earn more profits if the economy were operating at full employment. Government loses tax revenues from income tax, profit tax and indirect consumption taxes if the economy were operating at full employment with higher personal incomes, profits and consumption level. For employed workers, this can means a loss of additional incomes due to bonuses and dividends if the economy were producing more outputs.

2. Personal loss. For the unemployed this means a loss in personal income. Even if he receives some form of unemployment benefits this still means a reduction in personal income. On top of that a loss in self-esteem and possible more strained relationships with friends and family members.

Other non-economic costs are increase in suicide, homicides, cardiovascular mortality, mental illness, crime and vandalism and social unrest.
To address these problems, government will have to spend more not only on unemployment benefits alone but also more on healthcare, social service, and police.

3. Unequal burden of unemployment. The burden of unemployment are heavier on the young adults less than 25 years old, female workers, unskilled labours, ethnic minorities and people in rural areas.

4. People who have been unemployed for a long time, loss skills and motivation. Long term unemployment concentrated among ethnic groups and in certain regions can lead to social and political unrest. On the other hand, more government spending on healthcare, social service and police can create new jobs in the economy. Over all, the long-run costs of unemployment exceed benefits.

Measures to deal with Unemployment.

1. Frictional Unemployment. This is basically a problem of imperfect information in the labour market. Government can help by creating job centers and website to advertise job vacancy, to help in job placement and to improve job search skill like resume writing and interview tips. These job centers can also organize job fares by bringing together firms at especially employment depressed regions. However, these centers may also encourage more frictional unemployment because they lower the cost of searching for job and may encourage more people to seek better positions.
A more controversial measure is to reduce the length a person can receive unemployment benefit and increase the conditions for a person to qualify for unemployment benefits. These measures can provide the incentive to increase the intensity of job search and the likelihood of accepting a job offer.

2. Structural Unemployment. This usually involves supply-side policies that attempt to shift the aggregate supply of labour to the right. As mentioned before the problems with structural unemployment lie in a skill being obsolete and immobility of labour. The supply-side policies can take (a) market orientated approach, (b) interventionist approach or (c) a combination of both market orientated and interventionist approach. With the market orientated approach, government can set up job counseling programme to encourage people to adopt a more willing attitude towards retraining, to practice life-long learning to constantly upgrade or expand their skills, and if necessary accept a reduction in wages. Many people probably will deem the interventionist approach as more active because government provides retraining programmes, support life-long learning that upgrade or expand one's marketable skills, and sets up incentives for firms to set up in areas with high unemployment. A more successful measure probably will have to have components of both market orientated and interventionist approach. All these measures can increase labour mobility. It was reported (late 2001) that in Germany some of the unemployed were trained to become rock/pop-singers. In the regional setting, job centers like above may help, and government can provide grants for firms to set up new industries in the affected areas. However, placing an IT industry in a ex-mining town where most people knew only mining all their lives will not solve the problem of structural unemployment.

3. Cyclical Unemployment. Keynesians believe that an appropriate injection into the economy by the government via fiscal and/or monetary policies can close the demand-deficient gap. Monetarist are more skeptical about this recommendation and believe that government should provide a stable macroeconomic conditions to help the economy grows out of recession. Attempt question 4 below.

4. Disequilibrium Unemployment. For real-wage unemployment, government can work to reduce nominal minimum wage so to reduce the real wage rate. However, this is unpopular and puts the burden on workers with lower incomes. A government can also increase money supply so that the price level increases and lets inflation to reduce the real wage rate. This will of course incompatible with the objective of keeping inflation low and stable. A more effective measure is for government to dilute and break the bargaining power of labour union to raise wages.

5. Seasonal Unemployment.This is not a big worry to many governments because unemployment rate is often adjusted for this seasonal factor. A government can reduce the influx problem of school and college graduate leavers on the economy by providing job fares that target this group of job seekers. For tourism related industry, a training scheme can be set up to expand the skills of people affected. For example, a ski instructor can be trained to become a bird-watcher guide or guide to hikers in the summer.

NB: The high unemployment rate in Europe in the late 90s was believed to be caused by inflexible employment structure (high minimum wage, difficult to fire employee, etc).


Exercises

  1. Explain the economic costs of high unemployment to an economy.
  2. Measures to deal with unemployment could be categorized into "market-orientated" and "interventionist".
    Explain these measures that are (i) market-orientated and (ii) interventionist with examples.
  3. Explain two measures that can be use to deal with demand-deficient unemployment.
  4. What could be done to reduce the unemployment rate of full employment? Use AS-AD diagrams in your explanations.
  5. An economist says that the solution for real -wage unemployment is to simply reduce minimum wage rate and reduce the power of labour union.
    Evaluate the effectiveness of this recommendation?
  6. (a) Define equilibrium unemployment and disequilibrium unemployment.
    (b) Evaluate the effectiveness of demand-side policies in reducing unemployment.

Projects

  1. What is the rate of unemployment in your country at the moment? Is that level high? What are the likely causes of these unemployment? Is your government doing anything about it?
  2. Does the Okun's Law apply to the Unemployment- GDP gap in your country?
    [You need unemployment, potential GDP and real GDP data]