ECON 390 – Labor Economics

Employment and Unemployment

(sources:  various, Bartlett, Clarkson and Meiners, Phillips, Friedman, Keynes, Hayek, Krugman, Mankiw, common knowledge)

Measuring Unemployment

One of the most closely watched economic measures of the economy, even more than GDP, is unemployment. We all recognize how unemployment can affect each of us. And yet what does unemployment measure? How can the number of people employed increase and yet unemployment increases?

Measuring employment begins with the population. Since children don't officially work we eliminate everyone under 16 and base employment measures on the working age (WA) population.

A portion of the working age population chooses to not participate in the labor force or market. These include students, retirees, those ill and infirm, and others "of choice" which often includes a parent of young children. Those that choose to participate in the labor force: "People who are 16 year of age or older who have or are actively seeking a job." The percentage of the working age population who are in the labor force (LF) is called the participation rate.
 
 

That "actively seeking" means a person is

(1)

(2)

(3)

Each state can define what seeking means but someone who hasn't found a job in four weeks is not included in the labor force and, further, is defined as a discouraged worker. At one time someone had 270 days to find a job before becoming a discouraged worker.

The exact nature of the labor force can be differently defined as follows:

·                     Non-institutional LF: excludes those who are in jail or a mental hospital

·                     Civilian LF: excludes those in the military

·                     Non-agricultural LF: excludes farm workers, especially the migrant

workers who may be employed and unemployed several times throughout a year

The standard measure of the labor force is the civilian, non institutionalized LF.

The labor force is either employed or unemployed. Unemployment is usually stated as the percent of the labor force unemployed.

So, how can the number employed and the unemployment rate both increase? The labor force grew, some people becoming employed and some not. Knowing the unemployment rate, by itself, does not give you enough information to judge the labor market.

There are two times of year the labor force swells with related shrinkage following: summer and Christmas. The labor department applies a formula to adjust for these changes. Data which has been adjusted is designated sa or (sa), known as seasonally adjusted.

A Simple Example:

20 people  (including Deb) = relevant population (16 and over, civilian, non-institutionalized)

Leah - LF - E

Jonathan - LF - E

Milton - LF - E

Austin - NLF

Bo - NLF

Michael - NLF

Cody - - LF - U

Kayla – LF - U

Sean – LF - E

Adam - NLF

Levi - NLF

Paul - NLF

Travis – LF - E

Phil – LF - E

Ryan – LF - U

Joe – LF - E

Kelly - NLF

Joanne - NLF

Thomas - NLF

Deb – LF - E

Civilian Labor Force = 12

            Participation Rate = 60% (12/20)

Employed = 9

            Employment to population ratio = 45% (9/20)

Unemployed = 3

            Unemployment rate = 25% (3/12)

Not in the Labor Force = 8

Now:

 Let’s say that Bo enters the labor force but Travis leaves it.  Note that this does not change the labor force participation number or rate – but if Bo enters as unemployed, then both the employment to population ratio and the unemployment rates will change.

Now:

Employed = 8

            Ratio = 40%

Unemployed = 4

            Rate = 33.33%

If Bo enters as employed though, nothing changes.

Now:

New people enter the class:  Ruby, Sam, Max and Jerry enter the relevant population.  If they all enter as not in the labor force – then this will change the employment population ratio (using the initial numbers)

Employed = 9

            Employment to population ratio = 37.5% (9/24)

Will it change the labor force participation rate?  Yes

            50% (12/24)

Will it change the unemployment rate?  No, because it doesn’t change the number in the labor force.

Now:

If all new people enter as employed – what will that change?

Employed = 13

            Employment to population ratio = 54.2% (13/24)

Unemployed = 3

            Rate =  18.7% (3/16)

Now:

If 2 of the 4 new people enter as employed and the other two enter as unemployed – what will that change?

Employed = 11

            Employment to population ratio = 45.8% (11/24)

Unemployed = 5

            Rate =  31.2% (5/16)

NOTE:  Both employment and the unemployment rate went up at the same time (compared to our original numbers).

Bartlett:  There are actually two ways the BLS measures unemployment:

1)     Household survey – per month, official unemployment rate.

2)     Payroll survey – per month, employment records of domestic businesses – missed business start-ups (causing it to understate employment growth).  Revised data catches the new start-ups – so is much more accurate.

Growing divergence between the two surveys – careful to watch which statistics are being used in news articles, etc.  Household data will not always coincide with payroll data.

Major reasons:

1) 

2) 

But these can’t account for all differences.

Empirical Data:

Let’s look at some BLS numbers:  BLS - http://www.bls.gov/home.htm

Use and Critique of the Unemployment Rate:

1.  Social welfare measure -- performance measure.

2.  Available, but unutilized manpower -- cyclical measure.

Closely Related to Unemployment is Under-employment:

1.  Part-time workers who want to work full-time.

2.  People working full-time who do not make full use of their skills, training, experience, etc.

3.  People who don't have proper tools and equipment to achieve maximum efficiency.

Hidden unemployment:

Institutionalist view:  the problem of unemployment is a lot worse than it is ...  there are a number of people affected:  groups

1.  Active unemployed (measured)

2.  Partially unemployed (people working part-time, but want full-time).

3.  Discouraged workers -- (people who want a job, but don't look because of doubts they will find one.)

4.  Missing unemployed -- (people who live in isolated areas or have no fixed address.)

5.  People who are underemployed.

   1.  Part-time

   2.  Not using skills

   3.  Don't have necessary tools, etc.

Therefore:

There is significant hidden unemployment.

Choice Model View:  Would say that, on the other hand, unemployment is often overstated:

“Overstating unemployment” (Clarkson and Meiners)

1.  Underground economy

2.  Part-time counted as full-time (those looking for part-time)

3.  Use of 16 and 17 year olds

4.  Interview bias

5.  Requiring welfare benefits to register

6.  Pay people to remain unemployed

   (unemployment compensation)

7.  Added worker hypothesis

What is Meant by Full Employment?

Full employment is not attainable -- always have frictional or structural unemployment.

Frictional unemployment:

Structural unemployment:

Have bottlenecks at any point in time.

Natural Rate of Unemployment (best we can do at any given time) - Debate now is usually between 4-5% unemployment seen as full employment.

Qualify it by duration -- since we are always going to have some unemployment.

Most labor economists agree that frictional unemployment usually counts for 50% of unemployment.

Can also look at the unemployed by family status.

Large number of unemployed are married women and teenagers.  (Many are also looking for part-time work.)

Can also look at the unemployed by age.  Teenagers have always had high rate and so have those age 65 and over who are in the labor force.

Unemployment as a Labor Surplus

Intuitively, we often think of "unemployment" as a situation where people who are willing and able to work are somehow denied the chance to do so.

At the market clearing wage, there are neither labor shortages nor surpluses; unemployment is voluntary (not in the sense that it is cause for celebration, but in the sense that people do not want to work more at the market wage for jobs they are able to do).

Graph:

Analogy: Voluntary datelessness.  Not willing to date at the going rate - people who you are able to date!

So how is involuntary unemployment possible?  Only if the prevailing wage is too high! 

Graph:

This is no different from any other surplus good.  "Surplus" means "surplus at the current price."

More generally, there are only three possibilities:

1)     Market wage=market clearing wage; the labor market clears.

2)     Market wage<market clearing wage; there is a labor shortage.

3)     Market wage>market clearing wage; there is a labor surplus.

Note: there is no case where workers are both "under worked" and "underpaid."  If they are under worked, they are overpaid; if they are underpaid, they are overworked.

This simple application of S&D runs contrary to almost all popular beliefs about labor.  But most economists think it is reality – at least to a large degree.

The general solution to all involuntary unemployment boils down to: reduce the market wage until the surplus disappears.

Does reducing wages "reduce demand"?  Of course not.  Lower wages may mean less income for employees, but also means more income for employers.

Unemployment on the Free Market: Wage Fairness and Unionization

Famous Disagreement:  Classical economists (Smith, Ricardo, Say, etc.) vs Keynes

Classical economists (and neoclassical) assumed that unregulated markets clear.  Could this assumption be wrong in labor markets?

Keynes said that market institutions (including especially unions) will keep wages from falling, and therefore, markets from clearing.  Wages can be rigid.

Let’s look at some cases:

1.  Wage fairness.  There is good evidence that workers regard wage cuts as "unfair." 

Review: real versus nominal wages.

Perceived unfairness hurts morale, which typically leads to lower productivity. 

So employers are reluctant to cut wages when labor demand decreases or labor supply increases.

Graph:

The result: if market clearing wage is below prevailing wage, jobs will be "rationed."  Qualified, willing labor remains unsold because workers are overpaid.

Interesting: employees seem to resist nominal wage cuts much more fiercely than real wage cuts.  Nominal wage cuts hardly ever happen; real wage cuts are far more common.

How serious would the problem of surplus labor be under laissez-faire (completely free labor markets)?  It would definitely exist – especially in shorter time frames, but the historical record suggests that it would be fairly mild. 

Case 2:  Unionization.  Unions are basically labor cartels; their goal is to push wages up by restricting competition between workers.  Unions are "price-fixers."

(We will discuss unions in detail later)

The natural side effect is to create labor surpluses (due to higher wages).  Ideally (from the union's point of view), the surplus workers won't belong to the union anyway, so none of the members suffer.  In practice, though, the unemployment often spills over onto union members.

In economic terms, what are "scabs"?  They are workers who undersell the cartel.  If enough scabs exist, unions have little success.

Assuming the government prevents violence and threats of violence, it is difficult - though not impossible - for unions to keep wages up.  They succeed best when:

• Labor demand and labor supply are highly inelastic.  A change in wage does not bring a lot of change in demand or supply of labor.  Small, highly skilled craftsmen are a good example.
• The social stigma of "being a scab" is very high.

Under laissez-faire, involuntary unemployment created by unions would again exist, but not much of it.  As long as employers can legally hire non-union workers, and non-union workers feel physically safe to accept such offers, market forces sharply check the power of unions.

Unemployment on the Free Market: Corrective Government Policy

Is there anything government could do about the preceding problems?  In principle, yes.

• For real wage rigidity, intervention could help by pushing wages down.  If workers blame the government instead of the employer, presumably they don't blame the employer for being "unfair."

• For nominal rigidity, the government has an easier solution: print more money to raise the price level until the nominal wage clears the market.  If workers are clueless, they may never "see what hit them."

            Even though most governments deliberately try to push wages up, at the         same time many also try to erode real wages by inflating.  (Whether they    think of it in these terms is another matter).

• Similarly, unions might be banned, much as other cartels are illegal under the antitrust laws.

Unemployment – The Macro Theories

Theories regarding unemployment (causes and cures) can be separated into two basic camps (with some offshoots of those camps):

1. Longer-term unemployment is caused by a lack of job growth.  To “cure” unemployment and increase real wages – need to increase productivity because:

1. increases in productivity is what creates real job growth,
2. increases in productivity through technology (physical capital) will make workers (human capital) more productive – increasing their marginal physical product – thereby increasing their wage (most of the time – remember the price elasticity of demand matters here),
3. Increases in productivity will lead to a decrease in prices for goods and services – thereby increasing real wages.

This view believes in Say’s Law – that productivity leads to a “better economy” – job growth, low unemployment, more wealth, etc.

Hayek - real cause of unemployment (and measurement issues):

2. Unemployment is caused by a lack of aggregate demand in the economy.  To “cure” unemployment (at least) – need more spending in the economy because:

1. increases in spending will lead to an increase in revenue for firms, allowing them to hire more workers,
2. increases in spending will lead to more production of goods, increasing job growth.

This view believes that an economy is driven by aggregate demand.

Krugman on jobs:

Historical Perspective:

Classical Model:  labor markets clear, etc.  As long as government stays out of markets – unemployment will not be a problem (in the long term).

J. M. Keynes:  labor markets don’t always clear.  Unemployment a major issue – prolonged (and high rates of) unemployment observed. 

            Keynesian response:  decrease unemployment by increasing aggregate demand = C (consumption) + I  (Investment) + G (government spending)

• (1930s)  Pull up G, hold taxes constant – deficit spend in order to increase aggregate demand (increasing taxes would decrease C – therefore, pass taxes to next generation).  Roosevelt’s “New Deal”

• (1950s)  A. W. H. Phillips documents negative relationship between the inflation rate and the unemployment rate in the U.K from 1861 to 1957.  Phillip’s Curve Trade-Off – increase inflation, increase revenue for firms (assuming nominal wages constant), firms hire more workers, unemployment falls with higher rates of inflation – or lower real wages.  Short-term solution.

• (1970s)  Milton Friedman and others critique the Phillip’s Curve Trade-Off policy.  Long run outcome – with adaptive expectations – is hyper-inflation and same rate of unemployment.  The 1970s – stagflation (U and inflation increasing at the same time – no      trade-off).

• (1930s – 1980s)  F. A. Hayek explains the higher rates of unemployment (not simply returning to the same long term rate).  Inflation creates all sorts of distortions in markets – distorts interest rates (are lower real interest rates due to an increase savings by the public or an increase in the money supply by the government?), distorts relative prices and wages – which leads to a misallocation in resources – resources used unproductively – creating periods of “retooling” and high unemployment.

• (Now)  The debate continues in macroeconomics.  The label New Keynesian describes those economists who, in the eighties, responded to a new classical critique with adjustments to the original Keynesian ideas.

• The "Stimulus Package" plus TARP (troubled assets relief program) are a combination of fiscal and monetary policy.  Keynesian "stimulus" has been reborn - but not without its critics.  What happens economically will be interesting - and where it will take us in the world of ideas - who knows?

Primary Disagreement in the literature (text books, etc.):  how quickly wages and prices adjust

    New Classical –markets (including labor) clear because wages and prices are flexible.

    New Keynesians –market clearing prices (and wages) cannot explain short run fluctuations.

Sticky Wages and Prices lead to Involuntary Unemployment and we need monetary policy to influence economic activity.

Monetary Policy:

Long tradition (both New Keynesians and Monetarists) is that monetary policy affects employment and production in the short run because input prices and wages respond sluggishly to changes in the money supply (Phillip’s Curve trade-off).

If the money supply falls, people spend less, and the demand for good falls.  Because (input) prices and wages are inflexible and don’t fall immediately, the decreased spending causes a drop in production and layoffs of workers.

And vice versa.

New Classical criticized this tradition because it lacked a coherent theoretical explanation for the sluggish behavior of input prices and wages.

So the New Keynesians set out to explain (with respect to sticky wages):

Efficiency Wages:

Normally, an excess supply of labor would lead to cut in wages, thereby increasing the quantity of labor demanded and reducing unemployment.

Graph:

According to the New Keynesians, market clearing mechanisms might fail.

High wages make workers more productive – so firms don’t want to cut wages even with an excess supply of labor.  The firm is afraid it will lose productivity.  It will then pay above market wages (an extension of the "fairness" wage theory).

So the lower productivity would be greater than the savings on the wage bill.

Efficiency wage theory and productivity - Why do higher wages increase productivity?

1.

2.

3.

Policy Implications:

At the broadest level new Keynesian economics suggests that recessions do not represent the efficient functioning of markets.

Markets fail according to the New Keynesians.  Thus, new Keynesian economics provides a rationale for government intervention in the economy, such as countercyclical monetary policy or fiscal policy or BOTH (as we see today).

Fiscal Policy:

Whether the government should intervene in practice, however, is a more difficult question that entails various political as well as economic judgments. 

Again - does spending or productivity create jobs and reduce unemployment? 

Is a recession a market failure or the market correcting bad government policies?

Fiscal policy, depending upon what it is, could be used by both theories (tax cuts on capital - increase productivity or tax cuts on households - esp. lower income - will increase spending).  Government spending is usually only used by those who think demand increases jobs -- although some might see government spending on infrastructure and/or education as productive spending.