Unemployment

Important definitions

• Employed person: a person who works at least 1 hour per week in paid employment or works 15 hours unpaid in a family business in the survey week.
• Unemployed person: a person who works less than 1 hour per week or less than 15 unpaid hours in a family business and has actively looked for work during the past month.
• Underemployment: a person is employed but is not working as many hours as they would like and/or need.
• Labour force: total number of people over the age of 15, currently employed added to the total number of people over the age of 15, currently unemployed but actively engaged in seeking a job, also known as the ‘working population’.
• Participation rate: the percentage of the population over the age of 15 that is in the labour force.
• Civilian labour force: the sum of all people 15+ who are employed or unemployed and actively seeking work (i.e., the labour force) in the civilian population.
• New entrants seeking work; Re-entrants; Lost last job; Quit last job; Laid off (temporarily): examples of the dynamics within the labour market.
• Not in the labour force / Outside labour force / inactive population: people who are neither employed nor actively seeking work.

Labour force concepts: who is counted

• Working-age population: people of working age (commonly 15+).
• Labour force vs outside labour force: those in the labour force are either employed or unemployed and seeking work; those outside are inactive.
• The civilian labour force excludes armed forces, and often excludes certain subgroups (e.g., students, retirees, discouraged workers).

In and out of labour: the structure

• Working-age population → includes Employed and Unemployed (labour force).
• Labour force → Employed + Unemployed (actively seeking).
• Outside labour force (inactive) → those not in the labour force.

Significance of unemployment

• Primary economic problem: unlimited wants with scarce resources; unemployment represents underutilisation of labour and spare capacity.
• When unemployment is present, the economy operates below potential output (inside the Production Possibility Frontier, PPF).
• The unemployment rate is a major economic indicator used to judge economic performance and informs policy.
• High unemployment affects government policy: higher transfer payments (e.g., unemployment benefits) reduce revenue available for other spending; long-term unemployment leads to economic and social hardship.

How unemployment is measured (ABS methodology)

• Measurement source: monthly ABS household survey of a random sample; includes people 15+.
• Employed definition: worked at least 1 hour in paid work during the survey week or at least 15 hours unpaid in a family business.
• Unemployed classification: if unemployed, they are asked whether they have looked for work in the last month; if yes, they are counted as unemployed and part of the labour force.

Criticisms of how unemployment is measured

• Overstating unemployment (UE rate):
  • Respondents may report seeking employment to access benefits or due to misclassification (e.g., those engaged in illegal activities).
• Understating unemployment:
  • Discouraged workers (those who would like to work but have stopped seeking) are not counted as unemployed.
  • All part-time workers are counted the same as full-time workers, masking underemployment.
• Other measurement gaps:
  • No account of hours worked (involuntary leisure vs. leisure deprivation).
  • No earnings differentials across jobs, no treatment of duration of unemployment, job security, or job type.

Calculating key rates (formulas)

• Unemployment rate:
  u = rac{U}{L} imes 100
  where U = number of unemployed people, L = labour force (employed + unemployed).
• Participation rate:
  p = rac{L}{N} imes 100
  where N = population aged 15 and over (working-age population).
• Full-time/Part-time employment distinction (for context): employed individuals are categorized as full-time or part-time within the employed total.
• Underemployment rate (two common measures):
  • Definition A (share of employed who are underemployed):
    ext{Underemployment rate} = rac{Ue}{E} imes 100 where Ue = number of underemployed people, E = number of employed people.
  • Definition B (underutilisation rate: unemployed + underemployed as a share of labour force):
    ext{Underutilisation rate} = rac{U + Ue}{L} imes 100 where U = unemployed, Ue = underemployed, L = labour force.

Practice calculation concepts (from the slides)

• Data categories used: civilian population over 15, employed (full-time and part-time), not in the labour force, unemployed, underemployed.
• Practice steps:
  • Step 1: Labour force = Employed (full-time + part-time) + Unemployed.
  • Step 2: Participation rate = (Labour force / Working-age population) × 100.
  • Step 3: Unemployment rate = (Unemployed / Labour force) × 100.
  • Step 4: Underemployment rate = (Underemployed / Employed) × 100 (or use the alternative underutilisation rate as defined above).

Types of unemployment

• The overall number of unemployed arises from three types of unemployment. Understanding the type helps policy makers.
• The three types:
  • Frictional
  • Structural
  • Cyclical

The three types of unemployment

• Frictional unemployment
  • Definition: unemployment caused by the normal search time required by people with marketable skills who are changing jobs, initially entering the labour force, or re-entering the labour force.
  • Characteristics: always present; can be positive for the economy as it allows skills to be moved to where they are needed; short-term.
  • Labour-market frictions: imperfect information; limited knowledge about vacancies; geographic constraints can hinder matches.
  • Examples:
  • Ski-resort workers in Victoria between seasons.
  • Farm labour during harvest and layoffs after harvest.
  • Short-term lay-offs in construction.
  • Graduates taking time to find best-fit opportunities.
  • Relocation delays for new jobs.
  • Seasonal jobs (e.g., ski resorts).
• Structural unemployment
  • Definition: long-term or permanent unemployment resulting from a mismatch between the skills of workers and the skills demanded by employers.
  • Causes: changes in the structure of the economy (new technologies, shifts in demand, globalization); skill, age, location mismatches; need for retraining.
  • Market mechanism: labour market acts like any other market; wages adjust to equilibrate demand and supply, but mismatches persist.
  • Consequences: persistent unemployment in affected groups; higher training and retraining costs; geographic and skill mismatches.
• Cyclical unemployment
  • Definition: unemployment arising from the business cycle – downturns reduce aggregate demand and production, leading to job losses.
  • Relationship to economy: rises when real GDP falls; falls when economy expands.
  • Historical reference: Australia experienced higher unemployment during the recessions of the 1980s and 1990s (>6%).
  • Interaction: because frictional and structural unemployment exist, cyclical unemployment explains fluctuations around the “natural” rate.

Causes of structural unemployment (detailed)

• Minimum wages
  • Definition: legal lower bound on wages for specified groups.
  • Effect: can push wages above market-clearing levels, reducing demand for labour and causing unemployment among less-skilled workers.
• Wages determined by the labour market; a minimum wage can interfere with price discovery and may act like a price floor.
• Trade unions
  • Effect: can push wages above the equilibrium wage; firms may hire fewer workers to avoid costly strikes; higher wages reduce labour demand and can increase unemployment.
• Technology and automation
  • Effect: shifts in production processes replace labour with capital; workers must retrain to meet new needs.
• Changes in tastes, demand, and production structures
  • Examples: consumers switching to imported cars or newer products reduces demand for certain domestic jobs.
• Education and skills mismatch
  • Education deficiencies can leave workers ill-equipped for evolving job requirements; retraining is needed.

Visual and market analogies

• The labour market as a market for wages:
  • Equilibrium wage is determined by demand for and supply of labour.
  • Structural changes shift the demand or supply curves, creating unemployment even at wage that clears the market for some groups.

Cyclical unemployment (revisited)

• Causes: directly tied to downturns in the business cycle; reduced output leads to lower demand for labour.
• Policy relevance: macro stabilization policies aim to reduce cyclical unemployment by boosting aggregate demand.

The natural rate of unemployment and NAIRU

• Full employment vs zero unemployment:
  • Full employment exists when the economy is operating at an unemployment rate equal to the sum of frictional and structural unemployment.
  • Cyclical unemployment is zero at full employment.
• NAIRU (non-accelerating inflation rate of unemployment): the estimated rate of unemployment at which inflation is stable (does not accelerate or decelerate).
• Current estimates (contextual): Australia’s natural rate has been discussed around 4.0–4.5% in recent years, with debate about exact level.
• Important note: Economists cannot state with certainty the precise split between frictional and structural unemployment at any moment; NAIRU is an indicative target, not a precise measurement.

Phillips Curve

• Core idea: inflation and unemployment have an inverse relationship.
• Origin: William Phillips linked economic growth to inflation and employment levels.
• Graphical representation: downward-sloping (inflation on the y-axis, unemployment on the x-axis), typically convex.
• Interpretation: lowering unemployment can raise inflation and vice versa; a trade-off exists in the short run between inflation and unemployment.
• Caution: the relationship can shift due to expectations, supply shocks, and policy regimes; the curve is not fixed in the long run.

Costs of unemployment

• Two perspectives:
  • Economic costs
  • Social costs
• Economic costs
  • Spare capacity means the economy operates below potential; output is below potential GDP, reducing growth and living standards.
  • Tax revenue declines (particularly income tax) while transfer payments rise, increasing fiscal pressure.
  • Prolonged unemployment can lead to lower wages and worse long-term career prospects for individuals.
  • Long-term unemployment can cause hysteresis, reducing future earning potential.
  • GDP Gap concept: the difference between potential GDP and actual GDP.
• GDP Gap
  • Definition: the shortfall between potential GDP and actual GDP when unemployment is above the natural rate.
  • Consequence: lower living standards and slower growth.
  • Visual reference: depicted here in relation to the Production Possibility Frontier (PPF).
• Social costs
  • Health impacts (physical and mental), greater hardship for youth and older workers, increasing skills mismatch costs.
  • Societal inequality and reduced equity.

Reducing unemployment: policy options

• There are two broad policy categories:
  • Demand-side policies (AD-focused)
  • Supply-side policies (productivity and structure-focused)

Demand-side policies

• Goal: increase aggregate demand to generate more jobs.
• Mechanisms:
  • Fiscal policy (government spending and taxation): raise government spending or cut taxes to stimulate demand and create jobs.
  • Monetary policy (central bank actions, e.g., RBA cash rate): lower interest rates to encourage spending and investment, thereby increasing aggregate demand.
• Examples
  • Infrastructure spending (e.g., Metronet in Perth) to create construction jobs.
  • Government spending on hospitals and schools to raise incomes and stimulate consumption.
  • Pandemic-related grants to support construction and other sectors.

Supply-side policies to reduce unemployment

• Goals: raise the economy’s productive capacity and employment potential; reduce structural unemployment.
• Common reforms and rationale:
  • Curtailing union power: move wages closer to the market-clearing level; can increase employment.
  • Reducing taxes on labour: lowers cost of hiring, increases demand for labour; payroll tax reductions as an example.
  • Reducing taxes on capital: encourages investment and growth, leading to job creation.
  • Reforming welfare benefits: large unemployment benefits can create an incentive to search less for work; reforms can reduce “cruising.”
  • Deregulating the labour market: greater flexibility to hire and fire can encourage firms to create more jobs and respond to changing conditions.
  • Training and education reforms: align skills with labour-market needs; improve retraining programs.

Data caveats and trends

• ABS data includes seasonally adjusted and trend estimates; trend estimates can be subject to “trend breaks,” especially during extraordinary events (e.g., COVID-19).
• Use caution when interpreting trend data; seasonally adjusted figures help compare across periods.
• Indicators to monitor: unemployment rate, participation rate, underemployment rate, underutilisation rate, job vacancies, wage indices.

Quick reference: key equations

• Unemployment rate: u = rac{U}{L} imes 100
• Participation rate: p = rac{L}{N} imes 100
• GDP Gap (conceptual): ext{GDP Gap} = ext{Potential GDP} - ext{Actual GDP}
• NAIRU: non-accelerating inflation rate of unemployment (conceptual target, not directly observed)
• Phillips Curve: rac{d ext{inflation}}{du} < 0 (inverse relationship between inflation and unemployment)
• Underemployment rate (Definition A): ext{Underemployment rate} = rac{U_e}{E} imes 100
• Underutilisation rate (Definition B): ext{Underutilisation rate} = rac{U + U_e}{L} imes 100
• Full employment condition: u = u{ ext{frictional}} + u{ ext{structural}}, ext{ with } u_{ ext{cyclical}} = 0

Connections to broader concepts

• Links to the economic problem: scarcity, choice, and allocation of resources.
• Production Possibility Frontier (PPF): unemployment implies operating inside the PPF; GDP gap reflects underutilisation of resources.
• Policy trade-offs: balancing inflation and unemployment (short-run Phillips curve vs. long-run neutrality).
• Real-world relevance: policy choices affect macro outcomes (growth, inflation, employment) and social well-being; the role of institutions (unions, welfare, tax policy) shapes structural outcomes.

Ethical and practical considerations

• Policy tensions: expanding demand can raise inflation if the economy is near potential output; supply-side reforms may improve long-run growth but have short-run costs.
• Equity concerns: long-term unemployment disproportionately affects youth and older workers; education and retraining policies are critical to mitigate inequality.
• Welfare reforms: need to balance reducing disincentives to work with providing genuine support for those in transition.
• Automation and globalisation: structural shifts require proactive retraining and regional development strategies to avoid prolonged unemployment across groups.

Quick glossary of key terms

• NAIRU: Non-Accelerating Inflation Rate of Unemployment — the unemployment rate at which inflation remains stable.
• Fraser: not applicable here; focus remains on unemployment concepts and policy tools.
• GDP Gap: Shortfall of actual GDP from potential GDP due to underutilised resources.
• Frictional unemployment: Short-term unemployment due to normal job-search processes.
• Structural unemployment: Long-term unemployment due to mismatches between skills and job requirements.
• Cyclical unemployment: Unemployment tied to the business cycle fluctuations.
• Underemployment: Employed but working fewer hours than desired.
• Underutilisation: Combined measure of unemployment and underemployment relative to labour force.

Summary takeaway

• Unemployment arises from three main channels (frictional, structural, cyclical) and has both economic and social costs.
• The natural rate of unemployment (NAIRU) represents the level of unemployment when inflation is stable and cyclical unemployment is zero.
• The Phillips Curve describes an inverse relationship between unemployment and inflation in the short run, with policy trade-offs to balance macro objectives.
• Policy responses to unemployment are divided into demand-side and supply-side tools, each with distinct mechanisms, benefits, and potential drawbacks.
• Accurate measurement and awareness of measurement limitations are essential for sound policy-making and interpretation of labour-market data.