Unemployment and Its Natural Rate: consideration of the Labor Market 28 Unemployment and Its Natural Rate: consideration of the Labor Market

Objectives a. Calculate unemployment rate b. Calculate Labor Force participation rate c. Explain limitations of the unemployment rate as an economic statistic of interest (issue of precision) d. Explain the concept of a “full-employment” rate of unemployment (natural rate of unemployment) e. Distinguish between types of unemployment f. Explain public policy and institutional considerations in analysis of unemployment g. Discuss the competing theories of unemployment

Not all unemployment is the same Mankiw Text: Natural Rate of Unemployment Cyclical unemployment Types of unemployment (historically understood): a. Cyclical – correlated with the boom/bust cycle b. Frictional – ever present in a market economy c. Structural – the demand for types of labor changes *seasonal

UNEMPLOYMENT Data Describing Unemployment Three Basic Questions: a. How does government measure the economy’s rate of unemployment? b. What problems arise in interpreting the unemployment data? c. How long are the unemployed typically without work?

Question a: How Is Unemployment Measured? Unemployment is measured by the Bureau of Labor Statistics (BLS). It surveys 60,000 randomly selected households every month. The survey is called the Current Population Survey.

Unemployment Measurement? Based on the answers to the survey questions, the BLS places each adult into one of three categories: 1. Employed 2. Unemployed 3. Not in the labor force * If in Labor Force then either employed or unemployed…

How Is Unemployment Measured? Categories for each survey respondent: A person is considered employed if he or she has spent most of the previous week working at a paid job. A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job. A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force.

Unemployment: Measurement? Population: Adult population, 16 years and older, are either in the labor force or not in the labor force a. Not in labor force – Currently not working and not seeking work; homemaker, full-time student, retiree b. Labor Force: The labor force is the total number of workers. The BLS defines the labor force as the sum of the employed and the unemployed. Employed Unemployed but looking

Unemployment: Measurement? The unemployment rate is calculated as the percentage of the labor force that is unemployed (note: calculation involves only those in labor force… if one is not “looking” then not in the Labor Force)

Figure 1 The Breakdown of the Population in 2001 Adult Population (211.9 million) Employed (135.1 million) Labor Force (141.8 million) Unemployed (6.7 million) Not in labor force (70.1 million) Copyright©2003 Southwestern/Thomson Learning

Unemployment Rate from Data in Previous Slide (6.7 million / 141.8 million) Mk note: On ensuing slide correlate real GDP with unemployment… and changes in price levels…

Figure 2 Unemployment Rate Since 1960 Percent of Labor Force 10 Unemployment rate 8 6 Natural rate of unemployment 4 2 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Copyright©2003 Southwestern/Thomson Learning

Does the Unemployment Rate Measure What We Want It To Does the Unemployment Rate Measure What We Want It To? (a matter of precision) * At times it is difficult to distinguish between a person who is unemployed and a person who is not in the labor force. Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics - unemployment rate tends to understate the level of true unemployment ((unemployed + discouraged workers) > unemployed) Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t looking for work (this phenomenon would tend to overstate the rate of unemployment).

Compare Suppose someone goes from being unemployed (and therefore “looking” to being “discouraged” and out of the labor force): 6/100 > 5/99 (6/100) = 0.06 = 6% (5/99) = 0.0505 = 5% When unemployed stop “looking” the unemployment numbers improve… The labor market is dynamic not static therefore difficult to measure at a given point in time.

Another Labor Statistic: Labor Force Participation Rates The labor-force participation rate is the percentage of the adult population that is in the labor force.

Figure 3 Labor Force Participation Rates for Men and Women Since 1950 Rate (in percent) 100 Men 80 60 40 Women 20 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Copyright©2003 Southwestern/Thomson Learning

Table 1 The Labor-Market Experiences of Various Demographic Groups Copyright©2004 South-Western

“Full-Employment” Rate of Unemployment? Natural Rate of Unemployment (full-employment rate) - “full-employment does not equal a zero rate of unemployment, rather a “sustainable” rate In a market economy – with mobility of labor – there will be, at any given time, some percentage of people who are not working, but are seeking work… business failures, voluntary separations, career changes etc It is the amount of unemployment that the economy normally experiences (between 4% – 6%) * 5.5 % in the previous slide

Cycles of unemployment: The actual rate of unemployment at any given time can be > or < the natural or “full-employment” rate. This depends, primarily, on whether GDP is growing or contracting. GDP growing? Implies strong demand for labor, thus low rate of unemployment. Cyclical Unemployment Cyclical unemployment refers to the year-to-year (quarter to quarter) fluctuations in unemployment around its natural rate (unemployment increases when GDP contracts)

How Long Are the Unemployed without Work? Most spells of unemployment are short. Most unemployment observed at any given time is long-term. In other words, most of the economy’s unemployment problem is attributable to relatively few workers who are jobless for long periods of time.

Frictional vs. Structural Unemployment Frictional unemployment – qualified job seekers and firms demanding labor are not matched instantaneously (friction in labor markets) - Tends to be short term, discuss impact of communication revolution Structural unemployment – skills of workers not demanded due to changing consumption or production patterns, due to changes in technology, and institutional impediments - Tends to be a long term

Theories of Unemployment: Classical theory vs. Keynesian theory Classical: wages (and prices) flexible and rapid adjustments in (labor) markets. Therefore, all unemployment is voluntary (see graph) Keynesian: Wages are “sticky”, or slow to adjust, especially downward, therefore unemployment results (see graph) Most disagreements between Keynesians and Classical school turn on “efficiency of markets”

JOB SEARCH Job search the process by which workers find appropriate jobs given their tastes and skills. results from the fact that it takes time for qualified individuals to be matched with appropriate jobs – “friction” Many unemployed could be employed “tomorrow” but incur costs associated with “searching” to find the “right” job

Public Policy and Unemployment Government programs can affect the time it takes unemployed workers to find new jobs. These programs include the following: Government-run employment agencies – reduce friction Public training programs or financing re-training – address structural unemployment Unemployment insurance – what impact does this provision have on a given worker’s length of unemployment? * Does (state) intervention in labor markets help? Is it appropriate?

Public Policy and Job Search Government-run employment agencies give out information about job vacancies in order to match workers and jobs more quickly - Reduce friction in the labor market

Public Policy and Job Search Public training programs aim to ease the transition of workers from declining to growing industries and to help disadvantaged groups escape poverty. - Developed to address Structural Unemployment

Public Policy and Job Search Unemployment insurance is a government (federal and state) program that partially protects workers’ incomes when they become unemployed. Program mandated by federal government (1935) but program varies across states Offers workers partial protection against job losses. Offers partial payment of former wages for a limited time to those who are laid off. Tends to lengthen average unemployment duration Can reduce search effort May improve chance at a better worker/firm fit

Public Policy and Job Search Institutional impediments Minimum-wage laws Unions Efficiency wages theory

MINIMUM-WAGE LAWS When the minimum wage is set above the level that balances supply and demand, it creates unemployment (especially problematic for young, inexperienced, urban labor force) These laws can block entry to the labor market. Entry level, minimum wage jobs serve to provide experience, skill, contacts, referrals… things needed to advance in the labor market

Figure 4 Unemployment from a Wage Above the Equilibrium Level Labor supply Surplus of labor = Unemployment Labor demand Minimum wage LD LS WE LE Quantity of Labor Copyright©2003 Southwestern/Thomson Learning

UNIONS AND COLLECTIVE BARGAINING A union is a worker association that bargains with employers over wages and working conditions. In the 1940s and 1950s, when unions were at their peak, about a third of the U.S. labor force was unionized. A union is a type of cartel attempting to exert its market power (increase negotiating power via Collective Bargaining) - there is a difference between a handful of workers asking for a raise and the whole force asking for that raise (and threatening a strike)

UNIONS AND COLLECTIVE BARGAINING A strike will be organized if the union and the firm cannot reach an agreement. A strike refers to when the union organizes a withdrawal of labor from the firm. Workers in unions (insiders) reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs. By acting as a cartel with ability to strike or otherwise impose high costs on employers, unions usually achieve above-equilibrium wages for their members. (10%- to 20% higher than non-union)

Are Unions Good or Bad for the Economy? Critics argue that unions cause the allocation of labor to be inefficient and inequitable. Wages above the competitive level reduce the quantity of labor demanded and cause unemployment. Some workers benefit at the expense of other workers. Union members – those on the inside – tend to be more focused on wage rates and union leaders respond to membership (a 5% pay cut vs. some lay offs)

Unions Unions emerged in response to Monopsony – firms that held enormous market power. Private sector union membership has been declining for the past couple or three decades. Public unions (AFSCME) have emerged in the recent past to exert significant (political) power. Regional differences: Unions are more prevalent in the Northeast and Midwest. (where have the carmakers gone?)

THE THEORY OF EFFICIENCY WAGES Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity. The theory of efficiency wages states that firms operate more efficiently if wages are above the equilibrium level. 1. Worker Health: Better paid workers eat a better diet and thus are more productive. 2 and 3. Worker Turnover/effort: A higher paid worker is less likely to look for another job. (reduce shirking) 4. Worker Quality: Higher wages attract a better pool of workers to apply for jobs.

Summary The unemployment rate: (Unemployed / Labor Force) Labor Force Participation: (Labor Force / Adult Population) The Bureau of Labor Statistics calculates these statistic monthly. The unemployment rate is an imperfect (imprecise) measure of joblessness.

Summary In the U.S. economy, most people who become unemployed find work within a short period of time. Most unemployment observed at any given time is attributable to a few people who are unemployed for long periods of time.

Summary Job Search – time taken to find an appropriate job, one that suits skills and tastes Minimum-wage laws – Binding minimum wage laws increase unemployment Unions – cartel of workers (collective bargaining) Efficiency Wages – Firms offer above equilibrium wages