Macroeconomic Objectives: Low Unemployment - Detailed Notes

Macroeconomic Objectives: Low Unemployment

Causes of Unemployment

Four main types of unemployment:
- Cyclical (demand-deficient) unemployment
- Structural unemployment
- Frictional unemployment
- Seasonal unemployment

Cyclical (Demand-Deficient) Unemployment

Associated with economic downturns.
As the economy slows, aggregate demand (AD) falls due to reduced consumer spending, as shown in Figure 19.3(a).
The reduced consumer spending leads to a fall in the demand for labor.
Firms cut back production, needing fewer factors of production, including labor.
Illustrated in Figure 19.3(b).
Initially, the economy operates at a high level of activity (Y₁), with aggregate demand for labor at AD₀, resulting in an equilibrium wage W₀ for Q₀ workers.
If the economy slows, AD falls (Figure 19.3(a)).
Firms reduce their demand for labor from AD₀ to AD₁ (Figure 19.3(b)).
Ideally, wages would fall to W₁; however, wages are "sticky downwards".
Wage stickiness reasons:
- Firms fear discontent and reduced motivation among workers if wages are lowered.
- Labor contracts and trade union power prevent wage reduction.
With wages stuck at W₀, the aggregate supply of labor exceeds demand, creating unemployment of a - b.
Also known as Keynesian Unemployment, named after Keynes' observation that the economy can operate below full employment, leading to high unemployment.
Figure 19.3(a): A decrease in AD
- Shows a shift in AD from AD₁ to AD₂, resulting in a decrease in real output from Y₁ to Y₂ and a decrease in the average price level from P₁ to P₂.
- Curve definitions:
  - LRAS: Long Run Aggregate Supply
  - AD: Aggregate Demand
Figure 19.3(b): Demand-deficient unemployment
- Illustrates the labor market with the Aggregate Supply of Labor (ASL) and Aggregate Demand (AD) curves.
- A decrease in AD from AD₀ to AD₁ results in a decrease of number of workers from Q₀ to Q₁ but wage remains at W₀

Curing Demand-Deficient Unemployment

The main solution is to increase aggregate demand through:
- Fiscal policy: increased government spending or lower direct/indirect taxes.
- Monetary policy: decreasing interest rates or increasing the money supply.
Governments can use Keynesian demand management policies.

Structural Unemployment

Considered the worst type of unemployment.
Occurs due to changes in the structure of the economy.

Forms of Structural Unemployment

Permanent Fall in Demand for a Particular Type of Labour
- New jobs are created (e.g., software engineers, financial advisors), while others disappear (e.g., coal mining).
- Results in long-term unemployment due to a lack of occupational mobility (necessary skills for new jobs) or geographic mobility (jobs in different locations).
- Causes of this type of structural unemployment:
  - Technological change: Mechanization and robots lead to job cuts i.e. technological unemployment.
  - Globalization: Companies set up operations in countries with lower labor costs/less strict regulations, reducing demand for labor in developed countries like manufacturing industries that are blamed on imports from China.
  - Changes in consumer tastes: Concerns about negative externalities lead to decreased demand for certain goods (e.g., coal).

Figure 19.4: A fall in employment (structural unemployment)
- Illustrates structural unemployment in the manufacturing sector in Canada.
- Due to lower labor costs in emerging economies, the demand for manufacturing labor in Canada falls from D₁ to D₂.
- Employment decreases from Q₁ to Q₂, and wages fall from $16 to $12 per hour.

Change in the Institutional Framework of the Economy
- Examples include labor market laws and trade unions.
- Laws governing the labor market:
  - Stringent firing regulations may deter firms from hiring workers, reducing the demand for labor.
- Minimum wage legislation:
  - If a minimum wage of 12 per hour is imposed on fast-food restaurant workers (Figure 19.5), those previously earning 10 are affected.
  - Before the minimum wage, Q workers were employed at 10 per hour.
  - After the minimum wage, the quantity of labor demanded falls to Q₁ workers, increasing unemployment by Q-Q₁.
  - The higher wage increases the number of workers willing to supply their labor from Q to Q₂.
- Laws governing trade unions:
  - Unions protect members, sometimes preventing firms from hiring non-union members, contributing to unemployment.

Figure 19.5 Minimum wage and structural unemployment
- Illustrates the impact of minimum wage laws on the fast-food industry
- Increase in wage leads to more workers but the quantity of workers that firms are willing to hire drops.

Curing Structural Unemployment

Best addressed through supply-side policies.

Interventionist Policies

Enhance occupational mobility.
- Education system: trains people to be more occupationally flexible.
- Adult upskilling/retraining programs: to help people acquire necessary skills.
- Government subsidies: for firms that provide training for their workers.
- Subsidies/tax breaks: to encourage people to move to areas with available jobs (geographic mobility).
- Apprenticeship programs: to acquire skills (e.g., in Germany and Austria).
- Job centers: provide information about job vacancies, training, and interview-training.
Disadvantages:
- High opportunity cost.
- Effective only in the longer term.

Market-Based Policies

Lower unemployment benefits: to encourage unemployed workers to take available jobs.
Deregulation of labor markets: reducing legislation that businesses must follow in hiring, firing, and employment practices to increase "labor market flexibility".
Consequences:
- Lower living standards for those who lose unemployment benefits, increasing inequity.
- Potentially worse working conditions due to reduced labor market regulations.

Frictional Unemployment

Short-term unemployment when people are between jobs or have left education and are waiting for their first job.
Generally not seen as negative in a dynamic economy.
People move to jobs where they can be more productive.

Reducing Frictional Unemployment

Market-based: reduce unemployment benefits.
Interventionist: improve the flow of information from potential employers to people looking for jobs through internet job sites, newspapers, job centers, and employment counselors.

Seasonal Unemployment

Demand for certain workers falls at certain times of the year (e.g., construction workers or farmers in winter, ski instructors in summer).

Reducing Seasonal Unemployment

Encourage people to take different jobs in their "off-season".
Methods include reduced unemployment benefits and greater flow of information.

Natural Rate of Unemployment

The labor market may be in equilibrium without demand-deficient unemployment, but there may still be unemployed people.
Occurs when number of job vacancies equals the number of people looking for work.
NATURAL \ RATE \ OF \ UNEMPLOYMENT = Structural \ unemployment + frictional \ unemployment + seasonal \ unemployment
Workers may be unable or unwilling to take available jobs due to:
- Structural unemployment: lack of skills (occupational immobility), living in the wrong area (geographical immobility), or institutional frameworks.
- Frictional unemployment: voluntarily left jobs or new to the labor market in search of better opportunities.
- Seasonal unemployment: expertise is not applicable at the time of year or unwilling to take jobs outside of their existing range of skills.

Demand-Side vs. Supply-Side Policies for Reducing Unemployment

Solutions depend on the type of unemployment.
Demand-deficient unemployment: demand-management policies are suitable during economic downturns.
Concerns associated with demand-side policies:
- Expansionary fiscal policy may lead to budget deficits.
- Reduced taxes may not increase spending if consumer confidence is low.
- Reduced interest rates may not increase borrowing if consumer/business confidence is low.
- Time lags can cause policies to take effect after the economy has already recovered.
Natural unemployment: best addressed with supply-side policies.
Using demand management policies to cure natural unemployment will be unsuccessful and can lead to inflationary pressure.

Fiscal Policy: Discretionary Policy vs. Automatic Stabilizers

Discretionary Fiscal Policy: a deliberate change to a government policy to manage aggregate demand (e.g., increasing spending on infrastructure).
Automatic Stabilizers: do not require deliberate changes to government policy to change the level of aggregate demand.
- High unemployment: government tax revenues will fall, and transfer payments to the unemployed will increase automatically.
Automatic stabilizers are essential for controlling fluctuating economic activity because they automatically operate to increase aggregate demand during a slowdown, without political decision-making or time lags.
Governments commonly use a mix of demand-side and supply-side policies because it might be difficult to distinguish between the different types of unemployment.
Demand-side policies (particularly interest rates) narrow business cycle fluctuations.
Supply-side policies ensure that labor is skilled and flexible to adapt to changing economic conditions so that the LRAS is always shifting to the right.

Crowding Out

When governments run budget deficits to stimulate an economy and reduce unemployment, a potential problem known as "crowding out" may occur.
Government increases: demand for savings, or loanable funds, in the economy.
To run a budget deficit, the government has to borrow money. Governments do this by selling government bonds such as treasury bills or treasury bonds to financial institutions who then sell them on to people who want to save their money.
Illustrated in Figure 19.6.
Increase in demand leads to an increase in the interest rate which reduces the incentive for private businesses to invest and so their borrowing will fall i.e. Private businesses will have been "crowded out" of the market.
The final effect on aggregate demand will depend upon whether the increase in government spending outweighs the fall in private investment or not.
Different views among economists:
- Keynesian economists: crowding out will not occur if the economy is producing at less than full employment.
- New classical economists: crowding out is a significant problem of increased government spending.
- Extreme new classical economists: the supply of loanable funds is fixed, so any increase in government spending leads only to an increase in interest rates and greater crowding out (Figure 19.7).
Figure 19.6 Crowding out-moderate view
- Government increases demand for borrowing from D₁ to D₂ in order to finance a government spending deficit.
- This results in an increase in the interest rate from i₁ to i₂.
Figure 19.7 Crowding out-extreme view
- Increase in government demand for borrowing leads to a large increase in interest rates from i₁ to i₂.