Written by: Edmund Quek

CHAPTER 17 UNEMPLOYMENT

LECTURE OUTLINE 1 2 2.1 2.2 2.3 2.4 3 4 DEFINITION AND MEASUREMENT OF UNEMPLOYMENT CAUSES OF UNEMPLOYMENT Cyclical/Demand-deficient unemployment Structural/Mismatch unemployment Frictional/Search unemployment Seasonal unemployment FULL EMPLOYMENT AND NATURAL RATE OF UNEMPLOYMENT EFFECTS OF UNEMPLOYMENT

References John Sloman, Economics William A. McEachern, Economics Richard G. Lipsey and K. Alec Chrystal, Positive Economics G. F. Stanlake and Susan Grant, Introductory Economics Michael Parkin, Economics David Begg, Stanley Fischer and Rudiger Dornbusch, Economics

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Written by: Edmund Quek

DEFINITION AND MEASUREMENT OF UNEMPLOYMENT

Unemployment is the state of the economy where some people who are able and willing to work are not employed in the production of goods and services. The unemployed are people who are able and willing to work but who are without work. According to the International Labour Organisation (ILO), the unemployed are persons of working age who are without work, are available to start work within two weeks and either have actively looked for work in the last four weeks or are waiting to take up an appointment. In Singapore, the labour force comprises those who are 15 years of age and over (working-age population), who are able and willing to work, and are either employed or actively seeking employment. The labour force is also known as the economically active population. The difference between the working-age population and the labour force is the economically inactive population which comprises those who are unable to work (e.g. those who are physically or mentally handicapped and those who are in prisons) and those who are able but unwilling to work (e.g. housewives, students, retirees). The unemployment rate is the number unemployed expressed as a percentage of the labour force. The number unemployed The unemployment rate -------------------------------- 100% The labour force The labour force participation rate is the labour force expressed as a percentage of the working-age population. The labour force The labour force participation rate ----------------------------------- 100% The working-age population

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Written by: Edmund Quek

2 2.1

CAUSES OF UNEMPLOYMENT Cyclical/Demand-deficient unemployment

Demand-deficient unemployment is due to a deficiency in aggregate demand and this usually occurs due to a decrease in aggregate demand when the economy moves into a recession. When aggregate demand falls, firms will decrease production and hence the demand for labour. Since real wages are inflexible downwards, demand-deficient unemployment will occur. Downward inflexibility in real wages are often the result of trade unions trying to protect the standard of living of their members, firms refusing to lower real wages to avoid reducing the efficiency of their workers, or the existence of wage contracts.

In the above diagram, the initial equilibrium real wage rate is w0. A decrease in aggregate demand and hence the demand for labour in the economy leads to a shift in the aggregate demand for labour curve (ADL) from ADL0 to ADL1. At the same real wage rate w0, the supply of labour exceeds the demand for labour which results in demand-deficient unemployment. Demand-deficient unemployment is the type of unemployment that the government is usually more concerned about. The solution to demand-deficient unemployment is an increase aggregate demand and hence the demand for labour. However, as you will see later, demand-side policies have their limitations.

2.2

Structural/Mismatch unemployment

Structural unemployment is due to a change in the structure of the economy. The structure of the economy changes when some industries expand and some industries contract and this could be due to technological advancements, changes in comparative advantage or

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Written by: Edmund Quek

changes in the pattern of demand. When this happens, the expanding industries will create jobs and the contacting industries will lose jobs. However, as many of the workers who will lose their jobs in the contracting industries do not have the relevant skills and knowledge to find jobs in the expanding industries, structural unemployment will occur. Structural unemployment always exists. To reduce structural unemployment, the government can provide education and training directly, by setting up educational institutes, or indirectly, by giving subsidies or tax incentives to firms to induce them to send their workers for education and training. However, due to the effort that has to be expended on the part of the structurally unemployed workers who are mostly low-skilled, such measures may not decrease structural unemployment significantly. If the cause of structural unemployment is the loss of certain comparative advantages, subsidies and tariffs can be used to support declining industries, so that they can phase out slowly. In this case, the workers in the declining industries will have sufficient time to acquire the relevant skills and knowledge to find jobs in other industries. However, these protectionist measures run counter to the objective of free trade and they may provoke retaliation.

2.3

Frictional/Search unemployment

Frictional unemployment is due to lack of perfect information about the job market. Since firms are not fully informed about the types of labour available and workers are not fully informed about the types of job available, firms and workers need time to explore the job market and this leads to frictional unemployment. Frictional unemployment always exists. To reduce frictional unemployment, the government can increase expenditure on setting up more job market intermediaries. However, if firms think they are better able to assess prospective employees by themselves and hence reluctant to post their job vacancies in the intermediaries job banks, having more job market intermediaries will not lead to a significant fall in frictional unemployment. In addition to more job market intermediaries, an increase in job fairs may also help reduce frictional unemployment.

2.4

Seasonal unemployment

Seasonal unemployment is due to the low demand for certain types of labour during certain seasons of the year. For instance, some agricultural workers are unemployed during the off-harvest-season and some construction workers and lifeguards are unemployed during winter. Seasonal unemployment always exists. The solution to seasonal unemployment is the same as the solution to structural unemployment. In reality, it is difficult to decrease seasonal unemployment significantly because a large part of it is voluntary. However, seasonal unemployment is usually insignificant and is hence rarely a matter of social concern.

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FULL EMPLOYMENT AND NATURAL RATE OF UNEMPLOYMENT

Full employment is the state of the economy where there is no demand-deficient unemployment. In other words, when there is full employment, there still exists some unemployment which comprises structural unemployment, frictional unemployment and seasonal unemployment. Structural unemployment, frictional unemployment and seasonal unemployment are collectively known as natural unemployment. The natural rate of unemployment in Singapore is estimated to be around 2 per cent. In the US, it is estimated to be around 5 per cent.

EFFECTS OF UNEMPLOYMENT

Costs of unemployment Economy High unemployment will cause the economy to lose a large amount of output. The unemployed High unemployment will cause a large number of people to lose their income. Further, if the unemployed remain unemployed for a long period of time, they may lose their skills and knowledge. The employed When unemployment is high, the employed will lose some of their income in the form of a pay cut. Firms High unemployment will cause firms to lose a large amount of profit. The government When unemployment is high, the government will lose a large amount of tax revenue. Society High unemployment will lead to a high crime rate, high divorce rate, high suicide rate and social unrest.

Benefits of unemployment If the people in the economy are willing to bear with some unemployment, inflation may be kept at a moderate rate. By the same token, the cost of eliminating unemployment may be an intolerably high inflation rate. The inverse relationship between inflation and unemployment can be seen from the short-run Phillips curve.

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Written by: Edmund Quek

In the above diagram, when the unemployment rate is 0, the inflation rate is 0. At zero per cent unemployment rate, the inflation rate is 1, which may be intolerably high. The prospect of unemployment may reduce shirking.

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