Below is a mindmap outlining the causes of unemployment and the policies to reduce it. Useful for NCEA Level 2 – Internal Assessment and A Level Labour Market.
Below is a link to a very good podcast from the BBC ‘The Real Story’. Dan Damon discuss what should be done about rising unemployment in the age of Covid-19? Contributors include Australian economist Steve Keen author of ‘Debunking Economics’. Topics of debate include:
- Universal Basic Income
- Modern Monetary Theory
- How much debt can a government sustain in propping up an economy?
- Should a government subsidise companies taking-on workers?
Also features a very good interview with Daniel Susskind – author of ‘A World Without Work: Technology, Automation and How We Should Respond’
It is 53 minutes long but can take your mind off the commute to work.
Part 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 in London. 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.
Central banks have found that inflation has been the pest it has been in the past – most countries inflation rates have been short of its target rate. After the GFC the level of unemployment rose and inflation was quite subdues. However, with the post GFC recovery unemployment began to fall whilst the inflation rate was still showing no signs of accelerating which went against the original Phillips Curve. A further problem was that imported goods and services in one country have little relevance on the wages in another and the low levels of unemployment tempted people back into the labour force who hadn’t been counted as unemployed. This is particularly the case in Japan.
When there is an increase in job numbers, with a boom period, inflation may also be slow to rise. Although firms tend to be reluctant to lower wages when the economic climate slows as it is harmful to staff morale. The same could be said in good times as wages tend not to rise that quickly.
For many businesses changing the price of their goods or services can be costly especially for a small increase in price. Therefore the change in the business cycle tends not to be reflected in price changes as there needs to be major swings before prices will move at all. Central bank policy tends to manipulate interest rates to maintain a stable inflation causing unemployment to move up or down – unemployment is what changes not inflation.
The problem that central banks face today is that to keep the phillips curve flat they need to be able to cut interest rates to stimulate growth when inflation threatens to become deflation. However there is little room for further easing with rates so low. Central banks will need to work with the government’s fiscal policy to stimulate growth and spend the money that the central bank’s create.
In most economics textbooks the labour market is shown with a simple graph of the supply of labour and the demand for labour and where they intersect the wage that employees receive for their service and the amount employed. The theory is based on the following:
Demand for Labour
In this context the demand for labour is determined by the marginal revenue product where workers are paid the value of their marginal revenue product to the firm. The demand for labour is downward sloping as when there is a fall in the wage rate the firm will expand employment as the labour input has become relatively cheaper for a given level of productivity, compared to other inputs. A rise in the wage rate will causes a contraction of labour demand.
Supply of Labour
Economic theory would suggest that the real wage (adjusted for inflation) is a key determinant of the number of hours. Therefore the supply curve for labour slopes upward because people want to work more hours if you pay them more, at least in theory. An increase in the real wage on offer in a job should lead to someone supplying more hours of work over a given period of time, although there is the possibility that further increases in the going wage rate might have little effect on an individual’s labour supply.
The Minimum Wage
The minimum wage distorts the market equilibrium as there is now a wage floor – a level which the wage cannot fall below. If the minimum wage is below the equilibrium wage then there is no impact as the market will ensure that is reaches equilibrium. However a minimum wage above the equilibrium means that companies will hire fewer workers and therefore result in more unemployment. On the graph below a minimum wage of W1 means that the level of employment has fallen but those prepared to work but are involuntary unemployed has increased. However the people still employed are better off as they are paid more for the same work; their gain is exactly balanced by their employers’ loss. The jobs that someone would have been willing to do at less than the wage of We and for which some company would have been willing to pay more than We. Those jobs are now gone, as well as the goods and services they would have produced.
Real Impact of the Minimum Wage.
In reality the theory of the minimum wage explained above is not as simple as it is made out to be. From records in the USA there is no obvious relationship between the minimum wage and unemployment: adjusted for inflation, the federal minimum wage was highest from 1967 through 1969, when the unemployment rate was below 4%. One study in 1994 by David Card and Alan Krueger evaluated an increase in New Jersey’s minimum wage by comparing fast-food restaurants on both sides of the New Jersey – Pennsylvania border. They concluded, “contrary to the central prediction of the textbook model … we find no evidence that the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”
The idea that a higher minimum wage might not increase unemployment goes against the the theory in textbooks as if labour becomes more expensive firms will take on less employees. But there are several reason why this might not be the case:
- The standard model states that firms will replace labour with machines if wages increase, but what happens if labour saving technologies are not available at a reasonable cost.
- Some employers may not be able to maintain their business with fewer workers especially in service based industries. Therefore, some companies can’t lay off employees if the minimum wage is increased.
- Small firms are traditionally labour intensive and can’t afford large capital investment. Therefore the minimum wage doesn’t have the impact of laying off workers.
- If employers have significant market power that the theory of the supply and demand for labour doesn’t exist, then they can reduce the wage level by hiring fewer workers (only those willing to work for low pay), just as a monopolist can boost prices by cutting production (think of an oil cartel, for example, see graph Monopsony Labour Market). A minimum wage forces them to pay more, which eliminates the incentive to minimize their workforce.
- Even though a higher minimum wage will raise labour costs many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.
- Higher wages boost productivity as they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better. A higher minimum wage motivates more people to enter the labor force, raising both employment and output.
- Higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs.
All the above add a range of variables that are not considered in the simple supply and demand model for labour. It maybe useful as a starting point in discussing the minimum wage but has its limitations in the more complex real world
Source: Economism by James Kwak
I was surprised to see the official unemployment figures issued today – down from 4.2% to 4.0%. However this reflects those workers that were laid off but unable to seek further employment due to the Level 4 lockdown but still included in the labour force. Remember the unemployment calculation is those people who are unemployed and actively seeking employment.
According to the ASB a better measure in the current environment would be underutilisation – It is defined such that jobseekers outside the labour force are captured (unlike the unemployment rate) and includes people working part-time who would like to work more hours. Utilisation rose from 10.4% to 12%. The unadjusted LCI, more of a ‘raw’ measure of wage costs, rose just 0.4% qoq, with annual growth slowing from 3.8% to 3.1%. Average hourly earnings from the QES slowed to 2.5% yoy for private sector workers, a multi-year low.
End of wage subsidy
Although these were positive signs for unemployment figures later in the year it is inevitable that these figures will deteriorate when the wage subsidy ends and we return to an economy which isn’t propped up by government spending. Unemployment is forecast to peak at 9.8% in September.
Source: ASB Bank – Economic Note – 5-8-20
Wage Rate:- The price of labour as determined by market supply and demand.
The demand for labour is said to be derived demand: – the demand for labour is dependent on the demand for the goods & services produced.
Key factors that affect the quantity of labour supplied:-
- age of population
- non-wage factors
- Difficulty in acquiring qualifications – eg. doctors
- social attitudes to employment
Change in Demand for labour Change in Supply of labour
A more realistic version of the market model measures the price of labour in real wages rather than in nominal or money wages. The difference is that nominal wages are the actual dollars that are paid for any job while real wages are a measure of the ability of those dollars (earnings) to buy goods and services. Therefore real wages consider the purchasing power of your income.
Actual wages will rise much more easily than they will fall. Labour markets are extremely rigid when it comes to reducing wage levels. Several factors encourage wages to stick at higher levels and so prevent the market from clearing, as shown in ‘Supply and Demand Applications’ and below.
Equilibrium and Real Wages
Some of these factors occur through the natural operation of the labour market.
- Strong trade unions can operate as ‘monopoly suppliers’ of labour. This keeps wages above the equilibrium equilibrium. Fewer workers are hired.
- Hiring cheap labour may backfire on employers. This labour may not have the same level of skills as that of the firm’s existing workforce. This will increase costs for the firm if it has to provide too much training. Existing workers therefore hold the balance of power and can demand higher wages.
- The idea that a job has a certain worth, an intrinsic value regardless of the action of demand and supply, can keep wages above equilibrium.
- The influence of humanity values can be strong. It is easy to pay less for resources other than labour.
Some factors are imposed on the market by the government.
- Legislated minimum wages prevent the market from clearing. Although these wages aim to protect the incomes of those in the lower paid jobs, the result is fewer jobs for those same workers.
- Welfare benefits can be over-generous and this may discourage the unemployed from seeking jobs.
Just covering this topic with my A2 class. Part 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.
The number of people applying for unemployment benefit in the US over the last four weeks is astonishing – 22 million which represents 13% of the labour force. Some economists are suggesting that it will go above 15% in the next couple of months as the lockdown continues to impact businesses.
“There’s nowhere to hide,” said Diane Swonk, chief economist at Grant Thornton in Chicago told the New York Times. “This is the deepest, fastest, most broad-based recession we’ve ever seen.”
Getting money quickly to people who need it is essential to limiting the economic damage and heading off a prolonged downturn, economists say. Relying on state unemployment offices, however — which had been set up and staffed to deal with record-low jobless rates — has resulted in mammoth delays. New York Times
The graph below represent these figures in a historical context. It would not be surprising if the rate went above that of the Great Depression – 25%. However these estimates would be dependent on a L U V or W recovery – see previous blog post. The graph below is from GZERO.
ASB bank published some of its forecasting for the Global and New Zealand economies and number of potential routes – read the full article here. They have come up with a central scenario which focuses on what is actually happening at the moment although we know how things can change. They then do an upside and a downside around this central forecast. They also published some graphs that relate to their scenarios – see below.
The ASB also noted that compared to other countries New Zealand is currently in a good position:
- The economy is going into a deep but short-lived contraction – the economy will recover.
- NZ has more fiscal and monetary ammunition than other countries.
Where the economy actual ends up – how long is a piece of string? Stay safe.
Just finishing off unemployment with my A2 class and put together this mindmap in OmniGraffle (Apple software). Good for revision purposes with stimulus headings.