Macroeconomic Objectives: Low Unemployment

Causes of Unemployment

There are four main types of unemployment:

Cyclical (Demand-Deficient) Unemployment
Structural Unemployment
Frictional Unemployment
Seasonal Unemployment

Cyclical (Demand-Deficient) Unemployment

Associated with economic downturns (business cycle).
When the economy slows, aggregate demand (AD) falls as consumers spend less.
A fall in consumer spending leads to a fall in the demand for labor.
Firms cut back on production, needing fewer factors of production, including labor.
Figure 19.3(a): Shows a decrease in AD during an economic slowdown.
Figure 19.3(b): Illustrates the fall in demand for labor on a labor market diagram.
Initially, the economy operates at a high level of activity (Y₁) with aggregate demand for labor at AD₁, resulting in an equilibrium wage Wₑ for Qₑ workers.
If the economy slows, AD falls from AD₁ to AD₁₁, reducing the demand for labor.
Ideally, the real wage would fall to W₁, but wages are "sticky downwards".
Wage stickiness occurs because:
- Firms fear discontent and reduced motivation among workers if wages are lowered.
- Labor contracts and trade union power prevent wage cuts.
Since wages remain stuck at Wₑ, the aggregate supply of labor exceeds the aggregate demand, creating unemployment of a - b.
Also known as Keynesian unemployment, as Keynes observed that the economy could operate below full employment, leading to high unemployment.

Curing Demand-Deficient Unemployment

The solution is to increase aggregate demand through fiscal or monetary policies (Keynesian demand management policies).
Fiscal Policy:
- Increase government spending to directly increase AD.
- Lower direct and indirect taxes to indirectly increase consumption by households and investment by firms.
Monetary Policy:
- Decrease interest rates.
- Increase the money supply.

Structural Unemployment

The most harmful type of unemployment, resulting from changes in the economy's structure.
Two forms of structural unemployment:
1. A permanent fall in demand for a particular type of labor.
  - Occurs naturally in a growing economy.
  - New jobs are created (e.g., software engineers), while others disappear (e.g., coal mining).
  - Leads to long-term unemployment as people lack the skills for new jobs (lack occupational mobility).
  - Jobs may be created in one part of the country, while the unemployed live elsewhere (lack geographic mobility).
  - Causes:
    - Technological change (mechanization, robots) makes workers redundant (technological unemployment).
    - Globalization allows companies to operate in countries with lower labor costs/regulations, reducing demand in developed countries.
    - Increased trade from countries with lower production costs reduces demand for labor in higher-cost countries.
    - Changes in consumer taste reduce demand for particular labor types.
    - Example: Reduced demand for coal due to concerns about negative externalities, leading to unemployment for coal miners.
  - Figure 19.4: Illustrates a fall in demand for manufacturing labor in Canada due to lower labor costs in emerging economies, reducing employment and wages.
  - Demand-deficient unemployment is caused by an overall (temporary) fall in demand for all labor due to an economic slowdown.
  - Structural unemployment is a permanent fall in demand for one type of labor, requiring different solutions.
  - Demand deficient unemployment during a lengthy period of economic activity could result in structural unemployment.
2. A change in the institutional framework of the economy
  - Changes in laws governing the labor market and trade unions.
  - Laws governing the labor market - e.g. Laws preventing firms from firing workers without documentation might prevent some firms from hiring workers, reducing the demand for labor, causing unemployment.
  - Minimum wage legislation (Chapter 8) can cause structural unemployment.
  - Figure 19.5: Shows how a minimum wage of 12 per hour for fast-food workers increases unemployment (Q₁ - Q) because the quantity of labor demanded falls from Q to Q₁.
  - Laws governing trade unions- Trade unions protecting its members might prevent firms from hiring non-union members, contributing to unemployment in the economy.

Curing Structural Unemployment

Best addressed with supply-side policies.
1. Interventionist policies:
  - Enhance occupational mobility by training people for available jobs.
  - Long-term solution: education system that trains people to be occupationally flexible to adapt to changing economic conditions.
  - Adult upskilling or retraining programs to help people acquire necessary skills.
  - Government subsidies to firms that provide worker training.
  - Subsidies or tax breaks to encourage people to move to areas with jobs, enhancing geographic mobility.
  - Support for apprenticeship programs.
  - Job centers providing information about job vacancies, training opportunities, and interview training.
  - Disadvantages:
    - High opportunity cost.
    - Effective only in the longer term.
2. Market-based policies:
  - Lower unemployment benefits to encourage unemployed workers to take available jobs.
  - Reduced unemployment benefits might make workers more willing to work, shifting the aggregate supply of labor to the right.
  - Deregulation of labor markets to reduce labor market inflexibility and encourage businesses to hire workers.
  - Reducing or removing legislation that businesses must follow in their hiring, firing, and employment practices.
  - Burden of such policies:
    - People who lose unemployment benefits have lower living standards, increasing inequity.
    - Labor market deregulation can lead to worse working conditions.

Frictional Unemployment

Short-term unemployment when people are between jobs or waiting to take up their first job.
Not generally seen as negative in a dynamic economy.
People move to jobs where they can be more productive.

Reducing Frictional Unemployment

Reduce unemployment benefits (market-based solution).
Improve the flow of information from potential employers to job seekers through internet job sites, newspapers, job centers, and employment counselors (interventionist approach).

Seasonal Unemployment

Demand for certain workers falls at certain times of the year.
Examples: construction workers or farmers in cold climates, ski instructors in Austria in July.

Reducing Seasonal Unemployment

Encourage people to take different jobs in their "off-season".
Reduce unemployment benefits and increase the flow of information.

Natural Rate of Unemployment

The labor market may be in equilibrium (no demand-deficient unemployment), but unemployment may still occur.
The number of job vacancies equals the number of people looking for work, but some workers are unwilling or unable to take the jobs.
Unemployment greater than the equilibrium level (full employment level of output) is known as the natural rate of unemployment.
Comprises structural, frictional, and seasonal unemployment.
Workers who are structurally unemployed may be unable to take the jobs because they do not have the skills (occupational immobility), or wrong location (geographical immobility).
NATURAL \ RATE \ OF \ UNEMPLOYMENT = Structural \ unemployment + frictional \ unemployment + seasonal \ unemployment$$

Demand-Side vs Supply-Side Policies for Reducing Unemployment

Solutions depend on the type of unemployment.
Demand-deficient unemployment rises during economic downturns, making demand-management policies suitable.
Concerns with demand-side policies:
- Expansionary fiscal policy may require a budget deficit.
- Tax reductions may not increase spending if consumer confidence is low.
- Interest rate reductions may not increase consumption/investment if confidence is low.
- Lags before policies take effect; the economy may have already recovered, leading to inflation.
Even successful, there is likely to be a lag before they come into effect.
It is possible that aggregate demand will increase, but by the time that it does, the economy may have already recovered, and the extra impetus can then be inflationary.
At full employment, the economy produces near full capacity; increased AD leads to inflationary pressure.
Demand management policies to cure this type of unemployment will be unsuccessful.

Fiscal Policy: Discretionary vs. Automatic Stabilizers

Discretionary fiscal policy: A deliberate change to government policy to manage AD, such as increasing infrastructure spending or reducing healthcare spending.
Automatic stabilizers: Do not require deliberate policy changes to affect AD.
Automatic Stabilizers and Government Revenue: High unemployment reduces tax revenues as fewer people earn income.
Automatic Stabilizers and Government Expenditure: High unemployment increases transfer payments (unemployment benefits), if the government is able or willing to pay unemployment benefits.
Automatic stabilizers control fluctuating economic activity because they automatically increase AD during a slowdown and are not subject to political decision-making or time lags.
Distinguishing between types of unemployment is difficult.
Governments commonly use a mix of demand-side and supply-side policies.
Demand-side policies (interest rates) narrow business cycle fluctuations and reduce output gaps.
Supply-side policies ensure labor is skilled and flexible to adapt to changing conditions, shifting the LRAS to the right.

Crowding Out

When governments run budget deficits to stimulate the economy, "crowding out" can occur.
To finance a deficit, the government borrows money by selling government bonds.
This increases demand for savings/loanable funds.
Figure 19.6: Shows crowding out - moderate view with S₁ for supply of loanable funds, D₁ for demand curve for private business borrowing.
Increased government demand for loanable funds shifts the curve from D₁ to D₂ resulting in an increase in the interest rate from i₁ to i₂.
Overall, total borrowing increases from QLF₁ to QLF₂
The increase in government borrowing is QLF₂-QLF₃, the horizontal distance between D₁ to D₂.
The higher interest rate will reduce the incentive for private businesses to invest and so their borrowing will fall from QLF₁ to QLF₃.
Interest rate
- Private businesses are "crowded out" of the market.
- The higher interest rate causes interest-sensitive private investment to fall, which may reduce AD; the final effect depends on whether increased government spending outweighs the fall in private investment.
Whether crowding out occurs is debated among economists.
Keynesian economists argue it won't occur if the economy is producing below full employment.
New classical economists argue crowding out is a significant problem of increased government spending.
Extreme new classical economists argue that the supply of loanable funds is fixed; any increase in government spending only increases interest rates with no increase in total borrowing.
Figure 19.7: Shows crowding out - extreme view.
If the supply of loanable funds is perfectly inelastic, then the increase in government demand for borrowing leads to a large increase in interest rates from i₁ to i₂.
The quantity of borrowing stays at Q, but, with the higher interest rates, the quantity of private business borrowing falls to Q₂.
There is even greater crowding out than in the moderate view.s.