Employment and Unemployment

We now turn our attention to the labour market and consider why people find themselves out of work
and cannot find a paid job. Unemployment imposes heavy economic and social costs; we look at which
policies are likely to be most effective in keeping unemployment as low as possible.
Defining and measuring unemployment
Officially, the unemployed are people who are registered as able, available and willing to work at the
going wage rate but who cannot find work despite an active search for work. This last point is
important for to be classified as unemployed, one must show evidence of being active in the labour
market.
There are two main measures of unemployment in the UK:
1. The Claimant Count measure of unemployment includes those unemployed people who are
eligible to claim the Job Seeker's Allowance (JSA) or who have enough National Insurance
Credits. People who satisfy the criteria receive the JSA for six months before moving onto
special employment measures including the New Deal Programme. The Claimant Count is a
head-count of people claiming unemployment benefit.
2. The Labour Force Survey covers those who are without any kind of job including part time
work but who have looked for work in the past month and are able to start work in the next
two weeks. The figure also includes those people who have found a job and are waiting to start
in the next two weeks.
On average, the labour force survey measure has exceeded the claimant count by about 400,000 in
recent years. Because it is a survey (albeit a large one and one that provides a rich source of data on
the employment status of thousands of households across the UK), we must remember that there will
always be a sampling error in the data. The Labour Force Survey measure is the internationally agreed
definition of unemployment and therefore the measure that best allows cross-country comparisons of
unemployment levels.
Main causess of unemployment
We now consider some of the main underlying causes of people being out of work
Frictional Unemployment
Frictional unemployment is transitional unemployment due to people moving between jobs:
For example, redundant workers or workers entering the labour market for the first time (such as
university graduates) may take time to find appropriate jobs at wage rates they are prepared to
accept. Many are unemployed for a short time whilst involved in job search. Imperfect information in
the labour market may make frictional unemployment worse if the jobless are unaware of the available
jobs. Incentives problems can also cause some frictional unemployment as some people actively
looking for a new job may opt not to accept paid employment if they believe the tax and benefit
system will reduce the net increase in income from taking work. When this happens there are
disincentives for the unemployed to accept work.

Structural Unemployment
Structural unemployment occurs when there is a long run decline in demand in an industry leading to
a reduction in employment perhaps because of increasing international competition. Globalisation is a
fact of life and inevitably it leads to changes in the patterns of trade between countries over time.
Britain for example has probably now lost for good, its cost advantage in manufacturing goods such as
motor cars, household goods and audio-visual equipment. Manufacturing industry has lost over 400,000
jobs in the last five years alone. Many of these workers may suffer from a period of structural
unemployment, particularly if they are in regions of above-average unemployment rates where job
opportunities are scarce. The decline in manufacturing industry jobs is shown in the next chart.

There is often a mismatch between the skills required for job vacancies and the skills and experience
that unemployed workers have this is a problem associated with structural unemployment
Structural unemployment exists where there is a mismatch between their skills and the requirements
of the new job opportunities. Many of the unemployed from manufacturing industry (e.g. in coal, steel
and engineering) have found it difficult to find new work without an investment in re-training. This
problem is one of occupational immobility of labour
Cyclical Unemployment:
Cyclical unemployment is involuntary unemployment due to a lack of demand for goods and services.
This is also known as Keynesian "demand deficient" unemployment. When there is a recession or a
severe slowdown in economic growth, we see a rising unemployment because of plant closures,
business failures and an increase in worker lay-offs and redundancies. This is due to a fall in demand
leading to a contraction in output across many industries. A downturn in demand is often the stimulus
for businesses to rationalise their operations by cutting employment in order to control costs and
restore some of their lost profitability.

Cyclical unemployment and the output gap

Real wage unemployment:

This is considered to be the result of real wages being above their market clearing level leading to an
excess supply of labour. Some economists believe that the minimum wage risks creating unemployment
in industries where international competition from low-labour cost producers is severe. As yet, there is
relatively little evidence that the minimum wage has created rising unemployment on the scale that
was feared.
Hidden unemployment
Undoubtedly there are thousands of people who by any reasonable definition are unemployed, but who
are not picked up by the official unemployment statistics. Many have become discouraged workers and
have stopped actively searching for work.

Unemployment and the production possibility frontier

The economic and social costs of unemployment

High unemployment is widely recognised to create substantial costs for individuals and for the economy
as a whole. Some of these costs are difficult to measure, especially the longer-term social costs of a
high level of unemployment. Some of the costs are summarised below:
1. Loss of income: Unemployment normally results in a loss of income. The majority of the
unemployed experience a decline in their living standards and are worse off out of work
2. Loss of national output: Unemployment involves a loss of potential national output (i.e. GDP
operating below potential) and represents an inefficient use of scarce resources. If some
people choose to leave the labour market permanently because they have lost the motivation
to search for work, this can have a negative effect on long run aggregate supply (LRAS) and
thereby damage the economys growth potential
3. Fiscal costs: The government loses out because of a fall in tax revenues and higher spending
on welfare payments for families with people out of work. The result can be an increase in the
budget deficit which then increases the risk that the government will have to raise taxation or
scale back plans for public spending on public and merit goods

4. Social costs: Rising unemployment is linked to social deprivation. There is a relationship with
crime, and social dislocation (increased divorce rates, worsening health and lower life
expectancy). Areas of high unemployment see falling real incomes and a worsening in
inequalities of income and wealth
The Impact of Unemployment
Economic cost:
On the one hand, there is the loss to the economy of the output that an unemployed person would be
able to contribute. If we assume that the average output per person is 15,000, then a total
unemployment level of two million means a loss to the economy of 30 billion worth of goods and
services.

This productive loss to the economy is an example of the opportunity cost of unemployment.
On top of this, there is the cost to the economy in terms of the benefits to which the
unemployed are entitled.

In 2005-06, a total of nearly 130 billion was spent by the government on social security
benefits. This figure includes all benefits in addition to JSA, but it gives an indication of the
direct economic cost of unemployment and economic inactivity.

We also need to take account of another area of economic cost - the loss of tax receipts. When
individuals are employed, they pay income tax and national insurance.

In 2006-07, the government expected to receive 144 billion in income tax and 90 billion in national
insurance.
Social cost:
There is a clear impact on individuals and society of unemployment. Some of these effects are listed
below:

Social exclusion of the unemployed

Loss of self-reliance of the individual

Deterioration of self-confidence

Damage to the psychological well-being of the unemployed

Deterioration of physical well-being of the unemployed

These damaging effects are likely to result in an increased burden on the National Health Service
(NHS), the disruption and break-up of families and increased levels of crime.
Long-term unemployment can make people feel ignored and left behind by society - causing mental
health problems, depression and illness. Copyright: Ben Lancaster, from stock.xchng

Government policies to reduce unemployment

Some countries are more successful than others in reducing the scale of unemployment. In the long
term, effective policies are required for both the demand and the supply side of the economy so that
enough new jobs are created and that people possess the skills and incentives to take those jobs.
In general the most effective policies are those that:
1. Stimulate an improvement in the human capital of the workforce so that more of the
unemployed have the skills to take up the available jobs. Policies normally concentrate on
improving the occupational mobility of labour. The pattern of employment in any modern
economy is always changing, so people need to have sufficient flexibility to adapt to structural
changes in industries over the years

2. Improve incentives for people to search and then accept paid work this may require
reforms of the tax and benefits system for example a reduction in the starting rate of income
tax (an incentive for people in lower paid jobs). Or perhaps a change in welfare benefits such
that people who find work do not experience a sharp withdrawal of benefits because they are
now earning more. The reality is that simply cutting welfare benefits across the board makes
little difference to the unemployment figures because of the complex nature of most
unemployment. But targeted measures to improve incentives, including the linking of welfare
benefits to participation in work experience programmes which is part of the New Deal
programme or lower tax rates for people on low incomes might have an impact.
3. Employment subsidies: Government subsidies for those firms that take on the long-term
unemployed will create an incentive for businesses to increase the size of their workforce.
Employment subsidies may also be available for overseas firms locating in the UK as part of the
governments regional policy. Labours New Deal programme works by offering subsidised jobs
and training to the long-term unemployed. It differs from previous job creation schemes, in
that people who refuse to comply can have their benefits stopped. According to the
government's own figures, more than 40% of the jobs gained through the New Deal are shortterm.
4. Achieve a sustained period of economic growth this requires that aggregate demand is
sufficiently high for businesses to be looking to expand their workforce. The Keynesian theory
of unemployment emphasises the argument that if monetary and fiscal policy does not keep
demand at a high enough level, then the economy is less likely to be able to sustain a high rate
of employment. However, not every increase in aggregate demand and production has to be
met by employing more labour. Each year we expect to see a rise in labour productivity (more
output per worker employed). And, businesses may decide to increase production by making
greater use of capital inputs such as extra units of machinery. A growing economy creates jobs
for people entering the labour market for the first time. And, it provides employment
opportunities for people unemployed and looking for work.
Evaluation points on unemployment policies
1. There are always cyclical fluctuations in employment. If growth can be sustained and
monetary and fiscal policy can avoid a large negative output gap then it should be possible to
create a steady flow of new jobs
2. Demand and supply-side policies need to work in tandem for unemployment to fall in the long
term. Simply boosting demand if the root cause of unemployment is structural is an ineffective
way of tackling the problem. If demand is stimulated too much, the main risk becomes one of

rising inflation (i.e. the trade-off between these two objectives may worsen)
3. Full-employment does not mean zero unemployment! There will always be some frictional
unemployment it may be useful to have a small surplus pool of labour available
4. There are still large regional differences in unemployment levels and pockets of deep-rooted
long-term unemployment in many areas, which causes significant economic and external costs
The main explanation behind the decline in unemployment has been economic growth. Labour as a
factor input has a derived demand - so rising production generates a higher demand for labour. These
employment-creation effects have not been uniform throughout regions and industries.
Other factors that have helped bring down the unemployment rate include:
1. Demographic factors there has been a slower growth of the population of working age than
at a similar stage of the last economic cycle in the early 1980s. This has lead to a slowdown in
the numbers of people of working age entering the UK labour market.
2. Expansion of further and higher education - there is a trend for more young people choosing
to delay their entry into the labour market and remain in full-time post-16 further and higher
education to boost their qualifications. Government policies have an explicit aim of increasing
the participation rate of 18 year-olds in higher education. This puts less pressure on the
number of new entrants into the labour force looking for work.
3. "Discouraged worker effects" due to structural unemployment: Some workers have given up
active job search, in the process become economically inactive and moved onto permanent
sickness and invalidity benefits or early retirement. The precise number of people involved is
difficult to calculate with accuracy it probably affects several thousand people.
4. Employment creation from foreign investment: The British economy has been successful in
attracting billions of pounds worth of inward investment from overseas companies. A high
proportion of this has gone into building new plants in the UK and this has created thousands of
new jobs helping to offset some of the regional disparities in unemployment.
5. Increased investment in worker training: This seems to have reduced structural
unemployment. Labour shortages are problematic in some industries, notably in areas where
house prices are high and unemployment rates have fallen below 2%. But taking the economy
as a whole, it seems that shortages of labour have not proved to be as difficult as in previous
phases of economic expansion. The main shortages are in highly skilled jobs and in areas where
living costs are well above the national average. The government has suffered from a shortage
of workers in key public sector jobs.
6. Increased flexibility in the labour market: This has made it easier for businesses to hire
workers and match their desired labour input to planned production. The number of part-time
workers on short-term contracts has grown by many thousands. There has also been greater
functional flexibility with workers expected to perform a number of tasks within the business.

Extra material for types of unemployment:

The main types of unemployment
Frictional unemployment:

This type of unemployment is defined as occurring when people are 'between

jobs'

It may be due to delays in receiving invitations to interview or in issuing

requests for references

Frictional unemployment can be reduced by improving communication

between employers with vacancies and job applicants

Government can help this process by setting up a computerised job

information service in Job Centres

Structural unemployment:

As the structure of the economy alters over time, people have to adapt to
find new jobs in new parts of the economy

This may mean that they have to relocate or retrain, or both of these, in order
to get a new job

Due to labour immobility, large pockets of unemployment can remain trapped

in particular regions where the old industries were located

Government can help by providing subsidies to employers in regions with

high levels of unemployment, or by improving labour mobility

Cyclical unemployment:

This is caused by low levels of demand and is seen when the economy is in
recession

Falling demand in the overall economy leads to reduced demand for labour

Government can help by boosting the level of aggregate demand in the

economy

This would involve increasing public expenditure and/or cutting taxation

Seasonal unemployment:

This is caused by the seasonal variation of demand in certain industries or

sectors of the economy

It is seen at certain times of the year, in industries such as construction,

tourism and in agriculture

Industries affected may be encouraged to diversify their products or services

so attract demand throughout the year, such as tourism venues competing
for income from the conference market

Employees in the affected sectors can be encouraged to retrain to compete

for jobs in sectors unaffected by seasonal variation in demand

Technological unemployment:

This can be seen where firms use capital investment to reduce their reliance
on unskilled or semi-skilled labour

Examples of it can be seen in car production where automation and

computer-aided manufacture has been introduced or in administrative jobs
where the use of information technology has become widespread

Workers affected by technological unemployment must retain to seek new

jobs

Regional unemployment:

This is where there are high levels of unemployment located in specific areas

Where there has been concentration of industries which have declined as the
structure of the economy has changed, this type of unemployment exists

Government can help by offering regional aid, including incentives for new
industry to relocate to areas affected

International unemployment:

This is where UK producers have been replaced by firms based overseas

UK may be seen as uncompetitive in price or in terms of product build quality

Government may choose to use trade policies such as quotas or tariffs to

avoid this, but will face pressure from the European Union or World Trade
Organisation, if it does so

The exchange rate could also be used to artificially make UK goods less
expensive to overseas' buyers

Voluntary unemployment:

Some of the economically inactive may be so through choice

Perhaps they may find it more attractive to live off social security benefits

Government can make working more attractive by using the tax system to
allow low-paid workers to keep more of their income

At the same time, these people could have their benefit payments reduced if
they refuse to accept suitable job opportunities