Unemployment and the Labour Market

1
Unemployment and the Labour Market

• WEEK 6
• Professor Dermot McAleese
• .

2
OUTLINE

• ? Facts about unemployment
• ? Supply-side approach and the
  market mechanism
• ? Policies for unemployment
• ? Keynesian approach the importance of
  Aggregate Demand

3
UNEMPLOYMENT

• The unemployed are those of working age
  who, in a specified period, are without work and
  are both available for, and have taken specific
  steps to find, work. (ILO)

4
Definitional Problems

• Discouraged workers
• Involuntary part-timers
• Long-term unemployed
• Social welfare fraud

5
Table 1. Unemployment rates in OECD countries,
1960-2000

• Source OECD

6
ADJUSTMENT TO A FALL IN THE DEMAND FOR LABOUR
Fall in Demand
Supply exceeds demand
Unemployment
FLEXIBLE LABOUR MARKET (A)
INFLEXIBLE LABOUR MARKET (B)
Fall in pay
Pay rigidities
Rise in demand for workers
No decline in pay
Unemployment persists
Full employment
7
CLASSICAL LABOUR MARKET
Real wage (w/p)
S
D1
D
S1
E
T
R
W
W1
W2
S
D1
S1
D
L2
L
Quantity of labour
L1
8
LABOUR MARKET RIGIDITIES

• ? Minimum wages
• ? Replacement ratio
• ? Trade union power
• ? Employment protection legislation
• ? Tax wedges
• ? Rigidities in the product market

9
REPLACEMENT RATIO

• Replacement ratio is defined as unemployment
  benefit entitlements as a percentage of average
  earnings after tax.
• ? Average earnings after allowing for
• ? Income tax
• ? Rent allowances
• ? Medical subsidies
• ? Travel expenses

10
HYSTERESIS

• Hysteresis is defined as a failure of
  unemployment rate, that has been increased by an
  adverse shock, to return to its original level
  after that adverse shock has been reversed
• Causes ? human capital depletion
• ? labour market segmentation
  (Insider-Outsider Theory)
• ? physical capital depletion

11
IMPLICATIONS of HYSTERESIS FOR ANALYSIS OF
UNEMPLOYMENT

• ? Unemployed unable to exert downward pressure
  on real wage
• ? Pro-active labour market policies needed
• ? To prevent long-term unemployment
• ? To re-integrate long-term unemployed

12
Policy Implications of the Labour Market Approach
to Unemployment

• European Central Bank
• Bundesbank (pp 380-382)
• OECD Jobs Study 1994
• Professor Stephen Nickell (September 2001)

13

• The problem of unemployment in Europe is
  overwhelmingly structural in nature. It is caused
  mainly by inflexibility in euro area labour and
  goods markets.
• European Central Bank, Monthly Bulletin, January
  1999

14
BUNDESBANK VIEW OF THE CAUSES OF UNEMPLOYMENT

• Mismatch between demand and supply
• Poverty and employment traps
• ? Labour legislation

15
CONCLUSIONS FROM THE BUNDESBANK

• ? Most unemployment is structural, not
  cyclical
• ? Monetary policy cannot be expected to make an
  active and direct contribution to a (lasting)
  reduction in unemployment
• ? In light of deficits. No scope for
  expansionary fiscal policy

16
Trend in UK unemployment has been downward and
the unemployment rate is at lowest level for 35
years. Nickell gives two main reasons

• Shift in balance of power between trade unions
  and employers
• Real value of unemployment benefits have declined
  and access to other benefits made more dependent
  on work-seeking behaviour
• Source Royal Economic Society Newsletter October
  2001

17
But are we leaving out a major part of the
unemployment story? Aggregate demand doesnt
figure in the above theories. Keynes argued that
ignoring AD was a huge mistake --- that could
result in massively counterproductive policies.
18
I believe myself to be writing a book on
Economic Theory which will largely revolutionise
- not I suppose at once but in the course of the
next ten years - the way the world thinks about
our problems Keynes - letter to George
Bernard Shaw
19
The General Theory I have called this book the
General, Theory of Employment, Interest and
Money, placing the emphasis on the prefix
general. The object of such a total is to
contrast the character of my arguments and
conclusions with those of the classical1 theory
of the subject, upon which I was brought up and
which dominated the economic thought, both
practical and theoretical, of the governing and
academic classes of this generation, as it has
for a hundred years past. I shall argue that the
postulates of the classical theory are applicable
to a special case only and not to the general
case, the situation which it assumes being a
limiting point of the possible positions of
equilibrium. Moreover, the characteristics of
the special case assumed by the classical theory
happen not to be those of the economic society in
which we actually live, with the result that its
teaching is misleading and disastrous if we
attempt to apply it to the facts of experience.
20
KEYNESIAN APPROACH

• Focus demand side of the labour market
• ? Investment highly volatile
• ? Multiplier effect
• ? Self-adjustment is slow and week
• ? State intervention needed

21
AGGREGATE DEMAND AND KEYNESIAN AGGREGATE SUPPLY
CURVE
KAS
P
AD
P
AD
AD
0
National Output
Q
Q
22
OECD JOBS POLICY

• ? Set appropriate macroeconomic policy
• ? Enhance the creation and diffusion of
  technological know-how
• ? Nurture an entrepreneurial climate
• ? Increase labour cost flexibility
• ? Increase working-time flexibility
• ? Reform security-of -employment provisions
• ? Reform unemployment benefit systems
• ? Improve labour skills and competence
• ? Expand and enhance active labour policies.

23
There can exist no expedient by which labour as
a whole can reduce its real wage to a given
figure by making revised money bargains with the
entrepreneurs. Keynes Fundamental objection
to classical model
24
a somewhat comprehensive socialisation of
investment will prove the only means of securing
an approximation to full employment General
Theory p.378
25
Unemployment will not decline unless business
men have the incentive of plentiful credit, high
hopes and a slightly rising level of prices - a
slight inflation of prices but not of
costs. Keynes How to organise a wave of
prosperity article in Evening Standard, 1928