The Unemployment Rate in Europe - Case Study Example

Section Unemployment The unemployment rate is an important indicator of aggregate economic performance. It refers to the percentage of unemployed individuals as part of the total labour force, representing a fraction of unutilised human resources within the economy. However, even at full employment where an economy is said to be utilising all available labour to its full potential, such that it would be operating within its production possibility frontier (PPF); free-market economies still experience unemployment, such that at any given period, there will always be a percentage of the labour force separated from their job or unable to find employment. In this respect, unemployment arises not because of a shortage of available jobs or of an overflow of available labour, but as a result of imperfect information causing frictional unemployment or inefficient labour market structures causing structural unemployment. The unemployment level that persists even during periods of full employment when the market is in equilibrium is the natural rate of unemployment, which is a long-run indicator of unemployment where short-run fluctuations of unemployment rates gravitate around. It is also a level of unemployment where macroeconomic stability is achieved and the economy operates at full employment. Hence, full employment does not imply an unemployment rate equal to zero, rather an unemployment rate equal to the natural rate of unemployment, which is determined by the dynamics in the labour market. DIAGRAM 1. Unemployment and the Natural Rate of Unemployment Source: Mankiw, N G 2003, Macroeconomics, 5th Ed, Worth Publishers, New York, p. 156. For the labour market to operate efficiently however, it is expected to operate at equilibrium, where the unemployment rate is also equal to the natural rate of employment. In the short-run, however, unemployment may rise or fall as a result of fluctuations in the business cycle that may cause industries to expand or contract. Looking at a model of labour demand and supply, a decrease in demand shifts the demand curve to the left causing equilibrium to move to a new point, implying full employment at a lower wage level. However, since real wages are rigid the labour market will not adjust to the new point of equilibrium causing disequilibrium, such that demand-deficient unemployment transpires, as a result. Hence, demand-deficient unemployment is unemployment that results from a deficiency of employer’s demand for labour caused by a decrease in economic output, causing disequilibrium in the labour market. Since labour is a derived demand such that it fluctuates together with fluctuations in aggregate economic demand, demand-deficient unemployment has been described as cyclical, mirroring the business cycle. Thus, policies that curtail aggregate economic demand such as fiscal policies aimed at limiting government spending and reducing consumption and monetary policies that set high interest and exchange rates and induces individual savings where demand is elastic, will have similar effects that will increase demand-deficient unemployment. Policies to reduce demand-deficient unemployment must therefore focus on expansionary fiscal policies to stimulate demand and induce spending. As mentioned, unemployment is present even at times of full employment due to the natural rate of unemployment. In this respect, the natural rate of unemployment consists of two types of unemployment – structural unemployment, which refers to the unemployment resulting from wage rigidity and job rationing as determined by labour market structures such as minimum wages, unions, and efficiency wages that creates a mismatch between the type of available jobs and the abilities of available workers in the market; and frictional unemployment, which refers to the unemployment that arises as a result of a dynamic labour force affected by imperfect information, geographic mobility, and occupational immobility within the labour market, renders job search to be non-instantaneous. Frictional and structural unemployment are therefore supply-side causes of unemployment, such that going back to the supply and demand model, either rigid wages will prevent the market from reaching zero unemployment at a lower wage level, or those separated from their jobs do not find new jobs instantaneously. Hence, supply-side policies aimed at reducing structural or frictional unemployment must therefore alter the aggregate supply of labour by reducing information asymmetry or removing constraints that cause wage rigidities and prevents workers from adapting to structural changes in the market. By affecting either frictional or structural unemployment, supply-side policies therefore affect the natural rate of unemployment. However, since these policies can have a direct effect on the wage level of workers, in the form of minimum wage laws and efficiency wages, or an indirect effect through labour union bargaining and unemployment insurance, such policies therefore will consequent effects on the amount of inflation in the economy, as well. Section 2: UK Unemployment Looking at the historical trend of unemployment rates in the United Kingdom, unemployment has become a pervasive economic problem in the country from 1975 until the early 1990s. Beginning with low unemployment rates ranging from 3 to 4 percent between 1970 and 1974, unemployment has risen in the wake of the major economic recessions reaching peaks of 6 percent in 1978, a high of almost 12 percent in 1985, and around 11 percent in 1993, before gradually decreasing in 1994 and settling at around 5 percent since 2000, which is similar the rates in the mid-1970’s. UK unemployment has therefore been largely responsive to the macroeconomic fluctuations caused by the three major European recessions, such that UK unemployment has been largely demand-deficient. However, it should also be noted that while unemployment has been largely demand-deficient unemployment, the surges in unemployment rates, with exception of the 1990 recession, followed a cycle that ended with higher levels of unemployment prior to each recession, indicating an increasing natural rate of unemployment. The short-run effect of demand-deficient unemployment therefore has an enduring effect on its natural rate in the long-run. The periods of recession affecting UK unemployment from 1974 to 1993 however, were not an isolated national problem. Looking at the experience of other developed countries, the rise and fall in unemployment rates mimicked the same macroeconomic shocks, such that France, Germany, OECD, the United Kingdom, and even the United States illustrated similar fluctuations in unemployment rates, with European countries increasing more than others. However, whereas the US and the UK escaped rising unemployment rates by the 1980s for the US and the early 1990s for the UK, such that by 1995 unemployment began to steadily decrease in the UK settling at a level similar to that of the 1970s at 5 percent; the OECD, France, and Germany illustrated a rising trend. On one hand, this illustrates the ability of the US and the UK to generate new jobs and reduce structural unemployment and the overall natural rate of unemployment. On the other hand, the rising trends in France, Germany, and OECD countries illustrates the ability of supply-side policies to increase or decrease the natural rate of unemployment, such that by implementing inflationary policies that increases unemployment insurance and minimum wage requirements, and strengthens the bargaining position of labour unions, these countries discourage working and decreases the demand for labour increasing the amount of structural and demand-deficient unemployment.1 This contrasts with the UK where unemployment benefits did not increase as high, preventing the same rigidities that precipitated high unemployment rates across Europe.2 Hence, whereas exogenous factors have triggered demand-deficient unemployment sharply increasing unemployment rates across Europe and the US; endogenous factors through the choice of policies have allowed both the US and the UK to diverge from the pervasively high unemployment rates of France, Germany, and OECD countries and bring unemployment rates to its previous low levels similar to that of the 1970s, preventing the steep rise in structural unemployment. An exception to these trends is Japan where unemployment remained steadily low at rates between 1 and 6 percent since 1970, which although gradually increasing, managed to stay unaffected by exogenous macroeconomic shocks. In this respect, one can look at Japan’s ability to increase employment, allowing it to insulate itself from the exogenous shocks afflicting other developed countries3. The ability to create new employment is also evident in the US and the UK, illustrating a sharp contrast with France, Germany, and European countries in general, where the ability to create employment has decreased since the 1970s. Hence, whereas the aforementioned countries, with exception of Japan, suffered the same macroeconomic exogenous shocks that triggered sharp increases in unemployment, correct policy choices have allowed countries like the US and the UK to prevent further increases in unemployment and reduce the natural rate of unemployment. Whereas France, Germany, and OECD responded with policies that precipitated market rigidities in the long-run, these policies together with the inability to produce new employment has allowed the unemployment rates to soar at historically high levels. This is in contrast with the UK where policies focused on structural changes that lower unemployment, thus resolving structural unemployment and lowering the natural rate of unemployment allowing it to return to lower rates at the 1970 level. In this respect, whereas France, Germany and OECD countries still face high levels of demand-deficient unemployment caused by exogenous shocks and an increased level of structural unemployment as a result of inflationary supply-side policy choices, the UK’s policy problems insofar as unemployment is concerned has diminished to resolving demand-deficient unemployment and some traces of structural unemployment. References Cameron, D, 2001, ‘Unemployment, Job Creation, and Economic and Monetary Union’ in N Bermeo (ed.) Unemployment in New Europe, Cambridge University Press, Cambridge, UK. Higgs, R 1998, ‘Etceteras: A Tale of Two Labour Markets’, The Independent Review, vol. 11, no.4, p. 625-630. Mankiw, N G 2003, Macroeconomics, 5th Ed, Worth Publishers, New York. Saint-Paul, G 2004, ‘Why are European Countries Diverging in their Unemployment Experience?’, Journal of Economic Perspectives, vol. 18, no.4, pp. 40-68. Read More