A2 Macroeconomics / International Economy

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1 Tutor2u Limited All Rights Reserved. These study notes are protected by copyright and may not be reproduced in part or in whole, for whatever reason, without the prior written permission of tutor2u. The use of tutor2u content for commercial gain of any kind is strictly forbidden. We reserve the right to take legal action against any party or parties found to have breached our copyright. A2 Macroeconomics / International Economy Unemployment In this note we consider in more depth the causes and consequences of unemployment. After over a decade of falling unemployment, the number of people out of work in the UK economy is rising again, and this highlights some of the economic and social effects of people being unable to find paid work. Measuring unemployment in the UK Claimant Count The claimant count includes those people who are eligible to claim the Job Seeker's Allowance (JSA). Claimants who satisfy the criteria receive the JSA for six months before moving onto special employment measures. One problem with the claimant count is that it excludes many people who are actually interested in finding work and who might have searched for work in the recent period but they don t meet all of the criteria for claiming and therefore are not included in the unemployment count. In 2003, the claimant count averaged 933,000 or 3.0% of the labour force. Labour Force Survey The labour force survey (LFS) measure of unemployment covers those people who have looked for work in the past month and are able to start work in the next two weeks. On average, the labour force survey measure has exceeded the claimant count total by about 400,000 in recent years. Labour Force Survey (LFS) unemployment LFS Unemployment Per cent of the labour force Claimant Count unemployment Claimant Count Per cent of the labour force , , Related Materials AS Notes - Markets AS Notes - Market Failure AS Notes - Macroeconomics AS Presentations - Markets AS Presentations - Market Failure AS Presentations - Macroeconomics A2 Notes - Microeconomics A2 Notes - Macroeconomics A2 Presentations - Microeconomics A2 Presentations - Macroeconomics , , , , , , , , , , , , , Source: UK Labour Market Statistics Some basic labour market definitions Unemployment rate: = the percentage of the workforce that is registered as unemployed The labour force: = the number of people in employment + the registered unemployed Working population: = the population of working age (estimated in 2002 to be 36.5 million) Participation rate: = the percentage of working population who are in the labour force Roubini Global Economics Nouriel Roubini & RGE's Analysts Examine Critical Economic Issues Economics Made Simple Tutoring & Homework Help from experts. Reasonable Prices Trade Forex - Free Demo Free software, charts, and quotes. Try a practice account today.

2 You can find our information about unemployment in your own local area by using the Nomis data Invest in Penny Stocks Free Report: 3 Penny Stocks Set To Return Triple-Digit Gains! Learn or Teach Economics with high quality films and online resources learnecon.com The Causes of Unemployment Frictional Unemployment Trends in the two main measures of unemployment for the UK economy This is voluntary or transitional unemployment due to people moving between jobs: For example, newly redundant workers, or workers entering the labour market for the first time such as graduates and schoolleavers take time to find jobs at wage rates they are prepared to accept. Many of the frictionally unemployed are out of work for a short time whilst engaged in job search. Imperfect information in the labour market may lead to frictional unemployment if the jobless are unaware of the available jobs. Often this information failure is localised for few workers scan the vacancies available across the whole economy, they tend to restrict their search for work to a local area. Geographical mobility in the UK and also in the EU is lower than it is in the USA for example. Incentives to look for work are also important! Some people may opt not to accept jobs at prevailing market wage rates if they believe the income tax and benefit system will reduce the net increase in income people can expect from taking paid work. This problem is referred to as the unemployment trap. Structural Unemployment Structural unemployment occurs when people are made jobless because of capital-labour substitution which reduces the demand for labour in an industry, or when there is a long run decline in demand which causes redundancies and worker lay-offs. Structural unemployment exists where there is a mismatch between their skills and the requirements of the new job opportunities. Skills are required to cope with structural changes in output and employment Structural change is a constant feature of a flexible economy. As some sectors decline, so other sectors requiring different skills will expand. The pace of technological change and global integration will increase demand for a more highly skilled workforce with the ability to adapt to changing technologies and shifting product demand. Source: HM Treasury, the Benefits of a Flexible Economy, April 2004 Many of the unemployed from coal, steel and heavy engineering have found it difficult to gain reemployment without re-training. This problem is one of the occupational immobility of labour. The longterm decline in industrial employment has continued (a process known as deindustrialisation) and there has been a huge shift into service-based employment, especially in banking, finance and insurance, other business services and distribution, hotels and restaurants.

3 The changing pattern of jobs in the UK Employment change in the UK economy % change 000s 000s Banking, finance and insurance Education and health Distribution, hotels & restaurants Transport & communication Construction Agriculture & fishing Manufacturing Mining, electricity, gas & water Employment programmes to reduce unemployment Source: UK Labour Market Statistics The Labour Government's New Deal programme ( has focused attempts to reduce long-term unemployment by increasing the human capital of the unemployed and improving their employability in the eyes of potential employers. The New Deal is also designed to bring back into the labour market people who have given up the active search for work. These discouraged workers are longterm unemployed who have been out of formal employment for many months and whose motivation to engage in job search has declined to low levels. There is often a catch-22 in the labour market. It is difficult to find new work without having relevant experience but experience can only come from having a relevant job. Cyclical Unemployment Cyclical unemployment is involuntary or "demand deficient" unemployment due to a lack of aggregate demand. This is also known as Keynesian. When there is a recession we see rising unemployment because of plant closures and worker lay-offs. The fall in AD shown in the left hand diagram below takes the economy further away from full-capacity national output and leads to a negative output gap where actual GDP lies

4 below potential GDP. Because labour has a derived demand, a fall in real national output leads to a contraction in total employment. Voluntary and Involuntary Unemployment An important distinction is to be noted between voluntary unemployment when a worker chooses not to accept a job at the going wage rate and involuntary unemployment which occurs when a worker would be willing to accept a job at the going wage but cannot get an offer.

5 High Wage or Classical Unemployment There is a cyclical relationship between output and unemployment Classical unemployment is the result of real wages being above their market clearing level leading to an excess supply of labour. Some economists believe that the national minimum wage risks creating unemployment in industries where global competition from low-cost producers is severe. Consequences of Unemployment To many economists, persistent unemployment is a sign of market failure because unemployment is a waste of scarce resources and leads to a loss of potential output and a reduction in allocative efficiency. The economy is operating below the maximum output it could achieve. This might be illustrated by making use of

6 a PPF or using the concept of the output gap. When unemployment is rising for example during a recession, real national output will be contracting and the economy will be operating well below full-capacity. This is shown in the chart below, notice how during the depression during the early 1990s, the output gap became negative as the unemployment rate climbed towards 10 per cent of the labour force. Once the recovery had become well established, unemployment began its descent and the economy moved towards macroeconomic equilibrium with the negative output gap closing. Around the turn of the decade, the UK economy was estimated to be running pretty close to its potential level, with real GDP growing just above the trend rate of 2.5% per year. Unemployment drifted lower, mainly as a result of successful attempts to bring down structural and frictional unemployment. In 2005 however there was a marked economic slowdown, the output gap became negative again and we started to see the rate of unemployment edge higher. No recession, but we again saw the cyclical relationship between the growth of output and the rate of unemployment.

7 There are further costs associated with high or rising unemployment besides simply the lost output. Redundancies waste resources invested in training and educating workers and the longer each person s period of time out of work, the greater the loss of skill and motivation. A high rate of long term unemployment can therefore have a negative effect on a country s economic growth potential. High unemployment also affects government finances with higher spending on unemployment benefits and other welfare payments plus falling revenues from income tax, national insurance and VAT. There is also a strong link between unemployment and consumer spending. As consumer s confidence falls, so the willingness of people to spend declines and people build up their precautionary savings. Hysteresis effects The hysteresis effect describes a possible consequence of a country experiencing persistently high rates of long term unemployment. Hysteresis means to be behind and it relates to the economic costs of unemployment because of the damage that unemployment does to the skills and employability of those people out of work. The longer someone remains out of a paid job, the less attractive they become to a potential employer. Technical and social skills can become eroded. The incentives to prolong the search for work are damaged and the end result can be an increase in core structural unemployment and a consequent rise in the natural rate of unemployment. Overcoming the problem of hysteresis is now a major policy issue within the European Union where several countries are suffering from extremely high and damaging rates of unemployment, much of which is long term in nature. Social Costs of Unemployment Rising unemployment is linked to social deprivation leading to negative externalities. There is some relationship with crime, and other aspects associated with social dislocation (for example via increased divorce rates, worsening health and lower life expectancy). Areas and regions of persistently high unemployment see falling real incomes and a worsening in inequalities of income and wealth. It can become very difficult and expensive to reverse the decline of localities where unemployment rates are incredibly high and where employment opportunities are poor. This remains a major social and political problem for the UK despite the general progress in reducing unemployment. There has been a welcome reduction in long term unemployment over the last twelve years Possible benefits from unemployment One benefit of rising unemployment is that it helps to keep the rate of inflation down since high unemployment is often associated with a reduction in the bargaining power of workers to bid for higher wages and salaries. There might also be an environmental gain if unemployment is linked to a slower rate of growth of consumption and production, reducing the pressures on scarce environmental resources. Having

8 some people unemployed in a frictional sense might also be regarded as beneficial in that it means that there is a pool of unemployed workers who can take up new jobs as they become available. But this depends on these workers having sufficient geographical and occupational mobility. Full-employment in any economy is highly unlikely to be achieved. Government Policies to Reduce Unemployment The government does not have a specific target for any particular rate of unemployment. Instead its objective for the labour market is expressed in terms of a broad ambition to keep employment high and provide employment opportunities for all. Distinction can be made between demand-side and supply-side policies to improve the working of the labour market in matching people to the available jobs and to the changing demands and requirements of different industries. There are inevitably limits to what the government can do to achieve sustainable reductions in unemployment. And often the policies that are introduced to boost employment can be costly and involve an opportunity cost. Reducing occupational immobility of labour (supply-side policy) Immobility of labour is a cause of labour market failure and structural unemployment. Policies aimed at reducing this problem aim to provide the unemployed with the skills they need to find re-employment and also to improve the incentives to find work. Improvements in the availability and quality of education and work-place training will increase the human capital of unemployed workers and help to ensure that more of the unemployed have the right skills to take up the available job opportunities. For many years the relative paucity of work-place training has been seen as a weakness in the UK labour market. Both employers and employees may actually underestimate the long-term value of training in terms of the potential benefit to a business and the long term gains to a worker. The free-rider problem may also contribute to a sub-optimal level of training from society s point of view. Benefit and tax reforms (supply-side policy) To some economists, a policy that reduces the value of welfare benefits might increase the incentive for the unemployed to take a job. The evidence drawn from recent experience in the UK is that simply cutting the value of state welfare payments in reality makes little difference to the level of unemployment in the long run. It is rare that the root cause of someone staying out of work is the prospect of generous out of work welfare handouts. Instead, targeted measures to improve people s incentives, including the linking of welfare benefits to participation in genuine work experience programmes which is part of the New Deal programme or the introduction of lower marginal income tax rates for people on low incomes might by contrast have a noticeable impact. Reflating aggregate demand (demand-side policy) The government can use the traditional weapon of macro-economic policies designed to increase AD and thereby generate a higher level of national income and employment. Reflationary policies can help to mitigate the effects of an economic recession but there are risks involved in using both fiscal and monetary policy simply to boost demand when output is low. The government might also make more active use of regional policies to encourage inflows of foreign investment from multinational companies particularly to those areas and regions where unemployment is persistently above the national average. The main weakness of relying too heavily on demand-management policies to reduce unemployment is that much unemployment is not cyclical; rather it is frictional and structural in origin and cannot be solved simply by injecting vast amounts of money into the circular flow of income and spending. Employment subsidies (demand-side policy) Government subsidies for businesses that take on the long-term unemployed will create an incentive for firms to increase the size of their workforce. Employment subsidies may also be available for overseas firms locating in the UK in regions of below-average economic prosperity. Summary: The government s current labour market strategy is firstly to rely on monetary and fiscal policy to maintain a stable rate of economic growth as a pre-condition for high and stable rates of employment. Macroeconomic stability is regarded as essential for creating the right climate in which new jobs become available. Secondly, supply-side policies and in particular active labour market strategies such as New Deal and other welfare and education reforms are given a higher weighting in seeking to reduce structural aspects of the unemployment problem. The British economy has made substantial and significant progress in reducing unemployment over the last fifteen years. Despite a recent upturn in unemployment (the result of a slowdown in growth) the UK still has one of the lowest unemployment rates in the European Union.

9 Key Points Unemployment occurs when individuals are jobless but willing and able to work at the going wage rate. Official government figures only count people who register as unemployed and are actively searching for work. Discouraged workers who want a job but have given up looking because they have decided the search is hopeless many are suffering from long-term structural unemployment. Unemployment in the UK fell almost continuously from the summer of 2003 to the start of 2005.Since then there has been a modest upturn in unemployment on both the claimant count and the labour force survey measure. By the summer of 2006, unemployment had risen to a four year high. Unemployment has both demand and supply-side causes. Some unemployment can be due to the voluntary decisions of people in the labour market, but most unemployment is involuntary The economic and social costs of unemployment are greatest when unemployment is long term There are strong links between high unemployment and inequality and risk of relative poverty for households where no-one is in paid work. The unemployed tend to have some of the lowest incomes in society. Author: Geoff Riley, Eton College, September Ads by Google Tutor2u Limited All Rights Reserved. All materials published on are protected by copyright and may not be reproduced in part or in whole, for whatever reason, without the prior written permission of tutor2u. The use of tutor2u content for commercial gain of any kind is strictly forbidden. We reserve the right to take legal action against any party or parties found to have breached our copyright. Damages and other remedies are available to us in respect of copyright infringements. About tutor2u tutor2u is a leading publisher of e-learning resources for Economics, Business, Politics and related subjects. Our materials are used by over 3,500 schools and colleges in the UK and in educational institutions in over 85 other countries. tutor2u was named Online Learning

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