Macroeconomic Objectives: Low Unemployment

Macroeconomic Objectives: Low Unemployment

Causes of Unemployment

There are four main types of unemployment:

  1. Cyclical (Demand-Deficient) Unemployment
  2. Structural Unemployment
  3. Frictional Unemployment
  4. 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 12perhourforfast−foodworkersincreasesunemployment(Q1−Q)becausethequantityoflabordemandedfallsfromQtoQ1.</li><li>Lawsgoverningtradeunions−Tradeunionsprotectingitsmembersmightpreventfirmsfromhiringnon−unionmembers,contributingtounemploymentintheeconomy.</li></ul></li></ol></li></ul><h6id="curingstructuralunemployment">CuringStructuralUnemployment</h6><ul><li><p>Bestaddressedwithsupply−sidepolicies.</p><ol><li><p>Interventionistpolicies:</p><ul><li>Enhanceoccupationalmobilitybytrainingpeopleforavailablejobs.</li><li>Long−termsolution:educationsystemthattrainspeopletobeoccupationallyflexibletoadapttochangingeconomicconditions.</li><li>Adultupskillingorretrainingprogramstohelppeopleacquirenecessaryskills.</li><li>Governmentsubsidiestofirmsthatprovideworkertraining.</li><li>Subsidiesortaxbreakstoencouragepeopletomovetoareaswithjobs,enhancinggeographicmobility.</li><li>Supportforapprenticeshipprograms.</li><li>Jobcentersprovidinginformationaboutjobvacancies,trainingopportunities,andinterviewtraining.</li><li>Disadvantages:<ul><li>Highopportunitycost.</li><li>Effectiveonlyinthelongerterm.</li></ul></li></ul></li><li><p>Market−basedpolicies:</p><ul><li>Lowerunemploymentbenefitstoencourageunemployedworkerstotakeavailablejobs.</li><li>Reducedunemploymentbenefitsmightmakeworkersmorewillingtowork,shiftingtheaggregatesupplyoflabortotheright.</li><li>Deregulationoflabormarketstoreducelabormarketinflexibilityandencouragebusinessestohireworkers.</li><li>Reducingorremovinglegislationthatbusinessesmustfollowintheirhiring,firing,andemploymentpractices.</li><li>Burdenofsuchpolicies:<ul><li>Peoplewholoseunemploymentbenefitshavelowerlivingstandards,increasinginequity.</li><li>Labormarketderegulationcanleadtoworseworkingconditions.</li></ul></li></ul></li></ol></li></ul><h5id="frictionalunemployment">FrictionalUnemployment</h5><ul><li>Short−termunemploymentwhenpeoplearebetweenjobsorwaitingtotakeuptheirfirstjob.</li><li>Notgenerallyseenasnegativeinadynamiceconomy.</li><li>Peoplemovetojobswheretheycanbemoreproductive.</li></ul><h6id="reducingfrictionalunemployment">ReducingFrictionalUnemployment</h6><ul><li>Reduceunemploymentbenefits(market−basedsolution).</li><li>Improvetheflowofinformationfrompotentialemployerstojobseekersthroughinternetjobsites,newspapers,jobcenters,andemploymentcounselors(interventionistapproach).</li></ul><h5id="seasonalunemployment">SeasonalUnemployment</h5><ul><li>Demandforcertainworkersfallsatcertaintimesoftheyear.</li><li>Examples:constructionworkersorfarmersincoldclimates,skiinstructorsinAustriainJuly.</li></ul><h6id="reducingseasonalunemployment">ReducingSeasonalUnemployment</h6><ul><li>Encouragepeopletotakedifferentjobsintheir"off−season".</li><li>Reduceunemploymentbenefitsandincreasetheflowofinformation.</li></ul><h5id="naturalrateofunemployment">NaturalRateofUnemployment</h5><ul><li>Thelabormarketmaybeinequilibrium(nodemand−deficientunemployment),butunemploymentmaystilloccur.</li><li>Thenumberofjobvacanciesequalsthenumberofpeoplelookingforwork,butsomeworkersareunwillingorunabletotakethejobs.</li><li>Unemploymentgreaterthantheequilibriumlevel(fullemploymentlevelofoutput)isknownasthenaturalrateofunemployment.</li><li>Comprisesstructural,frictional,andseasonalunemployment.</li><li>Workerswhoarestructurallyunemployedmaybeunabletotakethejobsbecausetheydonothavetheskills(occupationalimmobility),orwronglocation(geographicalimmobility).<br/>12 per hour for fast-food workers increases unemployment (Q₁ - Q) because the quantity of labor demanded falls from Q to Q₁.</li> <li>Laws governing trade unions- Trade unions protecting its members might prevent firms from hiring non-union members, contributing to unemployment in the economy.</li></ul></li></ol></li> </ul> <h6 id="curingstructuralunemployment">Curing Structural Unemployment</h6> <ul> <li><p>Best addressed with supply-side policies.</p> <ol> <li><p>Interventionist policies:</p> <ul> <li>Enhance occupational mobility by training people for available jobs.</li> <li>Long-term solution: education system that trains people to be occupationally flexible to adapt to changing economic conditions.</li> <li>Adult upskilling or retraining programs to help people acquire necessary skills.</li> <li>Government subsidies to firms that provide worker training.</li> <li>Subsidies or tax breaks to encourage people to move to areas with jobs, enhancing geographic mobility.</li> <li>Support for apprenticeship programs.</li> <li>Job centers providing information about job vacancies, training opportunities, and interview training.</li> <li>Disadvantages:<ul> <li>High opportunity cost.</li> <li>Effective only in the longer term.</li></ul></li></ul></li> <li><p>Market-based policies:</p> <ul> <li>Lower unemployment benefits to encourage unemployed workers to take available jobs.</li> <li>Reduced unemployment benefits might make workers more willing to work, shifting the aggregate supply of labor to the right.</li> <li>Deregulation of labor markets to reduce labor market inflexibility and encourage businesses to hire workers.</li> <li>Reducing or removing legislation that businesses must follow in their hiring, firing, and employment practices.</li> <li>Burden of such policies:<ul> <li>People who lose unemployment benefits have lower living standards, increasing inequity.</li> <li>Labor market deregulation can lead to worse working conditions.</li></ul></li></ul></li></ol></li> </ul> <h5 id="frictionalunemployment">Frictional Unemployment</h5> <ul> <li>Short-term unemployment when people are between jobs or waiting to take up their first job.</li> <li>Not generally seen as negative in a dynamic economy.</li> <li>People move to jobs where they can be more productive.</li> </ul> <h6 id="reducingfrictionalunemployment">Reducing Frictional Unemployment</h6> <ul> <li>Reduce unemployment benefits (market-based solution).</li> <li>Improve the flow of information from potential employers to job seekers through internet job sites, newspapers, job centers, and employment counselors (interventionist approach).</li> </ul> <h5 id="seasonalunemployment">Seasonal Unemployment</h5> <ul> <li>Demand for certain workers falls at certain times of the year.</li> <li>Examples: construction workers or farmers in cold climates, ski instructors in Austria in July.</li> </ul> <h6 id="reducingseasonalunemployment">Reducing Seasonal Unemployment</h6> <ul> <li>Encourage people to take different jobs in their "off-season".</li> <li>Reduce unemployment benefits and increase the flow of information.</li> </ul> <h5 id="naturalrateofunemployment">Natural Rate of Unemployment</h5> <ul> <li>The labor market may be in equilibrium (no demand-deficient unemployment), but unemployment may still occur.</li> <li>The number of job vacancies equals the number of people looking for work, but some workers are unwilling or unable to take the jobs.</li> <li>Unemployment greater than the equilibrium level (full employment level of output) is known as the natural rate of unemployment.</li> <li>Comprises structural, frictional, and seasonal unemployment.</li> <li>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).<br />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.