Slide 0 LECTURE 6 Unemployment BUS 530: ECONOMIC CONDITIONS ANALYSIS LECTURE 6: Unemployment.

LECTURE 6 Unemployment

BUS 530: ECONOMIC CONDITIONS ANALYSIS

LECTURE 6: Unemployment

Contents

Economic classification of population and measurement of unemployment

Working of the labor market

Natural rate of unemployment

Types of unemployment

Causes of unemployment and policy response

Learning Objectives

Understand the working of the labor market and factors contributing to unemployment

Learn about macroeconomic policies for reducing unemployment

Composition of Population in terms of Economic Status

Definitions used in Bangladesh

Employed: A person who was either working during the previous week for one or more hours for pay or profit or working without pay in a family farm or enterprise during the week or found not working but had a job or business from which he/she was temporarily absent during the week

Definitions used in Bangladesh

Unemployed: A person who is involuntarily out of gainful employment during the reference period but either has been actively looking for a job or was willing to work but not looking for work because of illness

Important Formulae

Crude Activity Rate = Labor Force * 100%

Population

Refined Activity Rate = Labor Force * 100%

Population ≥ 15yrs

Unemployment Rate = Unemployed * 100%

Labor Force

Labor Force Survey 2005-06

Items Number (in millions)

Population 148.8

Labor Force 56.7

Outside the Labor Force 92.1

Employed 54.1

Unemployed 2.6

Children below 15 years 53.2

Household work, other inactive, old & disabled, discouraged worker

38.9

Crude Activity Rate (%) 38.1

Refined Activity Rate (%) 59.3

Unemployment Rate (%) 4.5


Natural Rate of Unemployment

The unemployment rate: the fraction of the civilian workforce that is unemployed

The “Natural” rate of unemployment: The average or long-run rate of unemployment around which the economy fluctuates.

In a recession, the actual unemployment rate rises above the natural rate.

In a boom, the actual unemployment rate falls below the natural rate.

Natural Rate of Unemployment

5-6% for the developed economies

Exists in the developing economies as well

Difficult to get rid of this type of unemployment

Thus when a country has 5-6% of unemployment, it is considered to be fully employed


Actual and Natural Rates of Unemployment in the U.S., 1960-2006

Per

cent

of l

abor

forc

e

0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Unemployment rate

Natural rate of unemployment

Bangladesh Unemployment Rate



Labor Force and Unemployment Rate

Notation:

L = workers in labor force

E = employed workers

U = unemployed workers

U/L = unemployment rate


Assumptions:

1. L is exogenously fixed (no population growth).

2. During any given month,

s = fraction of employed workers that become separated from their jobs

s is called the rate of job separation

f = fraction of unemployed workers that find jobs

f is called the rate of job finding

s and f are exogenousexogenous

The Transitions between Employment and Unemployment


Employed Unemployed

s E

f U

The Steady State Condition


Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constantconstant.

The steady-state condition is:

s E = f U

# of employed people who lose or leave their jobs

# of unemployed people who find jobs


Finding the “EQUILIBRIUM” Unemployment Rate

f U = s E

= s (L – U )

= s L – s U

Solve for U/L:

(f + s) U = s L

so,


The “NATURAL” Rate of Unemployment

Therefore, the natural rate of unemployment is defined as:

Rate of job separation (s)

Rate of job separation (s) + Rate of job finding (f)

Class Exercise

Suppose 1% of employed workers lose their jobs

19% of unemployed workers find jobs

Find the natural rate of unemployment


Answer

Each month, 1% of employed workers lose their jobs

(s = 0.01) 19% of unemployed workers find jobs

(f = 0.19)

The natural rate of unemployment:


0 010 05, or 5%

0 01 0 19

U sL s f

..

. .

Policy Implications


Any policy aimed at lowering the natural rate of unemployment must either reduce the rate of job separation (s) or increases the rate of job finding (f).

Similarly, any policy that affects the rate of job separation (s) or the rate of job finding (f) also changes the natural rate of unemployment, Because:


Why is there Unemployment?

If job finding were instantaneous (s = 0, f = 1), then all spells of unemployment would be brief, and the natural rate would be near zero.

There are two reasons why f < 1 and s > 0:

1. job search

2. wage rigidity


Job Search & Frictional Unemployment

Frictional unemployment: The unemployment caused by the time it takes workers to search for a job

Occurs even when wages are flexible and there are enough jobs to go around

Occurs because workers have different abilities, preferences jobs have different skill requirements geographic mobility of workers not instantaneous flow of information about vacancies and job

candidates is imperfect


Sectoral Shifts

defintion: Changes in the composition of demand among industries or regions.

example: Technological change more jobs repairing computers, fewer jobs repairing typewriters

example: A new international trade agreement labor demand increases in export sectors, decreases in import-competing sectors

Result: frictional unemployment

Structural change over the long run -

US


Structural Change in Employment: Bangladesh



More examples of Sectoral Shifts

Late 1800s: decline of agriculture, increase in manufacturing

Late 1900s: relative decline of manufacturing, increase in service sector

1970s: energy crisis caused a shift in demand away from gas guzzlers toward smaller cars.


Public Policy and Job Search

Govt programs affecting unemployment

Govt employment agencies:disseminate info about job openings to better match workers & jobs.

Public job training programs:help workers displaced from declining industries get skills needed for jobs in growing industries.


Unemployment insurance (UI)

UI pays part of a worker’s former wages for a limited time after losing his/her job.

UI increases search unemployment, because it reduces the opportunity cost of being unemployed the urgency of finding work Rate of job finding, f

Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment.


By allowing workers more time to search,

UI may lead to better matches between jobs and workers, which would lead to greater productivity and higher incomes.

Benefits of UI

Unemployment Benefits

Provided in developed countries

Eligibility excludes new entrants to the labor force and those giving up job voluntarily

Raises aggregate demand and contributes toward early recovery of an economy from recession


Why is there Unemployment?

Two reasons why f < 1:

1. job search

2. wage rigidity

DONE Next

The natural rate of unemployment:


Unemployment from Real Wage Rigidity & Structural Unemployment

Labor

Real wage

Supply

Demand

Unemployment

Rigid

real wage

Amount of labor willing to work

Amount of labor hired

If real wage is stuck above its equilibrium level, then there aren’t enough jobs to go around.


Unemployment from Real Wage Rigidity

Then, firms must ration the scarce jobs among workers.

Then, firms must ration the scarce jobs among workers.

Structural unemployment: The unemployment resulting from real wage rigidity and job rationing.

Structural unemployment: The unemployment resulting from real wage rigidity and job rationing.

If real wage is stuck above its equilibrium level, then there aren’t enough jobs to go around.


Reasons for Wage Rigidity

1. Minimum wage laws

2. Labor unions

3. Efficiency wages


The Minimum Wage

The minimum wage may exceedexceed the equilibrium wage of unskilled workers, especially teenagers.

Studies: a 10% increase in min. wage reduces teen employment by 1-3%

Tendency for firms to substitute towards illegal workers (who are not bound by the min. wage)

But, the minimum wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the minimum wage.

Minimum Wage Law

It is enacted in almost every country so that forces cannot drive it down too low.

When wages are pushed up to the level of w*, unemployment to the extent bc is created, since supply exceeds demand.

In addition, there is also unemployment to the extent of cd, which is due to people looking for better jobs

Labor Market


Labor Unions

Unions exercise monopoly power to secure higher wages for their members (collective bargaining).

When the union wage exceeds the equilibrium wage, unemployment results.

Insiders: Employed union workers whose interest is to keep wages high.

Outsiders: Unemployed non-union workers who would be willing to work for lower wages, so there would be enough jobs for them.

Collective Bargaining by Labor Union

Every country legalizes labor union activity to prevent excessive exploitation of labor by the employer

Experiences have shown that if politicization of labor union can be avoided and labor unions abide by the rules of the game then union activities can contribute towards congenial industrial relations

105,508Private sector (total)

20,381Government (total)

14,045Health care

3,312Education

10,951Professional services

6,304Finance, insurance

4,379Transportation

14,973Retail trade

15,518Manufacturing

600Mining

122.3

121.7

115.1

112.7

90.6

90.7

129.2

114.0

107.8

113.7

156.9

8.5%

40.5

8

15.4

3.1

2.1

24.4

5.8

13.7

9.5

13.88,053Construction

wage ratio

U % of total# employed

(1000s)industry

wage ratio = 100(union wage)/(nonunion wage) slide 41

Union Membership and Wage RATIOS by Industry, 2005



3. Efficiency Wage Theory IdeaIdea: higher wages increase worker productivity by:

Attracting higher quality job applicants

(“Adverse SelectionAdverse Selection” problem) Increasing worker effort, reducing “shirking”

(“Moral HazardMoral Hazard” problem) Reducing turnover, which is costly to firms Improving health of workers: better nutrition &

productivity (in developing countries)

Firms willingly pay above-equilibrium wages to raise productivity, causing structural unemployment.

Other Types of Unemployment and Macroeconomic Policies


Cyclical Unemployment

Y* represents full employment output level

Sometimes national output falls due to a fall in demand, this is called recession. Labor demand declines, additional unemployment to the extent of ee*

This is called cyclical unemployment

Stabilization Policy

Developed countries can stabilize cyclical unemployment through expansionary monetary or fiscal policies

Expansionary monetary policy increases credit supply which raises aggregate demand. An expansionary fiscal policy on the other hand reduces taxes

Disguised Unemployment

Developing countries are generally not close to the full employment level. Here, unemployment does not occur due to periodic demand shortfall. These countries, like Bangladesh suffer from disguised unemployment.

Structural Unemployment

Large scale unemployment caused by low productive capacity

Unlike cyclical unemployment, structural is of long-term nature

Reduction of structural unemployment requires expansion of productive capacity which takes time

Seasonal Unemployment

Periodic Unemployment

Agricultural workers suffer unemployment during agricultural lean seasons. Workers in developed countries can however easily switch skills to meet varying labor demands

Can also be countered through government intervention

Chapter Summary

1. The natural rate of unemployment the long-run average or “steady state” rate of

unemployment depends on the rates of job separation and job

finding

2. Frictional unemployment due to the time it takes to match workers with jobs may be increased by unemployment insurance

CHAPTER 6 Unemployment slide 52LECTURE 6 Unemployment

Chapter Summary

3. Structural unemployment results from wage rigidity: the real wage remains

above the equilibrium level caused by: minimum wage, unions, efficiency

wages4. Behavior of the natural rate in the U.S.

rose from 1960 to early 1980s, then fell possible explanations:

trends in real minimum wage, union membership, prevalence of sectoral shifts, and aging of the Baby Boomers


Chapter Summary

5. European unemployment has risen sharply since 1970 probably due to generous unemployment benefits,

strong union presence, and a technology-driven shift in demand away from unskilled workers



Sectoral Shifts

U.S. Auto Industry (Detroit): Struggling for many years: falling profits, increased foreign competition, insufficient R&D

- Recently, rising healthcare costs have caused significant increase in costs

-Auto workers have been leaving the industry to work in the services sector…healthcare (especially nursing) is an attractive option

-But transition can be painful (new skills, training, going back to school, etc)

In a dynamic economy, sectoral shifts occur frequently, contributing to frictional unemployment:

often referred to as the “cost” of economic development


Geography of a RecessionU.S. Housing and Labor Markets

January 2008


TREND: The Natural Rate rises during 1960-1984, then falls during 1985-2006


Explaining the Trend:

The Minimum Wage

0

1

2

3

4

5

6

7

8

9

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Dol

lars

per

hou

r

minimum wage in current dollars

minimum wage in 2006 dollars

The trend in the real minimum wage is similar to that of the natural rate of unemployment.

The trend in the real minimum wage is similar to that of the natural rate of unemployment.


EXPLAINING THE TREND:Union membership

Since the early 1980s, the natural rate of unemploy-ment and union membership have both fallen.

But, from 1950s to about 1980, the natural rate rose while union membership fell.

Since the early 1980s, the natural rate of unemploy-ment and union membership have both fallen.

But, from 1950s to about 1980, the natural rate rose while union membership fell.

Union membershipselected years

year percent of labor force

1930 12%

1945 35%

1954 35%

1970 27%

1983 20.1%

2005 12.5%


EXPLAINING THE TREND:

Sectoral shifts

Price per barrel of oil,

in 2006 dollars

From mid 1980s to early 2000s, oil prices less volatile, so fewer sectoral shifts.

From mid 1980s to early 2000s, oil prices less volatile, so fewer sectoral shifts.


EXPLAINING THE TREND:Demographics

1970s: The Baby Boomers were young. Young workers change jobs more frequently (high value of s).

Late 1980s through today: Baby Boomers aged. Middle-aged workers change jobs less often (low s).

slide 64

Unemployment in Europe, 1960-2005

Per

cent

of l

abor

forc

e

Italy

Germany

France

U.K.

0

3

6

9

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005LECTURE 6 Unemployment


The Rise in European Unemployment

Shock Technological progress has shifted labor demand from unskilled to skilled workers in recent decades.

An increase in the “skill premium” – the wage gap between skilled and unskilled workers.

Higher unemployment, due to generous govt benefits for unemployed workers

strong union presence.


Percent of workers covered by collective bargaining

United States 18%

United Kingdom 47

Switzerland 53

Spain 68

Sweden 83

Germany 90

France 92

Austria 98


Large scale unemployment caused by low productive capacity


Supply is relatively inelastic, thus stabilization measure aimed at raising aggregate demand will have less effect on aggregate demand and hence on demand for labor. Rather it will cause general price level to rise.

Actual & Potential GDP

Potential GDP is when labor and all other productive assets are fully employed. The area between potential and actual GDP shows the cost of unemployment.

Slide 0 LECTURE 6 Unemployment BUS 530: ECONOMIC CONDITIONS ANALYSIS LECTURE 6: Unemployment.

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