Types of unemployment

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Economists distinguish between four major types of unemployment, i.e., cyclical, frictional, structural and classical. (Another distinction, not discussed here, is between voluntary and involuntary unemployment.) Real-world unemployment may combine different types, while all four might exist at one time. The magnitude of each of these is difficult to measure, partly because they overlap and are thus hard to separate from each other. All but cyclical unemployment can be seen as existing at full employment, the level of employment and unemployment that represents the inflation barrier to demand-side growth.

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[edit] Cyclical unemployment

This type of unemployment exists due to inadequate effective aggregate demand. It gets its name because it varies with the business cycle, though it can also be persistent, as during the Great Depression of the 1930s. Gross domestic product is not as high as potential output because of demand failure, due to (say) pessimistic business expectations which discourages private fixed investment spending. Low government spending or high taxes, underconsumption, or low (or negative) net exports may also have this result.

Some consider this type of unemployment one type of frictional unemployment in which factors causing the friction are partially caused by some cyclical variables. For example, a surprise decrease in the money supply may shock participants in society. Then, we may see recession and cyclical unemployment until expectations adjust to the new conditions.

In this case, the number of unemployed workers exceeds the number of job vacancies, so that if even all open jobs were filled, some workers would remain unemployed. This kind of unemployment coincides with unused industrial capacity (unemployed capital goods). Keynesian economists see it as possibly being solved by government deficit spending or by expansionary monetary policy, which aims to increase non-governmental spending by lowering interest rates.

Classical economics rejects the conception of cyclical unemployment, seeing the attainment of full employment of resources and potential output as the normal state of affairs. However, it accepts the theory to some extent as full employment can never be reached.

[edit] Frictional unemployment

Main article: Search theory

This unemployment involves people in the midst of transiting between jobs, searching for new ones; it is compatible with full employment. It is sometimes called search unemployment and can be voluntary. New entrants (such as graduating students) and re-entrants (such as former homemakers) can also suffer a spell of frictional unemployment.

Frictional unemployment exists because both jobs and workers are heterogeneous, and a mismatch can result between the characteristics of supply and demand. Such a mismatch can be related to skills, payment, worktime, location, attitude, taste, and a multitude of other factors. Workers as well as employers accept a certain level of imperfection, risk or compromise, but usually not right away; they will invest some time and effort to find a better match. This is in fact beneficial to the economy since it results in a better allocation of resources. However, if the search takes too long and mismatches are too frequent, the economy suffers, since some work will not get done. Therefore, governments will seek ways to reduce unnecessary frictional unemployment.

Policies to reduce frictional unemployment include:

  • educational advice;
  • schooling and training facilities;
  • information on available jobs and workers;
  • combating prejudice (against certain workers, jobs or locations);
  • incentives and regulations (e.g. when the frictionally unemployed receive benefits);
  • relocation of industries and services;
  • facilities to increase availability and flexibility (e.g. daycare centers);
  • aid or grants to overcome a specific obstacle (e.g. if a handicapped worker is employed);
  • reduction of the gap between gross and net wages (e.g. by taxing consumption instead).

Frictional unemployment coincides with an equal number of vacancies. Numerically, it is therefore maximal when the labour market is in equilibrium. When for instance demand far exceeds supply, the frictionally unemployed will be few as they will get many job offers.

The frictions in the labour market are sometimes illustrated graphically with a Beveridge curve, a downward-sloping, convex curve that shows a fixed relationship between the unemployment rate on one axis and the vacancy rate on the other. Changes in the supply of or demand for labour cause movements along this curve. An increase (decrease) in labour market frictions will shift the curve outwards (inwards). It is possible to derive this curve mathematically by aggregating (infinitely small) submarkets of the labour market, if it is assumed that these submarkets follow a probability distribution. Formulae for the curve have been derived for the normal distribution[1] and the Weibull distribution[2]; the latter has the hyperbolic Beveridge curve (U x V = c) as a special case. Robert Shimer has studied the case in which the distribution of unemployed workers and vacancies across labor markets is multinomial, and has shown that it closely reproduces data on the US labor market.[3]

[edit] Examples

One kind of frictional unemployment is called wait unemployment: it refers to the effects of the existence of some sectors where employed workers are paid more than the market-clearing equilibrium wage. Not only does this restrict the amount of employment in the high-wage sector, but it attracts workers from other sectors who wait to try to get jobs there. The main problem with this theory is that such workers will likely "wait" while having jobs, so that they are not counted as unemployed. In Hollywood, for example, those who are waiting for acting jobs also wait on tables in restaurants for pay (while acting in "Equity Waiver" plays at night for no pay). However, these workers might be seen as underemployed (definition 1).

Another type of frictional unemployment is seasonal unemployment, where specific industries or occupations are characterized by seasonal work which may lead to unemployment. Examples include workers employed during farm harvest times or those working Winter jobs on the ski slopes or Summer jobs such as life-guarding at outdoor pools and agricultural labor.

[edit] Structural unemployment

Main article: Structural unemployment

The better the economy is doing, the lower this type of unemployment is likely to be. This is because people will usually be able to find jobs that suit them more quickly when the economy is doing well. This involves a mismatch between the good workers looking for jobs and the vacancies available. Even though the number of vacancies may be equal to the number of the unemployed, the unemployed workers lack the skills needed for the jobs — or are in the wrong part of the country or world to take the jobs offered. It is a mismatch of skills and opportunities due to the structure of the economy changing. That is, it is very expensive to unite the workers with jobs. One possible example in the rich countries is the present combination of the shortage of nurses with an excess labor supply in Information Technology. Unemployed programmers cannot easily become nurses, because of the need for new specialized training, the willingness to switch into the available jobs, and the legal requirements of such professions.

Structural unemployment is a result of the dynamic changes of a capitalist economy (such as technological change and capital flight) — and the fact that labor markets can never be as fluid as (say) financial markets. Workers are "left behind" due to costs of training and moving (e.g., the cost of selling one's house in a depressed local economy), plus inefficiencies in the labor markets, such as discrimination.

Structural unemployment is hard to separate empirically from frictional unemployment, except to say that it lasts longer. It is also more painful. As with frictional unemployment, simple demand-side stimulus will not work to easily abolish this type of unemployment.

Some sort of direct attack on the problems of the labor market — such as training programs, mobility subsidies, anti-discrimination policies, a Basic Income Guarantee, and/or a Citizen's Dividend — seems required. The latter provide a "cushion" of income which allows a job-seeker to avoid simply taking the first job offered and to find a vacancy which fits the worker's skills and interests. These policies may be reinforced by the maintenance of high aggregate demand, so that the two types of policy are complementary.

Structural unemployment may also be encouraged to rise by persistent cyclical unemployment: if an economy suffers from long-lasting low aggregate demand, it means that many of the unemployed become disheartened, while their skills (including job-searching skills) become "rusty" and obsolete. Problems with debt may lead to homelessness and a fall into the vicious circle of poverty. This means that they may not fit the job vacancies that are created when the economy recovers. Some economists see this scenario as occurring under British Prime Minister Margaret Thatcher during the 1970s and 1980s. The implication is that sustained high demand may lower structural unemployment. However, it also may encourage inflation, so some kind of incomes policies (wage and price controls) may be needed, along with the kind of labor-market policies mentioned in the previous paragraph. (This theory of rising structural unemployment has been referred to as an example of path dependence or "hysteresis.")

Much technological unemployment (e.g. due to the replacement of workers by robots) might be counted as structural unemployment. Alternatively, technological unemployment might refer to the way in which steady increases in labor productivity mean that fewer workers are needed to produce the same level of output every year. The fact that aggregate demand can be raised to deal with this problem suggests that this problem is instead one of cyclical unemployment. As indicated by Okun's Law, the demand side must grow sufficiently quickly to absorb not only the growing labor force but also the workers made redundant by increased labor productivity. Otherwise, we see a jobless recovery such as those seen in the United States in both the early 1990s and the early 2000s.

Seasonal unemployment might be seen as a kind of structural unemployment, since it is a type of unemployment that is linked to certain kinds of jobs (construction work, migratory farm work). The most-cited official unemployment measures erase this kind of unemployment from the statistics using "seasonal adjustment" techniques.

[edit] Classical unemployment

In this case, like that of cyclical unemployment, the number of job-seekers exceeds the number of vacancies. However, the problem here is not aggregate demand failure. In this situation, real wages are higher than the market-equilibrium wage. In simple terms, institutions such as "the minimum wage" deter employers from hiring all of the available workers, because the cost would exceed the technologically-determined benefit of hiring them (the marginal product of labor). Some economists theorize that this type of unemployment can be reduced by increasing the flexibility of wages (e.g., abolishing minimum wages or employee protection), to make the labor market more like a financial market.[citation needed]

[edit] Full employment

Main article: Full employment

In theory, it is possible to abolish cyclical unemployment by increasing the aggregate demand for products and workers. However, eventually the economy hits an "inflation barrier" imposed by the four other (supply-side) kinds of unemployment to the extent that they exist.

Some economists see the inflation barrier as corresponding to the natural rate of unemployment. The "natural" rate of unemployment is defined as the rate of unemployment that exists when the labour market is in equilibrium and there is pressure for neither rising inflation rates nor falling inflation rates [1]. More scientifically, this rate is sometimes referred to as the NAIRU or the Non-Accelerating Inflation Rate of Unemployment

No matter what its name, this means that if the unemployment rate gets "too low," inflation will get worse and worse (accelerate) in the absence of wage and price controls (incomes policies). Others simply see the possibility of inflation rising as the unemployment rate falls. This is the famous Phillips curve.

One of the major problems with the NAIRU theory is that no-one knows exactly what the NAIRU is (while it clearly changes over time). The margin of error can be quite high relative to the actual unemployment rate, making it hard to use the NAIRU in policy-making.

Another, normative, definition of full employment might be called the ideal unemployment rate. It would exclude all types of unemployment that represent forms of inefficiency. This type of "full employment" unemployment would correspond to only frictional unemployment (excluding that part encouraging the McJobs management strategy) and would thus be very low. However, it would be impossible to attain this full-employment target using only demand-side Keynesian stimulus without getting below the NAIRU and suffering from accelerating inflation (absent incomes policies). Training programs aimed at fighting structural unemployment would help here.

To the extent that hidden unemployment exists, it implies that official unemployment statistics provide a poor guide to what unemployment rate coincides with "full employment".

[edit] Hidden unemployment

Hidden, or covered, unemployment is the unemployment of potential workers that is not reflected in official unemployment statistics, due to the way the statistics are collected. In many countries only those who have no work but are actively looking for work (and/or qualifying for social security benefits) are counted as unemployed. Those who have given up looking for work (and sometimes those who are on Government "retraining" programmes) are not officially counted among the unemployed, even though they are not employed. The same applies to those who have taken early retirement to avoid being laid off, but would prefer to be working. The statistic also does not count the "underemployed" - those with part time or seasonal jobs who would rather have full time jobs. Because of hidden unemployment, official statistics often underestimate unemployment rates.

[edit] See also

[edit] References

  1. ^ P. Kooiman (1986), "Some empirical models for markets in disequilibrium", Ph.D. thesis, Erasmus University Rotterdam
  2. ^ G. den Broeder (1983), "A family of market transaction functions", Foundations of Empirical Economic Research 1983/1, Rotterdam: Netherlands Economic Institute
  3. ^ R. Shimer (2007), "Mismatch", American Economic Review 97 (4), pp. 1074-1101. See Fig. 1 for an illustration of the Beveridge curve in US data.