BUS 530: ECONOMIC CONDITIONS ANALYSIS

1. BUS 530: ECONOMIC CONDITIONS ANALYSIS LECTURE 6: Unemployment LECTURE 6 Unemployment

2. Contents • Economic classification of population and measurement of unemployment • Working of the labor market • Natural rate of unemployment • Types of unemployment • Causes of unemployment and policy response

3. Learning Objectives • Understand the working of the labor market and factors contributing to unemployment • Learn about macroeconomic policies for reducing unemployment

4. Composition of Population in terms of Economic Status

5. Definitions used in Bangladesh Employed: A person who was either working during the previous week for one or more hours for pay or profit or working without pay in a family farm or enterprise during the week or found not working but had a job or business from which he/she was temporarily absent during the week

6. Definitions used in Bangladesh Unemployed: A person who is involuntarily out of gainful employment during the reference period but either has been actively looking for a job or was willing to work but not looking for work because of illness

7. Important Formulae Crude Activity Rate = Labor Force * 100% Population Refined Activity Rate = Labor Force * 100% Population ≥ 15yrs Unemployment Rate = Unemployed * 100% Labor Force

8. Labor Force Survey 2005-06

9. Natural Rate of Unemployment • The unemployment rate: the fraction of the civilian workforce that is unemployed • The “Natural” rate of unemployment: The average or long-run rate of unemployment around which the economy fluctuates. • In a recession, the actual unemployment rate rises above the natural rate. • In a boom, the actual unemployment rate falls below the natural rate. LECTURE 6 Unemployment

10. Natural Rate of Unemployment • 5-6% for the developed economies • Exists in the developing economies as well • Difficult to get rid of this type of unemployment • Thus when a country has 5-6% of unemployment, it is considered to be fully employed

11. Unemployment rate Natural rate of unemployment Actual and Natural Rates of Unemployment in the U.S., 1960-2006 12 10 8 Percent of labor force 6 4 2 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 LECTURE 6 Unemployment

12. Bangladesh Unemployment Rate LECTURE 6 Unemployment

13. Labor Force and Unemployment Rate Notation: L = workers in labor force E = employed workers U = unemployed workers U/L = unemployment rate LECTURE 6 Unemployment

14. Assumptions: 1. L is exogenously fixed (no population growth). 2. During any given month, s = fraction of employed workers that become separated from their jobs s is called the rate of job separation f= fraction of unemployed workers that find jobs fis called the rate of job finding s and fare exogenous LECTURE 6 Unemployment

15. s E f U The Transitions between Employment and Unemployment Employed Unemployed LECTURE 6 Unemployment

16. Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant. The steady-state condition is: # of employed people who lose or leave their jobs # of unemployed people who find jobs The Steady State Condition sE =f U LECTURE 6 Unemployment

17. Finding the “equilibrium” Unemployment Rate f U =sE =s(L –U ) =sL –sU Solve for U/L: (f + s)U = sL so, LECTURE 6 Unemployment

18. The “Natural” Rate of Unemployment • Therefore, the natural rate of unemployment is defined as: LECTURE 6 Unemployment

19. Class Exercise • Suppose • 1% of employed workers lose their jobs • 19% of unemployed workers find jobs • Find the natural rate of unemployment LECTURE 6 Unemployment

20. Answer • Each month, • 1% of employed workers lose their jobs (s = 0.01) • 19% of unemployed workers find jobs (f = 0.19) • The natural rate of unemployment: LECTURE 6 Unemployment

21. Any policy aimed at lowering the natural rate of unemployment must either reduce the rate of job separation (s) or increases the rate of job finding (f). Similarly, any policy that affects the rate of job separation (s) or the rate of job finding (f) also changes the natural rate of unemployment, Because: Policy Implications LECTURE 6 Unemployment

22. Why is there Unemployment? • If job finding were instantaneous (s = 0, f = 1), then all spells of unemployment would be brief, and the natural rate would be near zero. • There are two reasons why f < 1 and s > 0: 1.job search 2.wage rigidity LECTURE 6 Unemployment

23. Job Search & Frictional Unemployment • Frictional unemployment: The unemployment caused by the time it takes workers to search for a job • Occurs even when wages are flexible and there are enough jobs to go around • Occurs because • workers have different abilities, preferences • jobs have different skill requirements • geographic mobility of workers not instantaneous • flow of information about vacancies and job candidates is imperfect LECTURE 6 Unemployment

24. Sectoral Shifts • defintion: Changes in the composition of demand among industries or regions. • example: Technological changemore jobs repairing computers, fewer jobs repairing typewriters • example: A new international trade agreement labor demand increases in export sectors, decreases in import-competing sectors • Result: frictional unemployment LECTURE 6 Unemployment

25. Structural change over the long run - US LECTURE 6 Unemployment

26. Structural Change in Employment: Bangladesh LECTURE 6 Unemployment

27. More examples of Sectoral Shifts • Late 1800s: decline of agriculture, increase in manufacturing • Late 1900s: relative decline of manufacturing, increase in service sector • 1970s: energy crisis caused a shift in demand away from gas guzzlers toward smaller cars. LECTURE 6 Unemployment

28. Public Policy and Job Search Govt programs affecting unemployment • Govt employment agencies:disseminate info about job openings to better match workers & jobs. • Public job training programs:help workers displaced from declining industries get skills needed for jobs in growing industries. LECTURE 6 Unemployment

29. Unemployment insurance (UI) • UI pays part of a worker’s former wages for a limited time after losing his/her job. • UI increases search unemployment, because it reduces • the opportunity cost of being unemployed • the urgency of finding work • Rate of job finding, f • Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment. LECTURE 6 Unemployment

30. Benefits of UI • By allowing workers more time to search, UI may lead to better matches between jobs and workers, which would lead to greater productivity and higher incomes. LECTURE 6 Unemployment

31. Unemployment Benefits • Provided in developed countries • Eligibility excludes new entrants to the labor force and those giving up job voluntarily • Raises aggregate demand and contributes toward early recovery of an economy from recession

32. Why is there Unemployment? • Two reasons why f < 1: 1.job search 2.wage rigidity The natural rate of unemployment: DONE Next LECTURE 6 Unemployment

33. Supply Real wage Unemployment Rigid real wage Demand Labor Amount of labor hired Amount of labor willing to work Unemployment from Real Wage Rigidity & Structural Unemployment If real wage is stuck above its equilibrium level, then there aren’t enough jobs to go around. LECTURE 6 Unemployment

34. Unemployment from Real Wage Rigidity If real wage is stuck above its equilibrium level, then there aren’t enough jobs to go around. Then, firms must ration the scarce jobs among workers. Structural unemployment: The unemployment resulting from real wage rigidity and job rationing. LECTURE 6 Unemployment

35. Reasons for Wage Rigidity 1. Minimum wage laws 2. Labor unions 3. Efficiency wages LECTURE 6 Unemployment

36. The Minimum Wage • The minimum wage may exceed the equilibrium wage of unskilled workers, especially teenagers. • Studies: a 10% increase in min. wage reduces teen employment by 1-3% • Tendency for firms to substitute towards illegal workers (who are not bound by the min. wage) • But, the minimum wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the minimum wage. LECTURE 6 Unemployment

37. Minimum Wage Law • It is enacted in almost every country so that forces cannot drive it down too low. • When wages are pushed up to the level of w*, unemployment to the extent bc is created, since supply exceeds demand. • In addition, there is also unemployment to the extent of cd, which is due to people looking for better jobs

38. Labor Market

39. Labor Unions • Unions exercise monopoly power to secure higher wages for their members (collective bargaining). • When the union wage exceeds the equilibrium wage, unemployment results. • Insiders: Employed union workers whose interest is to keep wages high. • Outsiders: Unemployed non-union workers who would be willing to work for lower wages, so there would be enough jobs for them. LECTURE 6 Unemployment

40. Collective Bargaining by Labor Union • Every country legalizes labor union activity to prevent excessive exploitation of labor by the employer • Experiences have shown that if politicization of labor union can be avoided and labor unions abide by the rules of the game then union activities can contribute towards congenial industrial relations

41. 8.5% 122.3 40.5 121.7 13.8 156.9 9.5 113.7 13.7 107.8 5.8 114.0 24.4 129.2 2.1 90.7 3.1 90.6 15.4 112.7 8 115.1 Union Membership and Wage RATIOS by Industry, 2005 industry # employed (1000s) U % of total wage ratio Private sector (total) 105,508 Government (total) 20,381 Construction 8,053 Mining 600 Manufacturing 15,518 Retail trade 14,973 Transportation 4,379 Finance, insurance 6,304 Professional services 10,951 Education 3,312 Health care 14,045 LECTURE 6 Unemployment wage ratio = 100(union wage)/(nonunion wage) slide 40

42. 3. Efficiency Wage Theory • Idea: higher wages increase worker productivity by: • Attracting higher quality job applicants (“Adverse Selection” problem) • Increasing worker effort, reducing “shirking” (“Moral Hazard” problem) • Reducing turnover, which is costly to firms • Improving health of workers: better nutrition & productivity (in developing countries) • Firms willingly pay above-equilibrium wages to raise productivity, causing structural unemployment. LECTURE 6 Unemployment

43. LECTURE 6 Unemployment

44. Other Types of Unemployment and Macroeconomic Policies LECTURE 6 Unemployment

45. Cyclical Unemployment • Y* represents full employment output level • Sometimes national output falls due to a fall in demand, this is called recession. Labor demand declines, additional unemployment to the extent of ee* • This is called cyclical unemployment

47. Stabilization Policy • Developed countries can stabilize cyclical unemployment through expansionary monetary or fiscal policies • Expansionary monetary policy increases credit supply which raises aggregate demand. An expansionary fiscal policy on the other hand reduces taxes

48. Disguised Unemployment • Developing countries are generally not close to the full employment level. Here, unemployment does not occur due to periodic demand shortfall. These countries, like Bangladesh suffer from disguised unemployment.

49. Structural Unemployment • Large scale unemployment caused by low productive capacity • Unlike cyclical unemployment, structural is of long-term nature • Reduction of structural unemployment requires expansion of productive capacity which takes time

50. Seasonal Unemployment • Periodic Unemployment • Agricultural workers suffer unemployment during agricultural lean seasons. Workers in developed countries can however easily switch skills to meet varying labor demands • Can also be countered through government intervention