Category Archives: Unemployment

A2 Economics – Wage Price Spiral and the Long Run Phillips Curve

Phillips CurvePart of the CIE A2 macro syllabus focuses on the wage price spiral which relates to the Phillips Curve. Here are some excellent notes that I picked up from Russell Tillson in my early days teaching at Epsom College. As from previous posts, the Phillips Curve analysed data for money wages against the rate of unemployment over the period 1862-1958. Money wages and prices were seen to be strongly correlated, mainly because the former are the most significant costs of production. Hence the resulting curve purported to provide a “trade-off’ between inflation and unemployment – i.e. the government could ‘select’ its desired position on the curve.

During the 1970’s higher rates of inflation than previously were associated with any given level of unemployment. It was generally considered that the whole curve had shifted right – i.e. to achieve full employment a higher rate of inflation than previously had to be accepted.

Milton Friedman’s expectations-augmented Phillips Curve denies the existence of any long-run trade off between inflation and unemployment. In short, attempts to reduce unemployment below its natural rate by fiscal reflation will succeed only at the cost of generating a wage-price spiral, as wages are quickly cancelled out by increases in prices.

Each time the government reflates the economy, a period of accelerating inflation will follow a temporary fall in unemployment as workers anticipate a future rise in inflation in their pay demands, and unemployment returns to its natural rate.

The process can be seen in the diagram below – a movement from A to B to C to D to E

Friedman thus concludes that the long-run Phillips Curve (LRPC) is vertical (at the natural rate of unemployment), and the following propositions emerge:

1. At the natural rate of unemployment, the rate of inflation will be constant (but not necessarily zero).

2. The rate of unemployment can only be maintained below its natural rate at the cost of accelerating inflation. (Reflation is doomed to failure).

3. Reduction in the rate of inflation requires deflation in the economy – i.e. unemployment must rise (in the short term at least) above its natural rate.

Some economists go still further, and argue that the natural rate has increased over time and that the LRPC slopes upwards to the right. If inflation is persistently higher in one country that elsewhere, the resulting loss of competitiveness reduces sales and destroys capacity. Hence inflation is seen to be a cause of higher inflation.

Rational expectations theorists deny Friedman’s view that reflation reduces unemployment even in the short-run. Since economic agents on average correctly predicted that the outcome of reflation will be higher inflation, higher money wages have no effect upon employment and the result of relations simply a movement up the LRPC to a higher level of inflation.

Unemployment – a ‘luxury good’ in the developing world

Image result for unemployment in developing countriesFollowing from my last post about the welfare state, the lack of jobless benefits in developing countries has led to very low unemployment levels as workers simply cannot afford not to work. In order for them to survive they need to be prepared to do any sort of job. Even if unemployment benefits are available a lot of the time they are not worth the effort. In Thailand, for example, payments last six months and range from 1,650 baht per month ($52) to 15,000. To be eligible, a Thai worker must register with the social-security office. But only one in three does so.

Therefore if they have lost their job what do they do? A laid-off factory worker might lend a hand on the family farm, become a casual day labourer, or sell trinkets on the street. When Annan Chanthan left his job as a graphic designer in Bangkok five years ago, he thought about collecting unemployment benefits, but never bothered. He now earns more money selling lottery tickets next to Hua Lamphong railway station than he did in his former profession.

But the situation can be complicated in developing countries, with their large informal sectors, which offer a relatively easy way for unemployed people to pick up some income — undetected by the government — while they continue to receive jobless benefits. However the level of the unemployment benefit influence the duration of the period of unemployment, but it doesn’t really help workers find better jobs (such as those that pay a higher wage). However, the level of the benefit does seem to improve wages somewhat, although not the unemployment duration.

In poor countries, unemployment is paradoxically concentrated among the better off and better educated. They can afford to wait a bit for a job that matches their aspirations and qualifications. Their behaviour may also explain unemployment’s curious stability but when times are bad, they may settle for a worse job or stop looking, rather than wait longer, which would add to the rate of unemployment.

Source: The Economist June 9th 2018 – The luxury of unemployment

 

 

Repairing the Welfare State

Back in July The Economist had an article in its ‘International’ section on updating or repairing the welfare state. They identified 3 major challenges faced by welfare states in rich countries.

  1. Ageing population
  2. Immigration
  3. Adapting to changing labour markets

1. Ageing Population

Image result for old age dependency welfare stateThe rapid increase in life expectancy over the past century has become an issue for governments around the world in terms of financing pensions, social care, and health care – see graph. With the political opposition to a reduction of public services a solution could be to increase the tax base by mobilising the potential workforce so that a greater share of those of working age actually work, while another can be found in productivity growth. Yet another route is raising the retirement age in response to longer and healthier life expectancy. The challenge of funding the pension system appears particularly daunting, with an increasing share of the population spending a longer period of time in retirement. Although immigration is a problem it may be a solution to ageing as economic research from the UK and Denmark has shown that since 2002 EU migrants have contributed much more in taxes than they have cost in public services.

2. Immigration

Immigration poses another challenge to the welfare state. In 1978 Milton Friedman argued that you could have open borders or generous welfare states open to all, but not both, without swamping the welfare system. Moreover, taxpayers are more tolerant of benefits that are seen to look after “people like them”. Evidence suggests that there has been tension between diversity and generosity.

Welfare chauvinism has been evident in many countries – France, Sweden, Denmark – have curbed the rights to benefits of non-EU migrants since 2002. Reforms in the USA in 1990s limited illegal immigrants’ access to benefits and of late Sweden has limited paid parental leave for new immigrants and cut support payments to some asylum-seekers. Moreover, attitudes towards immigrants are volatile and swayed by the political climate. In 2011, for example, 40% of Britons said immigrants “undermined” the country’s cultural life, and just 26% said they enriched it. By last year, in the wake of the Brexit vote, only 23% went for undermined, compared with 44% for “enriched”.

3. Adapting to changing labour markets

Recent research by the OECD in seven of its members estimated that 60% of the working-age population had stable full-time work. Of the other 40%, no more than a quarter met the typical definition of unemployed: out of a job but looking for one. Most had dropped out of the labour market or worked volatile hours. In many countries when the jobless do find work, their benefits are withdrawn in such a way as to create a high effective marginal tax rate. Nearly 40% of the unemployed in the OECD face a marginal rate higher than 80% on taking a job. Welfare recipients also often suffer from bureaucratic traps. For example, some have to wait weeks between losing a job and receiving benefits.

Universal basic income (UBI) may be one way to avoid such problems. It takes many very different forms, but at its heart it replaces a plethora of means-tested benefits with a single, unconditional one, paid to everyone. Scotland and the Netherlands are running experiments involving UBI and many others are set to follow. But in no country is it yet the foundation of the benefits system for working-age adults.

The OECD recently modelled two forms of basic income. Under the first, countries’ spending on benefits was divided equally among everyone—a revenue-neutral reform. Under the second, everyone would receive benefits equal to the current minimum-income guarantee, and taxes would rise to pay for it, if necessary.

Welfare Policy – Trilemma

The results, as ever in welfare policy, reveal a “trilemma” between:

1. The overall cost,
2. How much it alleviates poverty
3. Its effect on work incentives.

They also show that the effects of introducing basic income vary hugely based on what welfare system it would partly replace. Countries such as Italy, Greece, Spain, Austria and Poland all spend more on welfare for the richest 20% than for the poorest. For them, spreading benefits more evenly would benefit the poor, even under a revenue-neutral model. But in countries that target welfare spending on the poor (such as Britain), UBI would either lead to large tax rises, to maintain a minimum income for everyone, or see benefits cut for the worst-off.

A more realistic alternative for many countries may be a negative income tax (NIT). Championed by Friedman, the NIT means that, below a certain income threshold, the taxman pays you. As you earn more, tax kicks in, tapering your income. The effect is similar to a basic income, especially since most UBI models assume that rich people would have to pay more tax to afford them. A NIT, however, is more efficient in that it does not give the rich a stipend only to take most of it back in tax.

Versions of a NIT have been part of welfare policy in Britain and America for decades, in the form of tax credits that are paid to those working on low incomes. Britain’s Universal Credit, a (sputtering) attempt to merge six working-age benefits into one, takes the approach further. A recent analysis by the OECD finds this a better way at targeting the poor than UBI.

Source: The Economist – Repairing the safety net – The welfare state needs updating. July12th 2018

Least educated workers a symbol of recovering US economy

During the GFC the American workers who suffered the most were those without a high school diploma – their unemployment rate was 15.6% in the summer of 2009 more than three times the peak unemployment rate for college graduates – refers to cyclical unemployment. Furthermore this particular group of unemployed were also those that found it hardest to get back into employment. However by July this year the Labour Department recorded that the unemployment rate for those without a high school diploma fell to 5.1 percent in July this year. This is surprising considering that low-skilled workers, who makeup 7.2% fo the labour force, were seen as the least likely to recover from a recession

Cyclical unemployment (or demand deficient) occurs when there is not enough demand to employ all those who want to work. It is a type that Keynesian economists focus on particularly, as they believe it happens when there is a disequilibrium in the economy. It is also often known as cyclical unemployment because it will vary with the trade cycle. When the economy is booming, there will be lots of demand and so firms will be employing large numbers of workers. Demand-deficient unemployment will at this stage of the cycle be fairly low. If the economy slows down, then demand will begin to fall. When this happens firms will begin to lay workers off as they do not need to produce so much. Demand-deficient unemployment rises. The behaviour of demand-deficient unemployment will exactly mirror the trade cycle.

The increasing trade war between the USA and China seems to have done little to put a damper on hiring. The manufacturing sector, which is particularly sensitive to exports, was robust, adding 37,000 jobs.

Source: New York Times – 2nd August 2018

Shorter hours, higher productivity and yoga

According to surveys today’s millennial job applicants don’t want to work all hours – it seems that younger workers place a work-life balance ahead of career progression. During the GFC an applicant who asked a prospective employer about leaving work early on a Friday to go to yoga wasn’t taken seriously. However with the global economy growing at its fastest rate since 2011, qualified jobseekers are scarce so workers can start to make demands.

IG Metall – Germany’s biggest trade union – struck a deal that allows members to work 28-hour weeks for up to 2 years, typically when they have small children. Although Germany is unique, other national economies might follow suit if they have a limited supply of workers. It is important to note that in boom times the substitution effect comes into play as more people want to substitute money for leisure time – this is shown by the backward bending supply curve of labour. In most A2 courses income and substitution effects are examined. The textbook identifies each as follows:

Income effect – higher real wages might persuade people to work less hours and enjoy extended leisure time (see graph – SS2).

Substitution effect – people have an incentive to work extra hours because the financial rewards of working are raised, and the opportunity cost of not working has increased (see graph – SS1).

Work-life balance is typically discussed as a personal issue and again Germany has been leading the way:

1960 – average West German working year = 2,163 hours
2018 – average German working year = 1,363 hours

Furthermore once they leave work in the mid afternoon a lot of them are actually free of the office and more importantly emails. Daimler automatically erase emails to employees who are on holiday.

Workaholic countries slowing down

Countries that are renowned for working long hour – South Korea, China and Thailand – have already limited school homework. South Korea wants to reduce average annual working hours to less that 1,800 from 2,069 in 2016 – the most for any OECD high-income country.

Average wages are not above pre-crisis levels in all developed countries except the UK and Greece. The eurozone’s jobless rate is the lowest and US wage growth the fastest since 2009. Shorter hours won’t help the poorest paid workers, who can’t afford to work less but for the broad middle in rich countries a new working life is emerging. It could look like Germany – shorter workdays, high productivity and yoga.

Source: Why the 30-hour week is almost here – Simon Kuper – FT Magazine February 15 2018

The NAIRU in New Zealand

Below is an extract from a RBNZ paper from March this year on Estimating the NAIRU and the Natural Rate of Unemployment. Especially useful for A2 students.


The headline unemployment rate in New Zealand has been trending down over time. This fall in the unemployment rate has not been accompanied by a rise in inflation, suggesting that the underlying natural rate and the NAIRU may have also declined through time. In this section, we document some of the changes in the New Zealand economy that have influenced the unemployment rate over history.

As a first step, we disaggregate the unemployment rate into three sub-components as follows:

a. Cyclical unemployment results from changes in aggregate demand conditions over the course of a business cycle. As firms experience weaker demand, existing workers may be laid off and fewer new workers will be hired.
b. Frictional unemployment refers to the regular short-term churn in the labour market, both within, and in and out of, the labour force. It is determined by the efficiency of the matching process given the diversity of job-seekers and vacancies.
c. Structural unemployment represents a more fundamental mismatch between those hiring and job seekers given their skills and geographic location. This could arise from long-lasting changes in the structure of the economy such as socio-demographic trends, technological change, or a rapid change in the mix of industries.

The lines between these categorisations can be indistinct. For example, some argue that a prolonged period of cyclical unemployment could also lead to hysteresis effects that could spill over to structural unemployment. For example, an extended period of unemployment may lead to an erosion of human capital making workers less attractive to employers and hence reducing their bargaining power. In principle, frictional unemployment and structural unemployment should be captured by the trend in the NAIRU or the natural rate, as both forms of unemployment may continue to exist even if the labour market is in equilibrium. This is because those that are structurally unemployed may not be easily drawn back into employment despite an increase in labour demand and an upward adjustment in wages. In addition, the level of frictional unemployment is largely determined by the efficiency with which potential workers and employers can find jobs. In contrast, cyclical unemployment captures when the labour market may be operating below capacity as a result of a shortfall in demand.

Monetary policy has little influence over the level of frictional and structural employment. These are largely determined by the evolution of technology and the obsolescence of skills, and by structural policies to facilitate the acquisition of new skills and improve the match between employers and job-seekers. For example, policies that affect the cost of hiring (e.g. employment protection laws), the incentives for job finding (e.g. unemployment insurance), or the bargaining power of workers (unionisation and labour contract laws).

In Figure 3, we decompose the pool of unemployed workers on the basis of unemployment durations. In particular, we categorise those who have been unemployed for less than 4 weeks as contributing to frictional unemployment, 4 to 52 weeks as cyclical unemployment, and greater than 52 weeks as structural unemployment.

New Zealand’s Phillips Curve 1993-2017

Bill Phillips (a New Zealander) discovered a stable relationship between the rate of inflation (of wages, to be precise) and unemployment in Britain from the 1850’s to 1960’s. Higher inflation, it seemed, went with lower unemployment. To economists and policymakers this presented a tempting trade-off: lower unemployment could be bought at the price of a bit more inflation. The downward-sloping Phillips curve is apparent in the graph below which plots core inflation against headline unemployment for New Zealand.

There has been also an apparent shift inwards of this relationship where lower rates of unemployment have become possible for a given level of inflation, particularly relative to the 1990s. The simple plot in the graph does not take into account other factors such as changes in import prices, inflationary expectations and capacity constraints which also have the potential to shift the Phillips Curve. These are discussed further below:

1. The price of imports. As the price of imports increase whether it is raw materials or finished products, the price of local goods become more expensive which increase the general price level. Also if a country finds that its exchange rate depreciates the price of imports rises. Oil is a very inelastic import and with a barrel of oil below $30 in 2016 there was little pressure on the CPI. Where inflation has been higher is in those countries that have withdrawn price subsidies and also had sharply falling currencies – Argentina 24% and Egypt 32%.

2. Public Expectations. In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue.

Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990’s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves. In Japan firms and employees have become conditioned to expect a lower rate of inflation. Prime minister Shinzo Abe has called for companies to raise wages by 3% to try and kick start inflation.

3. Capacity pressures. This refers to how much ‘slack’ there is in the economy or the ability to increase total output. If capacity pressures are tight that means an economy will find it difficult to increase output so there will be more pressure on prices as goods become more scarce. Unemployment is the most used gauge to measure the slack in the economy and as the economy approached full employment the scarcity of workers should push up the price pf labour – wages. With increasing costs for the firm it is usual for them to increase their prices for the consumer and therefore increasing the CPI. However many labour markets around the world (especially Japan and the USA) have been very tight but there is little sign of inflation. This assumes that the Phillips curve (trade-off between inflation and unemployment) has become less steep. Research by Olivier Blanchard found that a drop in the unemployment rate in the US has less than a third as much power to raise inflation as it did in the mid 1970’s.

This flatter Phillips curve suggests that the cost for central banks in higher inflation of delaying interest-rate rises is rather low.

Is the Natural Rate of Unemployment in the US lower than economists think?

The natural rate of unemployment is the difference between those who would like a job at the current wage rate – and those who are willing and able to take a job. In the above diagram, it is the level (Q2-Q1).

Source: economicshelp.org

The natural rate of unemployment will therefore include:
Frictional unemployment – those people in-between jobs
Structural unemployment – those people that don’t have the skills that fit the jobs that are available.

It is also referred to as the Non-Accelerating Inflation Rate of Unemployment (NAIRU) – the job market neither pushes up inflation nor holds it back.

US Labour Market – tight but little wage growth.

The recent (February 2018) US Federal Reserve Monetary Policy Report stated that the US labour market appears to be near or a little beyond full employment. In theory this should suggest major labour shortages which ultimately end in higher wages for workers. Although employers report having more difficulties finding qualified workers, hiring continues apace, and serious labour shortages would likely have brought about larger wage increases than have been evident to date. The unemployment rate appears to be below most estimates of the natural rate.

January US unemployment rate = 4.1%
Congressional Budget Office’s (CBO) current estimate of the natural rate = 4.6%

The Unemployment Gap


The unemployment rate gap is the unemployment rate minus the CBO’s estimate of the natural rate of unemployment. The shaded bars indicate periods of business recession.

The median of Federal Open Market Committee (FOMC) participants’ estimates of the longer-run normal rate of unemployment and the CBO’s estimate of the natural rate of unemployment have both been revised down by about 1% over the past few years, one indication of the substantial uncertainty surrounding estimates of the “full employment” rate of unemployment.

The US Fed have suggested that with many advanced economies experiencing such low inflation that more persistent factors may be restraining price growth therefore the NRU could be lower in some countries than many economists think. Prices in many industries have been subdued due to technological changes – internet shopping which allows easy comparison – which restricts businesses ability to demand higher prices.

What could be the reasons for less wage growth?

• Employees need less compensation as the inflation rate has been low
• An increase in part-time employment
• Spare capacity in the labour market
• Employees keen on job security so put less emphasis on wage bargaining
• Increasing number of people participating in the labour force.
• Shorter working week
• Ageing and declining working age population

Although in the US there have been labour shortages in some areas of the economy, this hasn’t flowed through into the aggregate labour market. However speculation of higher inflationary pressure through higher wages has alerted markets that the US Fed may increase interest rates although they will remain reluctant to tighten too aggressively.

Source: US Federal Reserve Monetary Policy Report – February 2018.

Full v Fulfilling Employment

Just going through the Natural Rate of Unemployment with my A2 class and I remembered a post I did last year. Free Exchange in The Economist had an article which looked at the change in terminology used by Janet Yellen ex-chairman of the Federal Reserve. In a statement last year she alluded to the US economy near maximum employment and that rate rises could ensue. However only 69% of American adults have a job.

Full employment has normally been the concept that has been used to describe a situation where there is no cyclical or deficient-demand unemployment, but unemployment does exist as allowances must be made for frictional unemployment and seasonal factors – also referred to as the natural rate of unemployment or Non-Accelerating Inflation Rate of Unemployment (NAIRU). If a central bank wishes to stimulate demand below this level there is the concern that inflation will increase therefore they take a guess as to what is the natural rate of unemployment – the lowest rate of unemployment where prices don’t accelerate. Maximum unemployment is the same in that it refers to the labour market being as tight as it can be without increasing prices. Natural rates in the US have varied – around 5.3% in 1950 and then peaking at 6.3% in the stagflation period before falling 4.9% in 2008 and then rising to 5.1% after the GFC, see graph below.

NRU and its causes

The NRU mainly depends on the level of frictional unemployment – defined as those who are in between jobs. This number can vary as at different times of the business cycle as there can be a delay in matching those looking for work with the vacancies themselves – a mismatch sometimes referred to as Structural Unemployment. The increase in frictional unemployment in the 1970’s and 80’s was largely due to the decline in manufacturing jobs with the advent of automation and more right wing policies (Reagan and Thatcher). Workers would stay unemployed in the hope that good high paid manufacturing jobs would reappear.

Unions can also influence the NRU with protecting workers jobs and pushing up wages so that employers find it too costly to employ more labour. However the fall in the 1990’s could be due to the advent of technology in the hiring process and the growth of part-time jobs which assisted those workers facing a career change.

Another influence on the NRU is wage growth as with the higher wages you attract more of the labour force to engage in actively looking for work.

A central bank will have to use trial and error to make a decision on how much spare capacity there is in an economy. Only when prices start to increase do they have an idea how capacity is running.

Quality not Quantity

As alluded to by The Economist the goal of full employment must consider the quality of jobs as well. With the acceleration of technology over labour, maximum employment should consider more than capacity constraints or inflationary pressure.

Rather, governments need to consider the options available to workers: not just how easily they can find jobs they want, but also how readily they can refuse jobs they do not. By lifting obstacles to job changes and giving workers a social safety net that enables them to refuse the crummiest jobs, societies can foster employment that is not just full, but fulfilling.

Sources: The Economist 28th January 2017, St Louis Federal Reserve – Natural Rate of Unemployment

A2 Economics – Introducing Unemployment with UB40

I recently started teaching the Unemployment topic to my Year 13 A2 class and remembered that one of the first albums I bought was UB40 Signing Off – released in 1980 (see right). The front cover and reverse has been made to look like the UB40 unemployment benefit attendance card from which the band took their name. Their UK top-ten hit “One In Ten” was an attack on Thatcherism and is mistakenly cited as referring to the number of unemployed in the UK at that time. It is in fact a song about government statistics in general, and how politicians use them to de-humanise problems. Useful way to introduce the subject especially if the class like reggae. I found it useful to have two windows open and play the video along side the lyrics. Click here for the lyrics of the song and here to see UB40 perform on Top of the Pops in 1981.  I was surprise at how many of the class knew of the band.