Understanding the Link Between Economic Recovery and Growing Unemployment

Understanding the Link Between Economic Recovery and Growing Unemployment

Table of Content

Task 1………………………………………………………………………………….2
a) A definition of unemployment.……………………………………………………2
b) An explanation of two faster growing sectors of the economy.…………………...4

Task 2………………………………………………………………………………….6
a) A definition of ‘full employment’…………………………..……………………..6
b) Three different ways of full employment & disadvantages of each…………..…..6

Task 3………………………………………………………………………………….8
a) The benefits of increasing the rate of unemployment benefit to the unemployed...8
b) The benefits of increasing the rate of unemployment benefit to the society………8

Task 4…………………………………………………………………...……………10
a) Whether the government should tackle the causes of unemployment…………...10
b) The causes of three different types of unemployment…………………………...10
c) Discuss a policy measure for each of these three types of unemployment………11

Task 5………………………………………………………………………………...13
a) An explanation of supply-side economics………………...……………………...13
b) The remedies to reduce unemployment.………………………………………….14
c) Evidence and effects of using supply-side measures to reduce unemployment…14


Task 1
a) A definition of unemployment
What is Unemployment?
In economics, if a person has ability and he is willing to work, but currently, he has not got any jobs; his situation is therefore seemed as to be unemployed. Unemployment is economic phenomena that people with employability and employment requirements, but without job opportunities (Wikipedia, 2010). A person without employability, he does not have the problems of employment. A person with employability, but he is not willing to work, such kind of person is not called to be employed. However, different countries have different laws to define unemployment, for example, in USA, people who are over 16 years old without any formal jobs, or are looking for a job, then, they are unemployed people (U.S. Bureau of Labor Statistics, 2009). It is always using the unemployment rate to measure the unemployment level of a country.

Types of Unemployment
Basically, there are two kinds of unemployment: voluntary unemployment and involuntary unemployment, which is classified by whether the person is willing to be unemployed. Voluntary unemployment is the workers require the real wage more than their marginal productivity. They are not satisfied with the current working condition and income levels, and it is therefore they are choose to leave the current job, either not to produce output anymore or look for a job with better income. Voluntary unemployment refers to self-decisions. It is cannot eliminated by any economic instruments and policies. Thus, voluntary unemployment is not in the scope of economics study. Involuntary unemployment, which is those people with employability and are willing to accept the current income level, but they cannot find a job. There are lots of objective reasons may lead involuntary unemployment. Such kind of unemployment can be eliminated by economic instruments and policies (Murad, 1964).

In order to distinguish different types of unemployment, economists have classified unemployment into four types, which including frictional unemployment, structural employment, cyclical unemployment, seasonal unemployment and classic unemployment. Among them, the first three types of unemployment are quite typical.

Frictional unemployment, which unemployment is caused by people moving between jobs, and then, result in short-term, local unemployment. It is always transitional with a short term. Frictional unemployment is normally derived from the labour supply side, therefore, it is seen as job-seeker unemployment, which vacancies exist on the one hand, on the other hand, there is the corresponding number of unemployed looking for jobs. This is because the labour market information is incomplete. Both firms and unemployed have to take some time to find suitable employees and jobs. Frictional unemployment therefore exists all the time. It will increase as the economic structure changes. From the economic and social development point of views, frictional unemployment is normal phenomena. Hence, frictional unemployment is normally seemed as voluntary unemployment. However, there is a controversy that some economists suggest frictional unemployment is a classical form of involuntary unemployment: “Lucas contradicts both Keynes and Pigou in asserting that they are always immediate vacancies for unskilled labour, and abstracts from the very problem that Keynes seeks to address.” (Hayes, 2005)

Structural unemployment is caused by the labour supply and demand mismatch, which characterised by both unemployed and job vacancies. Job vacancies cannot be filled by either unemployed do not have suitable skills or residential place. Structural unemployment is always in a long term. It is derived from the demand of labour. Structural unemployment is caused by economic change, these economic changes will lead the demand of the specific labour force in specific markets or regions lower than the supply. Three reasons might be result in such a problem: firstly, the change of technology. The original workers find it is hard to meet the new technology requirement or the improved technology result the demand of the labour force decreasing. Secondly, the change of consumer preferences. The consumer preferences have been changed, which result some industries have to expand while some industries have to shrink. Thus, those people who work in shrinking industries might be unemployed. Finally, the labour force does not flow. The flow cost restricts unemployed flow from one place or industry into another place or industry. Therefore, same as frictional unemployment, structural unemployment always exists (Griffiths, 2007).

Cyclical unemployment is caused by the decline of aggregate demand in recession or depression of the economic cycle. When the economy is in a cycle of recession, the industry will shrink because of the lack of aggregate demand. It is therefore lead widespread unemployment. In general rule, when income is decreasing, cyclical unemployment will be more serious in those industries that the product demands dramatically decrease (Layard, 2005).

b) Explain why TWO sectors of the economy are growing faster than other sectors
Table 1 The Summarised data of the Second Economic Census
(billion) Increasing rate
(%) Enterprises
Increasing rate (%) Employees
(10,000) Increasing rate (%)
Industry 53,562.94 145.2 1,903,000 31.2 117.383 21.7
Construction 59,717.90 ------- 227,000 ------- 39.011 -------
Transport, Storage and Post
74,807.04 109.2 148,289 102.7 1,020.200 34.1
Wholesale and Retail Trade 247,482.6 123.1 1,403,000 58.8 1,891.2 36.4
Hotel and Catering Services 6146.9 102.2 145,000 56.3 585.2 36.4
Real Estate 30,586.5 107.5 214,397 66.1 552.2 39.6
Other Sectors in Tertiary Industry 121,696.6 ------- 2,975,000 23.9 7,272.9 0.24
Source: National Bureau of Statistics of China, 2009a,b,c

Table 1 above has summarised the information from the second economic census of China in 2008. According to the table, there were two sectors grew fast, which were industry and wholesale and retail trade. Compare with the first economic census of China in 2004, their revenue had increased 145.2% and 123.1% respectively. According to table 1, both wholesale and retail trade, hotel and catering services, real estate are the types of jobs that are required, especially real estate; compare to 2004, its employees quantity had increased 39.6%.

There are lots of reasons for industry and wholesale and retail trade growing fastest. First, within the economy increasing, both of the numbers of the labour force and enterprises in the two sectors were increased. Then, according to the report of statistical communiqué of the people's republic of china on the 2008 national economic and social development, in 2008, the investment in primary industry, the secondary industry and the tertiary industry were up by 54.5%, 28.0% and 24.1% to 2007 respectively. Among them, the fixed assets investment in urban areas of wholesale and retail trade had increased 29.2%, while the foreign direct investment in this sector had increased 65.6% (National Bureau of Statistics of China, 2009d). National Bureau of Statistics of China (2008) show the average wage of staff and workers by sector and region, within the report, the most increased sector was wholesale and retail trade. In 2003, the average wage in this sector was 10,939RMB per a year, however, in 2007, the average wage was increased to 20,888 RMB per a year, which had increased 90.9%. There still has one reason for industry growing fastest. Within the better technologies, the working efficiency has improved, thus, result in improve the productivity. Therefore, both investment amount, labour force and the productivity have been improved, which make industry and wholesale and retail trade growing fastest.

Task 2
a) A definition of ‘full employment’
Theoretically, full employment can be seen as a state in which the quantity of labour demanded equals to the quantity of labour supplied (Sloman, 2003). However, there is no formal definition of full employment. Neoclassical economists consider the ‘full employment’ is a rate to some extent less than 100% employment. They find that there are always some people who are unemployed for a period of time if they move from one job to another. But they emphasize that people can have a job if they want to. So full employment can occur when there is no cyclical unemployment and the only unemployment is frictional and structural (Volpe, 2006). In other words, even at a full employment, there is always some frictional and structural unemployment, so that there is always some unemployment. From this perspective, an economy with full employment can be considered as an economy in which employment is as high as it can be, without labour shortages appearing that lead to rising wages and hence prices (Crooks, 1999).

b) Explain three different ways that full employment can occur and identify any disadvantage of each
As discussed above, there are three different ways that full employment can occur. First, full employment can occur when there is no cyclical unemployment. Cyclical unemployment is often associated with economic recessions and with a fall in aggregate demand in an economy (Volpe, 2006). There is no cyclical unemployment of an economy to some extent implies there is no economic recession and the aggregate demand within this economy does not fall. However, it is impossible to achieve this situation in the long run. For example, if the economy moves into recession and that consumer demand falls, firms find that they are unable to sell their current level of output, so that they have to start to cut back on production and cut back on the amount of labour they employ. If firms do not do something like this, they would suffer increasing costs of production, which may even cause a bankruptcy soon. As more firms become to close down, the economy as a whole would enter a worse recession.

Second, full employment can occur when the unemployment is frictional. This type of unemployment occurs when people leave their jobs from one to another, either voluntarily or involuntarily. So those people are unemployed for a period of time when they are seeking for a new job (Volpe, 2006). Under this condition, full employment can be achieved but it to some extent reflects a situation that there is imperfect information in the labour market and workers have to spend some times to find a new job. In other words, the more the information is imperfect, the more the time those workers have to spend on seeking jobs. In the long-run, the whole labour market may not work efficiently because firms may not find proper employees on time and this may further results in a delay in the production process. In contrast, if workers are not informed perfectly, the new jobs may not satisfy their willingness, which may make them to change jobs in the future. So a bad cycle may form, which is neither good for the firms nor the workers.

Third, full employment can occur when the unemployment is structural. This type of unemployment is caused by changes in the structure of the economy. Employment in some industries may expand while in others it contracts (Volpe, 2006). If an economy always experiences the structural changes, it may cause an unstable of the society and induce many other unpredicted problems.

Task 3
a) The benefits of increasing the rate of unemployment benefit to the unemployed
The unemployed can benefit a lot if the rate of unemployment benefit is increasing. First of all, it helps the unemployed to ease their pressure. The unemployment benefit provides a living guarantee for the unemployed. Thus, the unemployed do not have to worry about the basic live expenses.

Then, after increasing the rate of unemployment benefit, more public facilities might be constructed for the unemployed, for example, relief station and job hunting training. The government may cost money to hire some people to train the unemployed jobs hunting skills. Even provide them some professional skills courses for them to gain a skill, and then try to find a job.

b) The benefits of increasing the rate of unemployment benefit to the society
There are lots of benefits to the society if increasing unemployment rate:
First, it helps to ease employment pressure. For example, if there has 5 million unemployed and the unemployment rate has increased to help them, which means there might have 5 million people less than before looking for jobs. The labour market suddenly change into a buyer from a seller, which can help to alleviate lots of social problems, for instance, in China, it is very difficult for graduates to find a suitable job; arrears of wages; low salary for workers and so on. After the labour market changes, the intense of the social competition will be alleviated. Graduates will find much easier to get a suitable job; arrears of wages will be eliminated and salary will be increasing. The value added product will be increased, because the labour cost is increased. Then, it promotes industry upgrading. The export cost will be increased as artificial wage is increased. It is therefore less competitive, which might result in a trade surplus decrease (Du, 2006).

Then, increasing unemployment rate helps to reduce crime. Imagine, 50 million people have been relief, which means it helps to reduce 50 million potential criminals. Social security will be greatly improved. Thus, the government can dramatically reduce relative expenses.

Third, after the labour market changes into a buyer from a seller, within unemployment benefit, people do not have to worry about the life without income. China is a country that always with high national saving rate. If people have living guarantee, high national saving rate will be decreased. The domestic demand is therefore can be increased, which can promote economy growth.

Finally, from the political point of view, increasing the rate of unemployment benefit helps the government to get the good reputation. It also helps to make the society more stable. As a result, promote to establish reliability between the government and its people.

Task 4
a) Explain whether the government should tackle the causes or the symptoms of unemployment
Actually, most of governments want to find a way to reduce the unemployment. However, economists find that sometimes government intervention to some extent makes the situation worse, which asks the government to find another way to fix the new problem that it created. For example, if the government creates a policy to ask firms to employ more graduates (in which firms may not afford), it will affect firms’ normal expansion that may create more jobs. As the result, this shortage in jobs supply leads to more unemployment and probably results in a chronic unemployment and poverty. From this perspective, over-regulation is seen as an important cause for unemployment (David, 2009). Government intervention seems to create more problems. So government should not tackle the causes of unemployment and stay out of the economy.

b) Explain the causes of three different types of unemployment
Cyclical unemployment is caused by a fall in aggregate demand with no corresponding fall in the real wage rate (Sloman, 2003). Because of the economic recession, the falls of consumer demand make the firms to cut back on production as well as the amount of employees. So the deeper the recession becomes and the longer it lasts, the higher will demand-deficient unemployment become. But as the economy recovers and begins to grow again, demand-deficient unemployment will start to fall again.

Frictional unemployment is mainly caused by the imperfect information in the labour market, which often asks workers to takes time to find jobs (Sloman, 2003).

Structural unemployment is caused by two main factors: the first one is the change in pattern of demand. Some industries experience declining demand that can be due to a change in consumer tastes or international competition. Certain domestic goods may go out of fashion or become no longer competitive compared to foreign goods. The second one is the change in methods of production. For example, an introduction of new techniques of production often allows the same level of output to be produced with fewer workers, which is known as a ‘labour-saving technical progress’. Unless output expands sufficiently to ask firms to absorb more labours, people will be made redundant (Volpe, 2006).

c) A policy measure for each of these three types of unemployment
Figure 4.1

Source: Sloman, 2003
If the government wants to decrease unemployment, it may apply expansionary policy. Due to money illusion, in the short run people take new jobs because of the higher wages attraction, but they do not recognize that real wages do not rise due to the inflation. Unemployment falls from U1 to U2, moving from point A to point B (see figure 4.1 ). Aggregate demand will rise, causing a rise in consumption and hence wages. Prices will also increase, causing rising inflation from P1 to P2. As inflation continues to rise, people start to expect inflation in subsequent years, based on past experience . In the long run money illusion disappears and unemployment falls back to its original level. The Phillips curve shifts upwards, moving the point of equilibrium from B to C. Thus the reduction in unemployment will be temporary, and lead to higher inflation in the long run .

Indeed, in the short-run policymakers always face a tradeoff between inflation rate and unemployment rate.If governments seek to reduce inflation, they are used to allow unemployment to rise by pursuing deflationary monetary policy. However, due to adaptive expectations, inflation will continue to rise for a while. Thus both unemployment and inflation rise. The stagflation occurs. On the other side, frictional unemployment may increase due to imperfect information in the labour market, causing increasing unemployment in times of inflation (Sloman, 2003).

Task 5
a) An explanation of supply-side economics
The term of ‘supply-side economics’ refers to a macroeconomic study, arguing that economic growth can be created by lowering barriers for people to produce (supply) goods and services and by allowing greater flexibility by reducing regulation. The typical policies of supply-side economics often associate with lower marginal tax rates (Wanniski, 1978), as supply-side economists believe high marginal tax rates strongly discourage income, output, and the efficiency of resource use (Gwartney, 2003).

Indeed, the UK government has used various supply side policies in order to reduce unemployment. For example, the Conservative government abolished minimum wages in 1993 to price unemployed workers back to work. The reason of why they do like this can be simply explained as follows. In figure 5.1, the equilibrium quantity of workers q* is employed at the equilibrium wage w* in a perfectly competitive labour market. If a minimum wage Wm is set above W* firms will reduce labour in terms of hours or workers. Workers that would be willing to work for the minimum wage but cannot get a job will be involuntary unemployed. A surplus of labour is created (Hardwick, 1999).

Figure 5.1

Source: Hardwick, 1999, p.344

If the cost of labours becomes relatively higher than that of capitals, firms will economize on labour and substitute machines for labour. Thus, the initial willingness of introducing a minimum wage to improve the situation of low- or semi-skilled workers with low wage might fail. On the other side, as discussed in Task 4, the effect of minimum wages may lead to inflation in the economy

b) The remedies that the supply side economists put forward to reduce unemployment
The remedies that the supply side economists put forward to reduce unemployment include removing the minimum wage, reducing powers of trade union enhancing the education and training within the society in order to make workers to be more attractive to employers, and reforming for a long-term growth of the economy (Volpe, 2006; Economics Blog, 2008). For example, governments may cut taxes on businesses and reduce regulation, which may provide a more flexible condition for firms to expand, and then more jobs will be created with the business expansion. The more workers are employed the more income they earned. Consumer demand would be increased again, which allow the firms to raise production again. This increased supply of goods and services ask firms to employ more labours. Hence, a good cycle would be formed and unemployment is reduced.

c) Evidence of governments who have used supply-side measures to reduce unemployment and a discussion of what effects those measures have had
However, there is little evidence that minimum wages produce an adverse effect on employment in reality. A study by Card and Krueger (1994) concluded that the increase in the minimum wage in New Jersey (from $4.25 to $5.05 in 1992) did not reduce employment in the state. In the UK, the unemployment situation has improved considerably since the new Labour government has introduced the National Minimum Wage (NMW) to the country in April 1999. The unemployment rate was reduced from 6.1% in April 1999 to 4.8% December 2003 (UK Statistics Authority, 2004). From this perspective, the NMW seems to have no adverse effects on employment in the UK.

In contrast, a study by Machin and Manning (1997) shows that the increase in minimum wages results in an increase in employment based on an analysis of the minimum wages and employment in France from the late 1960s to the mid 1980s. They also find that changes in minimum wage in the Netherlands did not bring the changes in employment structure and there is a ‘weak negative effect’ of minimum wage on employment in Spain (Machin & Manning, 1997).Therefore, it may conclude that an economy reacts towards a minimum wage can vary between countries and sectors.


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