Unemployment

Unemployment

There are a number of types of unemployment, defined in terms of cause and severity. These include the following:

Cyclical or demand deficient

Cyclical unemployment exists when individuals lose their jobs as a result of a downturn in aggregate demand (AD). If the decline in aggregate demand is persistent, and the unemployment long-term, it is called either demand deficient, general, or Keynesian unemployment. For example, unemployment levels of 3 million were reached in the UK in the last two recessions (1980-82 and 1990-92) and in the most recent (2008-09) recession, unemployment levels rose to over 2.4m. Unemployment reached a 17 year high of 2.6m in 2011.

Structural

Structural unemployment occurs when certain industries decline because of long term changes in market conditions. For example, over the last 20 years UK motor vehicle production has declined while car production in the Far East has increased, creating structurally unemployed car workers. Globalisation is an increasingly significant cause of structural unemployment in many countries.

Regional

When structural unemployment affects local areas of an economy, it is called ‘regional’ unemployment. For example, unemployed coal miners in South Wales and ship workers in the North East add to regional unemployment in these areas.

Classical

Classical unemployment is caused when wages are ‘too’ high. This explanation of unemployment dominated economic theory before the 1930s, when workers themselves were blamed for not accepting lower wages, or for asking for too high wages. Classical unemployment is also called ‘real wage’ unemployment.

Seasonal

Seasonal unemployment exists because certain industries only produce or distribute their products at certain times of the year. Industries where seasonal unemployment is common include farming, tourism, and construction.

Frictional

Frictional unemployment, also called ‘search’ unemployment, occurs when workers lose their current job and are in the process of finding another one. There may be little that can be done to reduce this type of unemployment, other than by providing better information to reduce the search time. This suggests that full employment is impossible at any one time because some workers will always be in the process of changing jobs.

Voluntary

Voluntary unemployment is defined as a situation when workers choose not to work at the current equilibrium wage rate. For one reason or another, workers may elect not to participate in the labour market. Reasons suggested for the existence of voluntary unemployment include: excessively generous welfare benefits, high rates of income tax and that the equilibrium wage rate is below the wage necessary to encourage individuals to supply their labour.

The ‘natural‘ rate of unemployment

This is a term associated with new Classical and monetarist economists. It is defined as the rate of unemployment that still exists when the labour market it in equilibrium, and includes seasonal, frictional and voluntary unemployment. The US economist Milton Friedman first used the concept to help explain the connection between unemployment and inflation. Friedman argued that if unemployment fell below the ‘natural’ rate there would be an increase in the rate of inflation.

See: AJ-LF diagram

See also: the Phillips Curve.

Over the last 30 years, employment in the service sector has increased to over 70% of total employment, while employment in manufacturing has decreased to under 20%. Since the 1940s employment in the primary sector, including agriculture, has been less that 3% of the workforce.

Recent changes have created ‘two speed’ economy, with a ‘booming’ service sector and a declining manufacturing one.

The main reasons are:

1. Globalisation and the rise of new ‘low cost’ overseas competitor countries.
2. Increased competition with the domestic product market.
3. The increasing comparative advantage of the UK as an international supplier of financial services.

Structural unemployment and labour mobility

Labour immobility is likely to increase structural unemployment. This is because those industries that are growing and need labour, often called ‘sunrise’ industries, are not necessarily able to employ the same workers who have been displaced in the declining, ‘sunset’, industries.

There are three types of labour immobility:

Geographical immobility

Geographical immobility occurs when workers are not willing or able to move from region to region, or town to town. It is made worse by immense house price variation between regions. It may be extremely difficult for someone in Yorkshire to sell their property and buy an equivalent one in London.

Other factors also contribute to geographical immobility, such as strong social and family ties, and parents being unwilling to disrupt their children’s education by changing schools. The stresses of moving home can also be a deterrent to mobility for some.

Industrial immobility

Industrial immobility occurs when workers do not move between industries, such as moving from employment in motor industry to employment in the insurance industry. Industrial immobility has affected the UK, and many other industrial countries, as the growth of service industries, and the decline of manufacturing industries, has increased the need for mobility.

Occupational immobility

Occupational immobility occurs when workers find it difficult to change jobs within a particular industry. For example, it may be very difficult for a doctor to retrain to be a dentist.

Industrial and occupation immobility are most likely to happen when skills are not transferable between industry and job.

Information failure also contributes to labour immobility in general because workers may be immobile because they do not know where all the suitable jobs for them are.

A resulting problem with labour market immobility is that it can create regional unemployment, which is a type of structural unemployment. This means that a change in the structure of industry leaves some people unable to respond by changing job, industry, or location and as a result, they remain temporarily or permanently unemployed.

Immobility can also lead to rising labour costs, as firms have to increase wages to encourage workers to re-locate.

Labour market or government failure?

New Classical economists would tend to see structural unemployment as an example of government failure. Labour markets do not clear, they argue, because wages are not allowed to adjust effectively, and the price mechanism is distorted. By removing distortions and imperfections in the labour market workers would move more quickly from job to job.

For example, by keeping welfare benefits to a minimum there is an incentive to retrain and look for paid work. Welfare benefits can ‘trap’ individuals into a life of unemployment because of the effects of moral hazard and the disincentive effect it creates. This increases labour immobility, and hence contributes to structural unemployment.

However, labour immobility can also be addressed from the perspective of labour market failure. Training and re-training are regarded as merit goods, where individuals under perceive the long term benefit to themselves. They also fail to appreciate the positive externalities that training and re-training generate for the wider community. This means that there is a significant role for the state in providing free or subsidised training and retraining programmes.

In addition, there is the potential situation of labour market ‘poaching’. Why should a firm in the booming service sector provide free training to a displaced worker from the manufacturing sector if the worker will leave for another job after training? There is a type of Prisoner’s Dilemma facing firms. Why should firms do any training at all if they believe that workers will be poached by higher wages? The poacher can afford to pay higher wages because of savings in training costs.