Unemployment

From Baripedia

An economy is characterised by the efficient use of its resources. A crucial variable in determining a country's standard of living is the unemployment rate. The higher the level of employment in an economy, the higher its output. Optimal use of the labour force is an overriding objective for any economic policy authority.

The loss of work is not an event that causes a fall in living standards only at the individual level. It also represents a loss for the economy as a whole in terms of under-utilisation of resources and sacrifice of production potential.

The unemployment rate measures the share of the active population that would like to work but cannot find a job at the prevailing wage.

The objective of this chapter is to analyse the determinants of unemployment and the intervention measures available to the government.

Okun's Law is the relationship between economic growth and unemployment:

${\displaystyle \Delta {\text{rate of unemployment}}=-{\frac {1}{2}}\times {\text{change in percentage of real GDP}}-3\%}$

This is an empirical regularity (the parameters may vary, even significantly, from one country to another and according to the periods that express the variations in the unemployment rate as a function of the rate of growth of output. The annual growth rate of GDP must be at least 3% to avoid an increase in the unemployment rate and a growth of more than 3% of 1 point leads to a fall of only 0.5% (and not 1%) in the unemployment rate.

The intuition is that the labour force and labour productivity grow over time (3% on average over the last few decades) and that the responsiveness of firms to changes in output is not 1 to 1.

Definitions and measurements

Definition

The natural rate of unemployment is the rate considered "normal" in an economy, i.e. the rate that does not even disappear in the long run. It is an average unemployment rate.

The cyclical unemployment rate indicates the annual fluctuations around the natural rate. It is associated with the ups and downs of the business cycle.

The unemployment rate in the United States. Source: U.S. Department of Labor

It is important to distinguish between these two forms of unemployment because combating them will require different policies (long-term in the first case and short-term in the second).

Measure

Unemployment data are collected on the basis of :

• unemployment subsidies (delicate international comparisons);
• regular (monthly) surveys by national statistical offices (more consistent data as they are based on a standardised definition of the International Labour Office, ILO).

Each individual of working age is classified in one of the following categories:

• having a job ;
• not in employment;
• not wanting a job.
Labour force = number of persons in employment + number of persons not in employment (= aggregate labour supply)
Unemployment rate = (number of people not in employment) / (labour force) ∙ 100 = percentage of labour force not employed
Participation rate = (active population) / (working age population) ∙ 100 = percentage of the adult population (+ than 16 years old) that is active

Official Definitions

According to the International Labour Office (ILO), an unemployed person is a person between the ages of 15 and 74 years old who

• has not been gainfully employed (self-employed or salaried) during the period under consideration;
• has looked for work during the previous 4 weeks (regardless of the intensity of the job search);
• is available for gainful employment within the next two weeks.

In Switzerland, an individual is officially considered to be a job seeker/unemployed if he/she is registered with an REO (Regional Job Placement Office), which does not necessarily entitle him/her to unemployment benefit. Anyone can register with an REO:

• inactive and looking for a job ;
• employed part-time and looking for full-time work;
• immediately available and suitable for placement;
• Age 14 years of age or older.

Example

UK: Distribution of the adult population in 2004.

Labour force = 28.4 + 1.4 = = 29.8 million

Unemployment rate = (1.4/29.8) - 100 = = = 4.7%.

Labour force participation rate = (29.8/47.4) - 100 = = = 62.9%.

Unemployment rate by group

The unemployment rate is an aggregate measure, but one can, of course, also calculate the unemployment rate by category (age, gender, country of origin, level of education, etc.). On youth unemployment, see The Economist 10.09.2011

Unemployment rate by gender and ethnic group (UK 2001-02).
Registered unemployed, by sex and nationality (Switzerland, January 2013).

Problems and remarks

It is not easy to distinguish between individuals who are unemployed and those who are not in the labour force:

• Discouraged workers = individuals who would like to work but have given up looking after a long unsuccessful search...
• false unemployed = individuals who declare themselves unemployed to obtain the subsidy even if they are not really looking for work

The duration of most unemployment is short term (considering the number of unemployed), but most unemployment measured over a certain interval is long term (considering the number of hours of unemployment): only an apparent contradiction.

It is important to distinguish the unemployment rate from the "underemployment" rate (= active persons employed part-time, willing and able to work more). See below.

Under-employment

EMPLOYMENT APPLICANTS (= "lack of work") ≈ unemployed + underemployed. Jobseekers tend to outnumber the unemployed.

Determinants of unemployment

The functioning of the labour market

The labour market, like all other markets, is governed by the forces of demand and supply. In an ideal world the wage (= labour price) should adjust to balance the demand and supply of labour, thereby ensuring full employment (cf. chapter 18 of the GL).

• Labour supply (of households)

From the microeconomics course we know the determinants of the consumer labour supply function and we know that this function can sometimes be a little odd (negative slope). Although in general this case is quite possible, we will later hypothesize that the relationship between labour supply and wage is positive (for any wage above the reservation wage).

• Labour demand (of firms)

In most cases, labour services are used as an input to produce final goods. The demand for labour on the part of firms will therefore be governed to some extent by the production function.

Attention to terminology

Job offer ≠ "Job offer" = Job demand

The job offer comes from individuals. Classified ads, also wrongly called "job offers" in newspapers, actually correspond to the demand for labour from businesses .

Reserve salary and job offer

The reservation wage is the minimum (hourly) wage that the person requires to participate in the labour market. For any wage below the reservation wage the labour supply is zero.

In other words, it is the "price" to be paid, at a given time, in terms of time spent outside the labour market (↓ leisure time), in return for a greater consumption of B&S allowing to maintain a given level of economic well-being (trade off).

The reservation wage is a function of :

• the spouse's income, family "gifts and legacies", State transfers and other non-State aid, the possibility of moonlighting, etc.
• the existence or not of fixed monetary (e.g. childcare) and non-monetary (e.g. travel time) costs;
• the system of transfers and direct taxation.

PmL and the work request function

Normally production functions are characterized by a decreasing marginal product of work (= amount of additional output that can be produced with an additional unit of this input).

Since p is the price of the final good, the value of the marginal product of labour is given by : ${\displaystyle VPmL\equiv p\times PmL}$ This value decreases with the number of workers employed by the company, all else being equal.

In perfect competition, a profit-maximizing firm employs a number of workers such that the PmL in value equals the nominal wage: ${\displaystyle PmL=w}$ (or ${\displaystyle PmL={\frac {w}{p}}}$). The VPmL function coincides with the labor demand curve → Decreasing demand function.

N.B. A firm that employs labor in accordance with the condition ${\displaystyle VPmL=w}$ is also producing to the point where ${\displaystyle p=Cm}$ (profit maximization condition).

The labour demand is deduced from the production function: at constant quantities of the other pdf (here K), the firm chooses the level of L which equals the labour profit (PmL) to its cost (w/p) at the margin. NB: pPmL (= marginal product in value terms) is a decreasing function, like PmL

Labour market equilibrium

Any supply or demand shock determines a change in the equilibrium wage (if no rigidities, no "structural" unemployment) .

Frictional unemployment vs. structural unemployment

Frictional unemployment: one of the causes of unemployment is that, for various reasons, the meeting between workers and jobs takes time. Frictional unemployment is the fraction of total unemployment explained by the time needed to find a job. In a continuously changing economy, a certain amount of frictional unemployment is inevitable. See next page.

Structural unemployment : wage rigidity is a second cause of unemployment. Unemployment resulting from wage rigidity and job rationing is called structural unemployment. At the prevailing wage, labour supply exceeds demand. There are several reasons for wage rigidity.

Job Search and Frictional Unemployment

It takes time and effort to find a job that suits people's tastes and qualifications.

Unemployment due to job search is inevitable in a continuously changing economy. Any change in the composition of demand between industries or regions causes sectoral or regional shifts in the demand for labour that take time to be covered.

This type of unemployment is different from structural unemployment because it does not depend on a wage above the equilibrium wage.

A number of public policies can reduce the time it takes to find adequate work and thus influence the rate of frictional unemployment :

• Public Employment Agencies (they disseminate information on available jobs by reducing the matching time);
• Public training programmes (they facilitate the transition of workers from declining to expanding industries);
• Unemployment insurance (it offers partial protection against job loss → it may discourage the search for a new job → potentially negative effect on the frictional unemployment rate).

Determinants of structural unemployment

We have structural unemployment when labour supply exceeds demand.

Rather related to longer-term unemployment.

Four main causes:

• Minimum wage legislation (the case of the floor price: when the minimum wage is set above the equilibrium wage, it creates unemployment). Cf. graph) ;
• Implicit contracts (in order to eliminate income fluctuations, companies and workers enter into contracts ensuring a constant monthly or even annual wage level, independent of economic fluctuations);
• The bargaining power of workers' unions;
• Efficiency wages.

Unions and Collective Bargaining

A trade union is a representative organization of workers that participates in collective bargaining with employers to determine wages and working conditions. A kind of "cartel" with some market power.

Consequences of union negotiations

The outcome of negotiations is often a wage above the equilibrium level and, as a result, an increase in structural unemployment.

Conflict between workers already employed (insiders) and workers wishing to be employed by the company (outsiders) who will bear the cost of collective bargaining .

Critics argue that the trade union system leads to an inefficient and iniquitous balance.

According to the supporters, the union is a necessary antidote to contrast the market power of companies.

Efficiency Salary

Wages higher than the break-even wage, paid by firms to make workers more productive. A decrease in wages in the presence of excess supply would determine a reduction in the wage bill paid by the firm, yes, but it would negatively affect the productivity of workers and therefore the firm's profits.

In the poorest countries, higher wages allow workers to eat better and therefore be more productive.

In developed countries high wages reduce worker turnover: the higher the wage, the greater the incentive for the worker to stay in the job.

The average quality of the labour force depends on the level of remuneration: if the company ↓ pays its wages, the best workers will look for work elsewhere (adverse selection).

High wages increase employee motivation: by paying high wages the company reduces moral risk behaviour.

Keynesian unemployment

Unlike structural unemployment, which refers to rigidities in wage adjustment, Keynesian economists believe that unemployment can also be caused by a lack of effective demand.

Summary

The unemployment rate measures the percentage of the total labour force that is unemployed.

A distinction is made between cyclical unemployment and natural unemployment.

The majority of the unemployed find work fairly quickly

The majority of unemployment is long-term

The labour market functions like any other market, with wages being the price that guarantees the balance between demand and supply of labour.

Frictional unemployment depends on how long it takes to find suitable work

A number of public policies can influence the frictional unemployment rate

Structural unemployment is unemployment that occurs when wages are higher than the equilibrium wage and therefore supply exceeds demand. It depends on three causes:

• the imposition of a minimum wage;
• union negotiations;
• the setting of efficiency wages;
• Keynesian unemployment is caused by insufficient effective demand.

Annexes

• Left behind, The Economist, 10.09.2011
• Pour ceux intéressés à la situation en Suisse: La situation sur le marché du travail en janvier 2011, SECO, 08.02.2011