Chapter 6-2: Full Employment and Unemployment

Question 1

Labour Force

Answer 1

Any person who is able and willing to work is said to belong to the labour force or workforce or for the working population. Thus, persons who are not actively looking for a job e.g. students, full time housewives and retirees are not part of the labour force.

Labour Force = Employed + Unemployed

When examining a country’s labour force, we are interested in:
The size of the labour force
Composition of the labour force

Size of Labour Force
The labour force depends on population size, output levels of the economy, educational attainment etc. It is used to It determine the unemployment rate.

Composition of Labour Force
This looks at the make-up of the labour force in terms of demographic characteristics e.g. age, gender, income. It has to potential to influence a country’s unemployment rate.

Question 2

Labour Productivity

Answer 2

It measures the output produced (i.e. amount of goods and services) per man-hour. Increase in labour productivity is usually attained via supply-side policies such as education and training which improve the quality of labour and the use of technology to increase the output without a change in quantity of labour. An increase in labour productivity is likely to increase the employability of workers and reduce the unemployment rate.

Question 3

Unemployment

Answer 3

Unemployment refers to the situation where people in the labour force, who are willing and able to work, but are unable to find employment.

In theory, an “unemployed” person must satisfy 2 criteria:

Able to work: belong to the legal working age group and are physically and mentally able
Willing to work: actively looking for a job

Yet, this person is still jobless or cannot find employment.

Thus, the term unemployment does not apply to just everyone or anyone who is not working or out of work. For instance, students, full time housewives and retirees do not fall into the definition of the unemployed. An unemployed person is someone who is actively seeking employment or is in the labour force but yet cannot find employment.

Question 4

Demand-deficient / Cyclical Unemployment

Answer 4

This occurs when there is an insufficient or lack of aggregate demand in the economy to maintain full employment. According to Figure 1, the lack in AD at AD0 results in Y0 being less than the full employment Yf, therefore workers are unemployed.

It is commonly associated with the downswing portion of the business cycle and can be illustrated by a fall in AD from AD0 to AD1.

When the economy enters a recession, the economy contracts as output falls due to falling aggregate spending. As businesses suffer poor sales and even losses, they may resort to retrenching or laying-off redundant staff. Consequently, workers may become unemployed. This is known as cyclical unemployment.

However, once the economy starts to recover and expand (upswing of business cycle), aggregate demand increases, leading to rising output and firms increase hiring. Thus, cyclical unemployment will fall.

For example the Global Financial Crisis in 2007/2008 triggered a rise in cyclical unemployment in US, Europe and many other countries. The fall in AD was a result of lack of consumer and investor confidence in the economy.

Question 5

Structural Unemployment

Answer 5

This arises when there is a mismatch of skills I.e. job seekers are unable to find suitable jobs because their skills do not match those required by employers in the economy e.g.low-skilled workers in Singapore would find it hard to find employment in the high-end manufacturing sector, which requires highly skilled workers e.g. in the biomedical sector

Question 6

Frictional Unemployment

Answer 6

New job seekers e.g. school leavers and new graduates may experience ‘frictional’ or temporary unemployment upon graduation because of the need to ‘search’ or look for suitable jobs available in the economy.The transition from school to employment is marked by ‘frictions’ due to the lack of perfect information concerning job availability in the economy. This form of unemployment, which is also known as ‘search unemployment’, is regarded as transitory or temporary.

Question 7

Other types of unemployment (3)

Answer 7

Seasonal unemployment: This occurs when people are unemployed at certain times of the year because they work in industries where they are not needed all year round. E.g. fruit pickers and ski resort instructors.

Underemployment: This is usually defined as the employment of workers with high skill level in Low-wage jobs that do not require such abilities. For example, someone with a college degree may be bar tending or driving a cab or working as a cashier. Alternatively, a skilled machinist may be working at a fast-food outlet.

Disguised unemployment: In an agricultural country, the concept of employment or unemployment is different from that in an industrial or advanced country. E.g. a farmer may invite his poor brother or relative to work on his farm not from the standpoint of productivity but from that of family relationship. This additional unit of labour does not contribute much to production. It is a sort of disguised unemployment because its marginal product (i.e. the additional output from the additional labour hired) is rather small.

Question 8

Full employment

Answer 8

When economists talk about “full employment”, they do not mean zero unemployment.

This is counter-intuitive to the layman’s understanding of full employment. The reason is because long as there are enough jobs to match the number of job seekers, the economy is said to achieve full employment.

For example, if there are 100 job seekers and there are 100 unfilled vacancies, then it can be said the economy is technically at full employment. In reality, not all the 100 vacancies may be filled immediately for 2 basic reasons:

Lack of information because job seekers might not know these jobs exist or where to find them. Time is required for job-seekers to search for them.

Skills mismatch because job-seekers might not be able to fill up the vacancies because of lack of relevant skills. Time is required to train or retrain job-seekers to fill up the vacancies.

Whilst search and retraining is taking place, it is inevitable that there will be some unemployment. This type of unemployment which exists due to the presence of frictional and structural unemployment is collectively called the ‘natural rate of unemployment’.

However there is no universally accepted standard of what the ‘natural rate of unemployment’ or the full employment rate is. In fact, the full employment rate varies from country to country.

In some developed countries, the unemployment rate could be as high as 5% to 6% but considered full employment rate for them. For Singapore, the full employment rate is considered achieved when our unemployment rate is about 2 to 3%.

Therefore, full employment refers to a non-zero, low rate of unemployment that is compatible with price stability, when all those who are able and willing to work have gained employment.

Question 9

Measuring Unemployment

Answer 9

Unemployment can be expressed as an absolute number (e.g. 500,000 people unemployed) or as a percentage (e.g. 3% unemployment rate) of the labour force or working population.

With the definitions of unemployment and the labour force in mind, we can now attempt to derive the unemployment rate.

Unemployment Rate = (No. of unemployed / Labour Force) x 100%

Question 10

Consequences of Unemployment

Answer 10

A high unemployment rate has serious economic, psychological and social costs.

lt also has an adverse impact on consumers, producers and governments.

It is best to look at the adverse consequences from these 3 different perspectives

(1) Consumers: Reduced levels of consumption and lower standard of living
(2) Producers: Reduced production and investment
(3) Governments: Impact on economic growth, standard of living and government budget

Question 11

Cost of High Unemployment - Consumers

Answer 11

Reduced levels of consumption and lower standard of living

The loss of jobs brings about reduction in income. As a result, purchasing power is reduced, and (induced) consumption on goods and services falls. Hence material standard of living is lowered.

In the event of prolonged unemployment, consumers (workers) may lose touch of their skills and knowledge, reducing their ability to gain employment. In addition, workers without regular employment not only lose their financial security, they may also suffer from loss of self-esteem, stress and become discouraged, demoralised, which often result in suicides and mental illness.

Unemployment also appears to be linked to a greater incidence of crime, violence on streets, drug abuse, alcoholism and vandalism. These are the social costs (intangibles) reducing their non- material standard of living.

Question 12

Cost of High Unemployment - Producers

Answer 12

Reduced levels of profits and investment

The lower consumer demand for goods and services from the unemployed reduces firms’ profit margins.

At the same time, the poor business sentiments, higher crime rate and social instability may reduce the investor confidence in the economy and discourage investment.

Question 13

Cost of High Unemployment - Government

Answer 13

Economic growth, living standards threatened, Government budget deficit

With unemployment, the economy faces a contractionary effect. There are several reasons:

Unemployment reduces (autonomous) consumer and investor confidence of the economy and this reduces consumption and investment in the economy. This could lead to a fall in AD and via the reverse multiplier, the economy’s actual output can fall till it is significantly lesser than its potential output. Potential economic growth is also slower due to the fall in I, thus the country is forgoing the opportunity to grow at a faster rate, and the consequent ability to enjoy better material living standards (both currently and in future).

Unemployment reduces the tax revenues earned by the government due to the loss in income since the unemployed can no longer pay income tax. Consumers are also more prudent in their spending, so collection of consumption tax (e.g. GST) is reduced. Due to lower production levels, firms make less profits and so tax revenue from corporate tax also falls. The fall in tax revenue would mean the government would have fewer funds available for infrastructural development which would hinder economic growth. Moreover for countries with a welfare system, the government needs to spend on welfare payments. If the government is already running a budget deficit, the loss in tax revenue could lead to a cut in budget spending which in turn will exert a contractionary impact on the economy, further worsening unemployment.

A country’s labour force may be affected: Those who have been unemployed for a prolonged period of time may lose their skills. Moreover, the unemployed may leave the labour market due to lack of motivation to find work. This lowers the economy’s productive capacity.

To sum up, the economic costs of high unemployment boil down to slow growth relative to the economy’s potential and the forgoing the opportunity to enjoy better overall standard of living. In some cases, it leads to widespread endemic poverty e.g. poor undeveloped countries in the world.

Question 14

Benefits of Low Unemployment

Answer 14

Ultimately, low unemployment means more efficient use of human resources. This will result in a gain in actual output (higher material standard of living). There will also be less of a drain on government revenues for unemployment benefits, and the government revenue can be used for other purposes such as improving infrastructural development and enhancing the education system which aids potential growth. With a high employment rate, there is both economic and social-political stability.

Question 15

Cause of Unemployment

Answer 15

A steep slowdown in growth causes demand to decrease and firms find they cannot sell all their current output, and stocks pile up. Firms will then adjust to the lack of demand by cutting back on production and hire fewer workers, leading to an increase in demand deficient unemployment. 

With a recession, aggregate demand decreases and the fall in output by firms will result in cyclical unemployment. 

Question 16

Causes of Structural Unemployment

Answer 16

The fundamental root cause of structural unemployment is skills mismatch. Job-seekers cannot find a job as they do not have the skills to fit the available requirements.

There are several underlying causes why skills mismatch may happen such as:

Technological advancement

Structural unemployment arises when changes in technology or international competition change the skills needed to perform jobs or change the location of jobs. People made redundant in one sector of the economy cannot immediately find jobs elsewhere because they either do not have the necessary skills or are unwilling to move to another area/region where prospects are better (occupational and geographical immobility of labour respectively).

Such structural changes can arise from the demand side or supply side:

If there is a permanent fall in the demand for the product of a particular industry, the output will have to be reduced and unemployment will result.

If supply of resources is not forthcoming, e.g. due to the depletion of mineral or forest reserves, unemployment will also result.

If more capital is used to substitute for labour (e.g. automation), unemployment can also result. This is known as technological unemployment.

Technological unemployment is a special case of structural unemployment, resulting from the successful growth of new industries using labour-saving technology. In contrast to mechanization

(workers operating machines), which has usually increased the overall demand for labour, automation (machines operating other machines) reduces the demand for labour. Whereas the growth of mechanized industry increases employment, automation of production can lead to the shedding of labour, even when industry output is expanding.

Globalisation: Outsourcing and Offshoring 

Emergence of new rivals like China in the global market have led to the loss of comparative  advantage for other countries such as USA and EU which previously were producing low-end labour intensive goods e.g. toys, textiles, shoes for exports.

China has a comparative advantage because of its cheap labour and land which best suits the production of such low-end manufactures. Moreover, China has also become a cheap production base for world’s auto-makers and other high end electronic products like smartphones and computers. Now, many firms relocate their production facility to take advantage of cheap labour and land in China.

Beside offshoring, there is also the phenomenon of services moving overseas which is termed as outsourcing, which involves contracting tasks to another company, which can provide the same service cheaper. Many MNCs have outsourced their call-services to India’s call-centres.

Note: Outsourcing, which involves contracting parts of the manufacturing process to other companies (within the country or in another country), is different from off-shoring, which involves relocation by a firm from one country to another.

As a consequence, low-skilled workers in countries like USA and EU found their jobs taken away by firms overseas. Unless they are able to reskill and fit into other available jobs these workers in

developed countries will face the problem of structural unemployment.

Question 17

Policies for Structural Unemployment

Answer 17

Supply-side policies

Retrain existing workforce to fit into other available jobs in the economy

Restructure economy to create new jobs for the workforce to replace old jobs loss.

Protectionism

If structural unemployment is caused by the permanent fall in demand of the country’s product due to increased competition from foreign producers, protectionism can be used to protect the country from these foreign competitors.

For example, a tariff can be imposed making imported goods more expensive resulting in domestic consumers turning to goods produced by domestic firms thereby enabling the domestic firms to survive and continue employing workers.

Question 18

Causes of Frictional Unemployment (2)

Answer 18

The root cause of frictional unemployment is the time associated with searching for a suitable job: 

Two basic reasons:

(1) Lack of information

Job-seekers generally do not know who is hiring and prospective employers do not know who is interested in filling existing job vacancies. Typically, there are 2 categories of job seekers - the first category are those who are already in the labour force (employed) but seeking greener pastures or change in work environment. These job seekers are said to be “ in-between jobs” - moving from one job to another.

The second category are the new entrants to the labour force - school leavers and fresh graduates. These job-seekers are looking for a job for the first time. Naturally, they form the bulk of job-seekers and also they are more likely to spend more time to look for available vacancies in the job market, to apply, attend interviews etc. In the meantime, these job-seekers are said to be frictionally unemployed.

(2) Expectations mismatch

Not every job-seeker will accept the first job offered. Typically job-seekers have so-called job expectations related to a job offer such as pay, working conditions, distance from home, promotion prospects etc. Unless the expectations of prospective employers and employees matches, the job-seeker might not want to take up an initial job offer. Meantime, the job-seeker is said to be frictionally unemployed.

The length of search time can be worsened by other factors such as unemployment benefits, parental support and mindset of job seekers. For instance, if the state provides generous unemployment benefits or if parents are willing to support their non-working adult children, jobseekers will tend to be more selective and hence prolong the period of search.

Question 19

Policies of Frictional Unemployment

Answer 19

Provide Job information

To deal with frictional unemployment, policies that focus on improving labour market information would help improve efficiency in the labour market. 

For example, in the US, state governments set up websites to help collate potential employees’ details and match them to the needs of prospective employers. 

Other examples include job fairs that the Community Development Councils in SG regularly to bring together employers of the same industries to hold a mass recruitment exercise where workers can seek out their most suitable jobs. 

Moderate Job Expectations 

In countries where there are generous unemployment benefits, a reduction of these benefits could help raise the opportunity cost of being unemployed, giving the frictionally unemployed greater urgency to re-enter the work force.

Another means to moderate job expectations is to provide job counselling. 

Others

Provide good and affordable transportation system so that workers are willing to travel anywhere to work.

Decentralised workplaces to minimise transport issues. Offices, industrial parks are located or spread out in various regional locations (e.g. Tampines, Woodlands, Jurong) and not just concentrated in one location e.g. CBD (central business district).

Question 20

Cause + Policies of Seasonal Unemployment

Answer 20

Unemployment that varies with the season or weather e.g. workers in the construction industry during winter, ski instructors are jobless in summer, fruit pickers being laid off during the non-harvesting season etc. All these predominately happen in temperate countries. Hence, the industries that are likely to be affected by seasonal trades include building, tourism and agriculture. Seasonal unemployment is usually not a serious problem unless the economy is heavily dependent on industries that have a seasonal demand.

Not much can be done by the government for seasonal unemployment. For a country that is heavily dependent on seasonal demand, perhaps the strategy is to diversify its industries in the long run.