Session 14
Managing the Economy II
Unemployment - definitions and measurement. Recent
trends in unemployment. Causes of unemployment.
Inflation and unemployment. Keynesian and
Monetarist approaches.
What is meant by 'full employment'? Critically
discuss the view that full employment is no longer
an achievable objective of economic policy in the
U.K.
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Since the 1970s unemployment has become the most dramatic problem
for industrialized societies. Reflecting on that, the OECD's meeting
at ministerial level on May 1997, worded its central theme as
"promoting sustainable growth and social cohesion"
social cohesion meant "reducing levels of unemployment".
The meeting stated that "eliminating high and persistent unemployment
is the major economic policy challenge for most OECD countries. The
Jobs Strategy review concluded that for the OECD area as a whole,
unemployment has fallen only slightly from its peak in 1994 and that
structural unemployment has risen. In a number of countries it is at
unacceptably high levels. Ministers agreed that the bulk of this
unemployment remains structural in nature, although there is also
cyclical unemployment in some countries".
And about the policies to solve the problem, the meeting was rather
puzzled, because the recipe for success ( deregulation of the labour
market ) is creating a problem as socially dangerous as unemployment:
extreme inequalities, and even social exclusion.
The meeting said: "Ministers also acknowledged that the structural
changes often required may involve difficult adjustment for some firms,
regions, sectors and segments of the work-force. But they agreed that
hindrances to competition and technological progress or other sources of
structural change would constrain growth and thus run counter to the
interests of Member countries. At the same time, Ministers recognised
that the gap between the "haves" and "have nots" within some OECD
countries may have widened, the latter more often than not being less
skilled. Whilst the key preoccupation is to boost employment, there are
also some concerns about widening income inequalities or unequal access
to opportunities and there is a need to prevent people from drifting
into long-term unemployment and social exclusion."
The dimension of the unemployment problem is given by the following
data:
RATE OF UNEMPLOYMENT. SELECTED OECD COUNTRIES
OECD.- Standardised unemployment rates. 1976-1996
Country 1968 1976 1984 1992 1996
United States 3.6 7.6 7.4 7.5 5.4
Japan 1.2 2.0 2.7 2.2 3.4
Germany* 1.2 3.7 7.1 4.6 9.0
France 2.6 4.4 9.7 10.3 12.4
Italy 5.3 6.6 9.4 10.5 12.0
United Kingdom 2.3 5.6 11.7 10.1 8.2
Canada 4.5 7.1 11.2 11.3 9.7
Australia 1.8 4.7 8.9 10.7 8.6
Belgium 2.9 6.4 12.1 7.7 9.8
Finland 4.0 3.8 5.2 13.0 15.7
Ireland 5.3 .. 15.5 15.5 12.3
Netherlands 2.5 5.5 11.8 5.6 6.3
New Zealand 0.6 .. .. 10.2 6.1
Norway 1.8 1.7 3.1 5.9 ..
Portugal 3.8 .. 8.4 4.1 7.3
Spain 1.3 4.5 19.7 18.1 22.2
Sweden 1.8 1.6 3.4 5.8 10.0
TOTAL OECD 3.0 5.4 8.0 7.5 7.6
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* Up to and including 1992, data concern western Germany
NOTE: These unemployment rates are based on the ILO/OECD Guidelines. The
unemployed are defined as persons of working age who are without work,
are available for work and are actively seeking employment; unemployment
is expressed as a percentage of total labour force including all members
of the armed forces. Brake is marked by (|). The data above are averages
of quarterly or monthly figures. For a detailed description of the
sources and methods used, see STANDARDISED UNEMPLOYMENT RATES, SOURCES
AND METHODS (OECD, 1985)
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source: OECD ECONOMIC OUTLOOK, No. 61, June 1997, OECD, 1997, and other
issues.
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MEASURING UNEMPLOYMENT: DIFFERENT CRITERIA
One difficult with comparing rates of unemployment across countries is
that there are different ways of measuring it.
Drawing from J. Shields, "Job Creation and Labour Market Policy",
Economic Review, Vol. 5, No. 1, September 1987, we have:
"Some countries such as the United States, Canada and Sweden use a set
of agreed criteria to determine whether a person is unemployed. The
individual has to be working less than a given number of hours a week,
not have another job to go to, be available for work within a short
period and be making efforts themselves to find a job for which they
are suited. By conducting regular sample surveys of the population,
the proportion of people falling within the definition of unemployment
is assessed at different point sin time".
The United Kingdom way of measuring unemployment is totally different.
"We simply produce a computerised count each month of the number of
people claiming state benefits because they are unemployed"...This
procedure "throws back on the administration of the state benefit system
the decision over whether or not a person should be categorised as
'genuinely' unemployed. This means that people who see no reason to
'sign on' will not be counted as unemployed (for example, married women
may not need credits for their national insurance records). On the other
hand, some people not actively seeking work may be included in the
unemployment total simply as a result of their entitlement to benefit".
"A consequence of this method of measurement is that any change in
administrative procedure...will affect the unemployment count"
(J. Shields, 1987)
OECD's system is almost identical to the system used in United States,
Canada and Sweden. The system is based on the ILO/OECD Guidelines. The
unemployed are defined as persons of working age who are without work,
are available for work and are actively seeking employment; unemployment
is expressed as a percentage of total labour force including all members
of the armed forces. For a detailed description of the sources and
methods used the student must see STANDARDISED UNEMPLOYMENT RATES,
SOURCES AND METHODS (OECD, 1985).
UNEMPLOYMENT STATISTICS: DIFFICULTIES AND ERRORS
There are three main sources of error in unemployment statistics:
1) at any point in time there can be large number of discouraged
workers who have given up looking for jobs and are no longer
considered part of the workforce. The number of discouraged workers
is difficult to estimate with accuracy -recent estimates have exceeded
one million -but it is clear that this number rises when the
measured rate of unemployment increases.
The existence of discouraged workers means that published unemployment
statistics underestimate the magnitude of the problem because these
people are not counted in the unemployment calculations.
2) a significant number of people are working in the underground
economy; that is, supporting themselves with criminal activities
or being paid in cash to avoid taxes. These people are not only
omitted in the employment figures, but they frequently are counted
as unemployed.
The existence of underground work probably means that the measured
unemployment rate overstates the "true" unemployment rate by a
percentage point or two.
It must be recognized, however, that more people turn to underground
employment when the prospects for "above ground" employment are poor.
For example, bootlegging and moonshining have historically increased
when the coal mines of Appalachia close down, and marijuana cultivation
may have become more popular when the California state economy was
in the doldrums in the 1980s and early 1990s.
3) another source of error in the unemployment statistics stems from
the immigration of illegal aliens. No one knows how many illegals
enter the United States each year, but the Bureau of the Census
estimated the annual figure to be between 100,000 and 300,000 during
the 1980s; others think the number is much higher. Since many illegal
aliens do find jobs, they represent an increase in the working
population. If they were added to the official unemployment
calculations, this would reduce the unemployment rate. Illegal aliens
frequently take jobs that pay the minimum wage or lower and probably
exert some downward pressure on low wages.
Two final factors that are not accounted for in the measured rate of
unemployment are INVOLUNTARY PART-TIME WORK and UNDEREMPLOYMENT. (In the
US) about 18 percent of all workers held part-time jobs in the early
1990s, but only two-thirds of these people did so by choice. Those
working part-time involuntarily are officially counted as being
employed. Workers are underemployed if they are working at a job for
which they are overqualified -perhaps a Ph.D. civil engineer driving
a taxi, or a college graduate working as a clerk. Determining the
extent of underemployment is difficult, but many scholars think that
it has increased in recent years.
WHAT CAUSES UNEMPLOYMENT?
A first approach to look at the main causes of unemployment, W. S. Brown
description is useful ( from "Principles of Economics", West Publishing
Company, 1995):
People are classified as unemployed only if they are actively looking
for a job; people who have given up looking for a job are considered
"discouraged workers" and not part of the labour force.
The economy is operating at "full employment" when everyone who is
willing and able to work can find a job, but full employment does
NOT mean that the unemployment rate is zero. Most economists believe
that the full employment rate of unemployment has risen from about
4 percent to around 6 percent over the past 40 years.
Why isn't the full employment rate of unemployment zero? To answer
this question, we need to define three different kinds of
unemployment.
Most of the variation in unemployment that occurs over the business
cycle is CYCLICAL UNEMPLOYMENT.
If the economy falls into a recession and you loose your job because
your factory closes down, you will be classified as cyclically
unemployed. People who have the wrong skills or live in the wrong
location are said to be STRUCTURALLY UNEMPLOYED. For example, a typist
who has not acquired word processing skills will be structurally
unemployed in short order in today's economy -whether the economy is
in recession or not.
The structurally unemployed have difficulty finding jobs even when
the economy is booming.
Finally, there will always be some people who deliberately quit
their old jobs to look for better jobs. These people are said to
be FRICTIONALLY UNEMPLOYED.
Therefore, the full employment rate of unemployment is not zero
because there will always be some people who are structurally
or frictionally unemployed.
THE FULL EMPLOYMENT RATE OF UNEMPLOYMENT
Many economists believe that the full employment rate of unemployment
has risen since the 1950s.
One explanation is based on structural changes in the economy:
--as technology evolves and the workplace changes, some people find
that their job skills are no longer needed.
Another explanation attributes the rise in the full employment rate
of unemployment to demographic changes in the labour force.
--One demographic change is the rise in the number of two-worker
families. If both partners are in the labour force, the other can
afford to look longer for just the right job. As a result, the full
employment rate of unemployment will increase because longer search
times increase the number of people out of work at a point in time.
By and large, the upward trend in the unemployment rate is a global
phenomenon, though it has affected the United States less than many
advanced nations (See OECD.-Standardised unemployment rates. 1976-95)
The data below shows variations in cyclical unemployment in the U.S.
up to 1991. From 1992, as we know, the U.S. economy began to speed
up, until, probably, late 1997/early 1998.
BUSINESS CYCLES IN THE UNITED STATES, 1929-1991
Percentage change in
Unemployment Unemployment Real GDP from Peak
Peak Trough at Peak at Trough to Trough
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8/1929 3/1933 3.2% 24.9% -32.6%
5/1937 6/1938 11.0 20.0 -18.2
2/1945 10/1945 0.9 4.3 NA
11/1948 10/1949 3.8 7.9 -1.5
7/1953 5/1954 2.5 6.1 -3.2
8/1957 4/1958 3.7 7.5 -3.3
4/1960 2/1961 5.0 7.1 -1.2
12/1969 11/1970 3.4 6.1 -1.0
11/1973 3/1975 4.6 9.0 -4.9
1/1980 7/1980 5.7 7.8 -2.5
7/1981 12/1982 7.2 10.8 -2.6
7/1990 3/1991 5.5 6.8 -1.6
Post-World War II averages
Average recession : 11 months
Average expansion : 44 months
Average rise in unemployment in recession: 2.76 percentage points
Average decline in GDP in recession : 1.23%
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Sources: G. H. Moore, "Business Cycles, Inflation, and Forecasting",
Cambridge, 1983, and Federal Reserve Bulletin, varios issues.
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In the United Kingdom, Economic Trends publishes data por business
cycles. The following table is from Economic Trends various issues:
BUSINESS CYCLES IN THE UNITED KINGDOM. 1969-1996
Peak Trough
May 1969 February 1972
July 1973 August 1975
May 1979 January 1981
January 1985 August 1986
June 1990 March 1992
July 1994 July 1996
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NOTE: the students should complete this table adding rates of
unemployment in order to see the behaviour of cyclical unemployment,
and then draw some general conclusions about trends in the last 30
years in the United Kingdom. The data is in the section Statistics of
The Robinson Rojas Archive (RRojas Databank)
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IS THERE A TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT?
From the above definitions of unemployment, it is clear that cyclical
unemployment, being related to business cycles where prices tend to go
up in the expansionary section and the reverse is true for the
recessionary section, must be connected to price fluctuations. Thus,
on account of cyclical unemployment there must be trade-off between
levels of prices and levels of unemployment.
The two main economic theories competing in contemporary times see
prices and unemployment having totally different relationships:
Keynesian approach is that being demand for labour a derived demand,
then fluctuations in employment will be the outcome of fluctuations
in demand. From here is obvious than Keynesian expect rises in
prices if there is going to be a decrease in the level of unemployment.
(See the section demand-pull inflation in any textbook).
Monetarist will argue that levels of unemployment are related to costs,
that is, to levels of wages. A deregulated labour market without
minimum wages and without trade unions will deliver full employment.
By and large, the economy growths trough business cycles, and business
cycles are about one moment demand being in excess of supply, and the
nex moment supply being in excess of demand.
When demand is larger than supply prices , output, investment and
employment increase. The reverse occur when there is too much supply in
relation to demand.
Therefore, one major cause of inflation is 'excessive growth of
aggregate demand'. From the latter it follows that 'too much
employment is inflationary' also.
Another cause of inflation is when costs of production increase and
a phenomenon called 'stagflation' can appear (from 'stagnation' plus
'inflation'). The experience of the mid-late 1970s is clear about this
when the oil prices rocketed. In this case prices and unemployment
increase, there is no trade-off. We have the case of cost-push
inflation. Another cause for cost-push inflation, in accordance with
monetarist theory, is rocketing wages (the price of labour).
Bringing the above concepts to a logical network, we have the following:
--for any given rate of growth of the aggregate supply curve, a faster
rate of growth of the aggregate demand curve will lead to more inflation
and faster growth of real output,
--for any given rate of growth of the aggregate supply curve, a slower
rate of growth of the aggregate demand curve will lead to less inflation
and slower growth of real ouput,
--if fluctuations in the economy's real growth rate year to year are
caused primarily by variations in the rate at which the aggregate demand
curve reflects more income, then the data should show that the most
rapid inflation occurs during years when output expands most rapidly
and the slowest inflation occurs when output expands more slowly. As a
sequel to the above, higher levels of unemployment should appear with
lower levels of inflation-rate of growth,
--the unemployment rate and the growth rate of output/prices should be
inversely related: the faster the economy grows, the lower the
unemployment rate, and the slower the economy grows, the higher the
unemployment rate,
--from the above, then, if fluctuations in economic activity are
primarily caused by variations in the rate at which the aggregate
demand curve shifts to the right from year to year, then the data
should show that low unemployment rates are associated with high
inflation rates and high unemployment rates are associated with low
inflation rates.
The above conceptual framework is implicit in the work done by the
economist W. Phillips, when he plotted data for the levels of wages
and the rates of unemployment for several extended periods of British
economic history. Since then, the 'Phillips curve' have been at the
center of a misguided controversy. Misguided in the sense that the
Phillips curve was a 'statistical relation' and not an analytical tool.
Therefore, if the 'statistical fitness' of the original Phillips curve
is not similar to contemporary statistical data, there is no connection
with the conceptual tenets of the trade-off as described above.
If we incorporate in the analysis the concept of TECHNOLOGICAL
UNEMPLOYMENT, that is the level of unemployment that productivity
advances adds to the 'natural rate of unemployment' thought as the
amount of unemployment wich is consistent with the clearing of the
goods market, we have that over time, the so-called Phillips curve
should shift to the right. In different words, less people will create
the same amount of output that more people was creating in the past.
Or, a higher level of unemployment will appear as necessary to keep
the economy at a given level of inflation.
Ignoring technological unemployment, monetarist will argue as follows:
a) to the extent that economic fluctuations emanate from the demand
side, we expect to find an inverse relationship between unemployment
and inflation -a dowward-sloping Phillips curve.
b) in the short-run, it is possible to 'ride up the Phillips curve'
toward lower levels of unemployment by stimulating aggregate demand.
Conversely, by restricting the growth of demand, it is possible 'to
ride down the Phillips curve' toward lower rates of inflation. There
is, thus a 'trade-off between unemployment and inflation'.
Stimulating demand demand will improve the unemployment picture but
worsen inflation; restricting demand will lower inflation but
aggravate the unemployment problem.
c) however, there is no such trade-off in the long-run. The economy's
self-correcting mechanism ensures that unemployment eventually will
return to the 'natural rate', no matter what happens to aggregate
demand. In the long run, faster growth of demand leads only to higher
inflation, not to lower unemployment; and slower growth of demand
leads only to lower inflation, not to higher unemployment.
( from W. J. Baumol and A. S. Binder, "Economics. Principles and
Policy", HBJ Publishers, 1979)
Keynesians and monetarists will utilise Fiscal and Monetary policy
in ways consistent with the above ideas. The former will focus on
pushing demand and employment up regardless of level of nominal prices.
The latter will focus on controlling nominal prices, regardless of
levels of unemployment.
In both cases, Keynesian and monetarist cannot do anything about the
most important law of capitalist economic growth, which is producing
more with less in order to maximize profits. In the long run, that
will means that the rate of growth of unemployment will be always
higher than the rate of growth of employment, whatever the rate of
growth of labour force. From that point of view, whatever the levels
of skills of the labour force, the latter will be too large. There
always be a redundant section of the labour force...which lead us to
the (monetarist) notion of 'natural rate of unemployment' increasing
over time regardless the economic policies adopted by the governments
of industrialized societies, be them Keynesian or monetarist.
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BOX 1
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INDICATOR ANALYSIS (Knowing our bussiness cycles)
In all industrialized economies forecasting the business cycles is very
important, specially because of political reasons. The U.S. economists
are "top of the class" in forecasting business cycles.
As Brown,1995, pages 572-573, states
One of the most useful methods for forecasting business cycle turning
points is "indicator analysis". In the U.S. the economic indicators were
developed in the late 1930s by W. Mitchell and A. Burns. Burns and
Mitchell found a set of economic data series that had a consistent
relationship with business cycle turning points.
Based on Burns and Mitchel work, the U.S. National Bureau of Economic
Research (NBER) publishes three indicator series:
the leading indicators
the coincident indicators, and
the lagging indicators
THE LEADING INDICATORS
The Department of Commerce compiles a list of 11 leading indicators.
These series were selected because of their stable statistical
relationship with past economic activity, not necessarily any
theoretical relationship. Nevertheless, the economic rationale for the
inclusion of particular series is usually clear.
For example, one of the leading indicators is the hours worked in
manufacturing. Because firms can more easily adjust hours than
employment, changes in the hours worked generally preced employment
changes. The index also includes financial variables, variables that
reflect delivery speed, inflation, and new business formation.
The 11 leading indicators are:
(1) stock market prices,
(2) the real money supply,
(3) an index of consumer expectations,
(4) the percentage change in sensitive materials prices,
(5) the average workweek of manufacturing production workers,
(6) initial claims for unemployment insurance,
(7) new building permits,
(8) new orders for consumer goods,
(9) contracts and orders for investment goods,
(10) the change in manufacturers' unfilled orders for durable goods,
(11) vendor performance (how easy is to get delivery of inputs)
The most common use of the leading indicators is the INDEX OF LEADING
INDICATORS, a mathematical combination of the 11 indicators into a
single series...The index generally precedes cycle turning points by
about six months.
THE COINCIDENT INDICATORS
The coincident indicators are a set of data series that are thought to
turn at the same time as the general economy. The coincident indicators
include industrial production and personal income, but not Gross
Domestic Product. GDP is not included because GDP data are available
only quarterly, and the indicators are published monthly.
THE LAGGING INDICATORS
These series typically lag behind overall economic activity by about six
months. Among the important lagging indicators are
bank prime interest rates,
the average duration of unemployment, and
the unemployment rate
HOW ACCURATE ARE INDICATOR FORECASTS?
The biggest problem with the economic indicators is that they frequently
give 'false signals' -they rise or fall without a corresponding change
in aggregate economic activity...Thus, when the indicators are watched
carefully and interpreted correctly, they can be very accurate. In fact,
every business cycle turning point since World War II has been preceded
by a change in the leading indicators. Even the 'false signals' are not
entirely without meaning: if dips in the index do not result in full-
fledged recessions, they almost always warn of GROWTH RECESSION
-declines in the rate of economic growth, which are not severe enough to
be classified as recessions.
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end of BOX 1
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