Now we know that full employment is any level of unemployment found in natural labour market equilibrium with only voluntary unemployment, let us look at natural unemployment. Structural unemployment is commonly talked about in the press, as a major initiator in the U.K. is often perceived as the transformation that came about in the 1980’s party due to Thatcherite policies (more or which later). It is caused by a market failure arising from “mismatches between job applicants and vacancies with respect to skills, occupations or localities.”[2] These mismatches then occur because within the national labour market there are numerous different markets based on the above variations. Most commonly is the geographical factor. This occurs when an employee suitable for a vacancy lives far enough from the vacancy to make the cost of accepting the job greater than the benefit. The opportunity cost of being unemployed (being employed) is too great. For example a highly skilled ship carpenter may be located in Tyneside, while a there is a vacancy in
Our ship carpenter would require learning new skills to be compatible with the job. He would have to catch up with any changes in the required composition of output (in this case perhaps safety features required or new materials to work with). Structural unemployment is considered voluntary, as it is technically the employee’s choice not to move to a market where there is excess demand rather than supply.
With frictional unemployment we have a number of employees and employers; each with relevant skills and vacancies, but who have not yet been able to find each other or because of imperfect information (and attempts to correct it) not hired anyone yet. For example another ship worker and a company looking for a nautical engineer - it takes time to find the vacancy advertised and will then have to be interviewed, his references checked and the company decide if they can find anyone with more experience relevant or if he is sufficient. In addition the workers reservation wage, the wage he or she expects to obtain, may be inaccurate. This is especially common when seeking jobs in unfamiliar regions and even countries in the EU, and means that workers are either over-valuing themselves or will be undervalued by a prospective employer.
Structural and frictional unemployment can be shown diagrammatically. On figure 1 we can see a labour demand curve ND, a total labour force LF and an labour supply curve NS(aj) (The ‘aj’ is for accept jobs and represents the number of people who will accept jobs at a wage rate). There is a natural equilibrium wage rate of W* and N* employment at point A. 0 to N* represents full employment at this equilibrium, while N* to N1 represents structural and frictional unemployment.
Technical change in an industry can have a huge effect on the numbers in full employment as it can change the demand curve for labour. Figure 2 shows a set of production possibility frontiers. Starting at output Y1 if we then had an improvement in technology, shifting the p.p.f. from its initially fixed position y=f(N) to y=f’(N) we see that Y1 can be produced using only N2 labour. This causes a reduction in employment, but also a reduction in unit costs of production; meaning firms’ profit maximising price is lower. This will mean a reduction in market price. Should this stimulate the market demand (as it should if it is anything but perfectly inelastic) there can be an increase in output, say to Y2, which will require an increase in employment. That said a further move in technology to the p.p.f. y=f’’(N) will mean Y2 can be produced at only N4. This is clearly an important factor in full employment as technology is always being pushed forward by companies seeking to gain production advantage over their competitors.
It is possible here to link the last three factors together. Some external explanations for unemployment focus on the changes to production structure caused by economic globalisation and economies of scale from large international factories instead of small little ones, creating mismatch problems and so greater structural unemployment[3]. Hysteresis has commonly been sited as increasing structural unemployment. This is whereby after a long period of job searching workers loose motivation and confidence, the skills gap broadens as time goes on and frictional unemployment can soon change to structural. Employers are reluctant to hire someone who has been out of work for some time as the reason for the gap may not be obvious. This causes the natural rate to rise. Full employment’s natural equilibrium may be affected therefore by larger technical changes and longer periods of mass unemployment.
An additional cause of natural unemployment is classical or real wage unemployment, or that caused by an overly high national minimum wage. Either trade unions or workers collectively have negotiated a wage higher than the equilibrium real wage, W* on fig 1, let us say W1. This creates a position where the real NS (AJ) curve runs horizontally from W1 to the point where it meets NS (AJ) and then follows it upwards, shown by the red line on fig 1. This intersects ND at point B. NSu illustrates the union supply curve. We can now clearly see we have lower full employment, at N2, with unemployment due to an inflated real wage being N2 – N3, and structural and frictional unemployment being N3 to N4 (N3 being how many people would accept jobs at W1, and N4 being how many would seek jobs at W1). This remains natural unemployment, and N2 full employment because that is the equilibrium at W1, and it is institutional factors that cause the wages to remain high. It must be realised though that this type of unemployment is rare in modern economies now.
Demand deficient unemployment can have two effects. One is on voluntary and so natural rate of unemployment, the other creating involuntary, cyclical or Keynesian unemployment as we shall see in a moment. The dependent factor is whether or not workers expect and can respond flexibly to a drop in the price level. Consulting figure 3 we see a diagram not adjusted for price level. Initial equilibrium is at W*, A, N* where NS (P0) and ND (P0) (for price level P0). The economy experiences a sudden drop in price level to P1 and Demand. If the workers are successful in maintaining the price level at W* through contracts and sticky wages we have a restricted supply curve as with real wage unemployment. The resulting unemployment N1 – N* is voluntary as workers have inadvertently or not forced ‘real’ wages up (because the price level has dropped while money wage levels remain the same). If workers do not perceive a price level fall but supply to their expected real wage not money wage, then NS (P0) remains the supply curve, because they haven’t perceived the fall in price level, but will accept a lower monetary wage as real wage has increased (price level has still fallen further than wages). Again this is voluntary, as a further fall in money wages would reduce real wages back to equilibrium levels. However this can only happen if they perceive the fall in price level. It may not be possible, if they do perceive it, to move to NS(P1) due to sticky wages of some and long term labour contracts, so it is only possible in the long run which will still create some voluntary unemployment. Equilibrium will only return in the long run if wages are perfectly flexible though and they can drop to W2 in figure 3.
This is voluntary and so natural rate unemployment. However in reality a fall in price level is very rare, indeed
If we look at a fall in aggregate demand without a drop in price level, that is to say a perfectly elastic aggregate supply curve, like that in figure 4, we can obtain involuntary, Keynesian or cyclical unemployment, when unemployment is above the natural rate. Y* gives us a natural rate of unemployment that can be seen on figure 4 when we realise that N*, i.e. quantity of labour demanded, is a function of Y*, the demand for the product of labour. We will have only natural unemployment.
However a fall in demand prompts a reduction in output to Y1 as that is all the firm can sell in a quantity controlled goods market. This creates demand for labour of N1, creating a labour demand curve B C N1, kinked at C on Figure 3. If the money wage remains at W* we can see D is nowhere near either the unconstrained supply or demand curves, thus we have involuntary unemployment. Lowering the money wage will not actually reduce unemployment, as workers can’t price themselves into being employed.
We can see this translated onto figure 1 where we see Nc – the constrained labour demand, being the total level of employment, giving us at W* cyclical unemployment of Nc to N* and structural and frictional unemployment N* to N1. We may also have some real wage unemployment at the same time with real wages too high at W1 and cyclical unemployment Nc – N2, classical N2 – N3 and N3 – N4 frictional and structural. It is entirely possible to have a situation of cyclical unemployment in the case of a large economy such as the
High level of employment is consistently a macroeconomic policy objective for a number of reasons. First there is extensive political pressure from the public, nearly everyone has to have, and wants a job. Employment is essential to the economy, as with out it there simply would be no economy; high levels of employment are likely (but not certain) to provide higher levels of aggregate demand as more people have more money to spend and will also help to raise average standards of living. Employment provides individuals with earning that are then taxed by government. Public choice or individualist public policy theorists would argue that it is in bureaucrat’s interest to maximise revenues from employment tax so they can expand their budgets for their own prestige[5]. This is a little torturous, however it is clear that government would want to maximise its tax revenue and limit its social welfare payments. Costs are not just the direct welfare payments but additional social costs of unemployment. Structurally unemployed individuals will naturally have a lower income and as Mocan argues it is likely to increase income inequality in the country if structural unemployment grows, and can then foster additional social problems causing even more cost to the public purse[6]. In my opinion however government’s main aim is to reduce unemployment, either by moving people into employment or into being inactive. In the short run government can raise employment by stimulating demand (the opposite of cyclical unemployment – above) or focusing on policies to reduce structural and frictional unemployment, for example through job centres, CV clinics and so on. In the short run they could also raise the level of the inactive population.
Encouraging people to become inactive has significant benefits. As the group consists of those in education, encouraging the structurally and frictionally unemployed to enter training can help them transfer to industries with demand greater than supply of labour by updating skills in the medium and long run. This will also have the effect, especially amongst the young, of pushing forward the countries Production Possibility frontier that will increase employment in the long run. Having some unemployed move to the inactive market also means that if there is an external increase in demand to domestic labour, say through an increase in demand for exports, the economy will have room to expand.
Governments have effects on the levels of employment both directly and indirectly through policy instruments. The effect of the levels of unemployment assistance on both employment and unemployment levels has been a key issue in the last 25 years. Larsen describes how some have blamed systems in the EU for high unemployment, and although the concept of eurosclorosis has been largely discredited (see chapter 6 of Blanchard), the effects of a poorly planned benefit system are clear. Figure 5 shows an initial equilibrium at A, with Wage W*, and N* employment, and N* - N1 unemployment. An increase in the amount paid for unemployment benefits or the time they are paid for will reduce the opportunity cost of being unemployed both for those inactive and employed. Marginal individuals will decide they are better off registered as unemployed rather than employed or inactive. A well structured social security benefit system that pays benefits only for those actively seeking employment, and forces people to accept jobs will increase employment.
Eurosclorosis theorists argued that over regulation of employers regarding employment would create additional costs of employing someone, thus reducing the labour demand curve. The same effect is seen with any cost or tax. This is shown in figure 6. A tax on employees will reduce real disposable income from any money wage, thus a lower supply curve at any particular money wage, and this is shown in figure 7. The effects of these actions are primarily on employment as they involve a shift in N*.
In conclusion we can say that full employment involves any level of employment that results from natural equilibrium in the labour market, with a natural rate of unemployment existing at the same time. This can vary for structural, frictional and real wage unemployment. Unemployment may rise above the natural rate when Keynesian demand deficient or cyclical unemployment occurs, usually during a recession, as there is no change in the price level. Governments have a high level of employment as a policy aim because it allows for what I believe to be their primarily aim of reducing unemployment, either by increasing employment in the short run buy boosting demand in a Keynesian way or in the long run by increasing labour productivity by moving people into the inactive section of the population so they can retrain. Government seek to reduce unemployment, because of political pressure, it allows them to maximise tax revenue and can reduce the chance of instability by increasing aggregate demand.
** All general facts, theories on types of employment and unemployment and factors affecting them, and graphs above are taken from Lecture notes – Mr M Macmillen 2005
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Bibliography
+ Mr M. Macmillen - EPP Lecture Notes – 2005
+ Oliver Blanchard - Macroeconomics, second edition – 1999
+ Christian Larsen - Structural unemployment. An analysis of recruitment and selection mechanisms based on panel data among Danish long term unemployed. –2003 – International Social welfare 12 pp170-181
+ Mocan, H. Naci – Structural unemployment, cyclical unemployment and income inequality – 1999 – The review of economics and statistics 81 (1) pp 122 – 134
+ Camarero and Tamarit – Hysteresis vs. natural rate of unemployment – 2004 – Economic Letters 84 pp 413 - 417
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