Unemployment

Chapter 3: Unemployment

• Determination of the natural rate of

unemployment (long term)

• Causes of unemployment

• Policies to tackle unemployment

2CHAPTER 6 Unemployment

Natural rate of unemployment (NRU) Natural rate of unemployment:

The average rate of unemployment around which the economy fluctuates (given labor market

imperfections impeding workers to find jobs)

How a recession affect the actual unemployment rate ?

How a boom affect the actual unemployment rate ?


Natural rate of unemployment (NRU) Natural rate of unemployment:

The average rate of unemployment around which the economy fluctuates (given labor market

imperfections impeding workers to find jobs)

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

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

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 20100

2

4

6

8

10

12

Actual and natural rates of unemployment, U.S., 1960-2010

Per

cent

of l

abor

forc

e Unemployment rate

Natural rate of unemployment


Job loss, Job Finding and NRU

• What determines the natural rate of unemployment ?

→ Model of labor-force dynamic

Notation:

L = workers in labor force

E = employed workers

U = unemployed workers

U/L = unemployment rate


Assumptions:

1. L is exogenously fixed.

2. During any given month,

s = rate of job separations, the fraction of employed workers that become separated from their jobs

f = rate of job finding, fraction of unemployed workers that find jobs

s and f are exogenous


The transitions between employment and unemployment

Employed Unemployed

s E

f U


Finding the “equilibrium” U rate

f U ( job finders) = s E (job losers)

= s (L – U )

= s L – s U

Solve for U/L:

(f + s) U = s L

so,

U s

L s f

• If the unemployment rate is neither rising nor falling


Example:

Each month, 1% of employed workers lose their jobs

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

(f = 0.19)

Find the natural rate of unemployment ?


Example:

Each month, 1% of employed workers lose their jobs

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

(f = 0.19)

Find the natural rate of unemployment:

0 010 05, or 5%

0 01 0 19

U sL s f

..

. .


Policy implication

From

We get

Question: What kind of policy can reduce the unemployment rate ?


Policy implication

A policy will reduce the natural rate of unemployment only:

if it lowers s : the rate of job separation

or if it increases f : the rate of job finding


Why is there unemployment in the first place ?

If job finding were instantaneous (f = 1), then the natural rate of unemployment would be near zero.

There are two reasons why f < 1: ??


Why is there unemployment in the first place ?

If job finding were instantaneous (f = 1), then the natural rate of unemployment would be near zero.

There are two reasons why f < 1:1. job search

2. wage rigidity


Job search & frictional unemployment frictional 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 is not

instantaneous flow of information about vacancies and job

candidates is imperfect


Sectoral shifts and unemployment (I)

The demand for goods and services vary over time…..

…. So How does it affect the labor market ?


Sectoral shifts and unemployment (I)

The demand for goods and services vary over time…..

…. So does the demand for labor that produces these goods


Def: 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

These scenarios result in frictional unemployment

Sectoral shifts and unemployment (II)

CASE STUDY: Structural change over the long run

4.2%

28.0%9.9%

57.9%

Agriculture

Manufacturing

Other industry

Services

1960

1.1%

13.9%8.5%

76.5%

2006


More examples of sectoral shifts

Industrial revolution (1800s): agriculture declines, manufacturing soars

Energy crisis (1970s): demand shifts from larger cars to smaller ones

In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.


Public policy and job search

Question:

What can governments do to tackle

frictional unemployment ?


Public policy and job search

Govt programs affecting unemployment include: Govt employment agencies

disseminate info about job openings to better match workers & jobs.

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


Case study Unemployment insurance (UI) UI pays part of a worker’s former wages for a

limited time after losing his/her job.

Studies: (Woodbury et al.(1987)):

- The longer a worker is eligible for UI, the longer the duration of the average spell of

unemployment

- The probability of a person finding a job more than double when its benefits run out

Why ??


UI increases unemployment because it reduces the opportunity cost of being unemployed the urgency of finding work

Case study Unemployment insurance (UI)


What are the Benefits of UI ?


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


Why is there unemployment?

Two reasons why f < 1:

1. job search

2. wage rigidity

U sL s f

The natural rate of unemployment:


Unemployment from real wage rigidity

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 eq’m 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 eq’m level, then there aren’t enough jobs to go around.


Reasons for wage rigidity

1. Minimum wage laws

2. Efficiency wages

3. Unions power


1. The minimum wage

The min. wage may exceed the equilibrium wage of unskilled workers, especially teenagers.

Studies (Brown (1988), Journal of Economic Perspective): a 10% increase in min. wage reduces teen employment by 1-3%

But !!! the min. wage cannot explain the majority of the natural rate of employment, as most workers’ wages are well above the min. wage

2–32

Effect of Minimum Wage


2. Efficiency wage theory

Theory in which higher wages increase worker productivity

Idea: A firm operates more efficiently if it pays its workers a high wage

“Efficiency wage theory”



Theory in which higher wages increase worker productivity

How ? By which mechanisms ?



Theory in which higher wages increase worker productivity by: attracting higher quality job applicants increasing worker effort, reducing “shirking” reducing turnover (workers leave because wages are

low), which is costly to firms improving health of workers

(in developing countries)

Firms are willing to pay aboveequilibrium wages to raise productivity

Structural unemployment !!


TREND: The natural rate rises over 1960-84, then falls over 1985-2005

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 20103

4

5

6

7

8

9

Per

cent

of l

abor

forc

e

EXPLAINING THE TREND:

The minimum wage

Dol

lars

per

hou

r

$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

minimum wage in 2009 dollars

The real minimum wage and natural u-rate have similar trends.

The real minimum wage and natural u-rate have similar trends.

EXPLAINING THE TREND: Sectoral shifts

1965 1970 1975 1980 1985 1990 1995 2000 2005 20100

20

40

60

80

100

120

140

1970-1986: volatile oil prices create jarring sectoral shifts1970-1986: volatile oil prices create jarring sectoral shifts

1986-2005: oil prices less volatile, so fewer sectoral shifts1986-2005: oil prices less volatile, so fewer sectoral shifts

Price per barrel of oil,

in 2009 dollars

EXPLAINING THE TREND:Union membership

Since early 1980s, the natural rate and union membership have both fallen.

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

Since early 1980s, the natural rate 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%

2008 12.3%

Unemployment in Europe, 1960-2009P

erce

nt o

f lab

or fo

rce

1970 1975 1980 1985 1990 1995 2000 2005 20100

2

4

6

8

10

12

FranceGermanyItalyUnited Kingdom


Why unemployment rose in Europe but not the U.S.Shock

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

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

Effect in Europe

Higher unemployment: Why ?


Why unemployment rose in Europe but not the U.S.Shock

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

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

Effect in EuropeHigher unemployment, due to generous govt benefits for unemployed workers and strong union presence and minimum wage laws (France)

Percent of workers covered by collective bargaining, selected countries

United States 18%

United Kingdom 47

Switzerland 53

Spain 68

Sweden 83

Germany 90

France 92

Austria 98



Case study

“Minimum wage: a poor way to reduce poverty”, Cato Institute

Documents

Unemployment