Unemployment
Lecture notes
Dan Anderberg
Royal Holloway College
January 2003
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Unemployment
² Why are some workers unemployed?
² No unemployment in the standard supply-demand model.
Fig 3.1
² However, unemployment does exists:
Fig 3.2
² Fundamental question: How can we understand the existence of unemployment?
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Why is unemployment so important?
² Lost production
² Uncertainty and personal loss of well-being
3
Some facts about unemployment that need to be explained
3.1
Changes in long run unemployment
² Most countries have experienced long-term increase in unemployment since the 1960s.
² Particularly continental Europe.
Fig 3.3
Question: What can explain:
² The secular changes in unemployment?
² Di¤erences in unemployment rates across countries?
Some factors may be:
² Unemployment bene…ts becoming more generous up to about 1980 (Not in the US)
² Wage determination – growth of union coverage (Not in the US)
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3.2
Increase in long-term unemployment
Fact: Key di¤erence between European and American unemployment:
² Length of unemployment spells:
– Longer spells in Europe than in US
– Larger ‡ows in US than in Europe
3.3
Unemployment relative to vacancies has gone up
² Ratio of no. unemployed workers to vacancies has gone up in many countries.
² Says something about how well the market works
Question: What has caused the increase?
² Less search by unemployed
² Increased mismatch between skills demanded and supplied.
3.4
Unemployment rates vary across groups
Varying by the following:
² Age (young are more unemployed than older workers)
² Gender
² Geographic region, e.g. north v. south.
² Ethnic origin
– Lowest among white
– Black, Pakistani/Bangladesh considerably higher
² Skill level: manual workers are more unemployed than professional/managerial
– Di¤erence has become more marked since 1970s
– 16% for men without quali…cations in 1998.
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Can unemployment be understood from a standard supplydemand model?
Fundamental question: Why do wages not go down?
Explanations: Two classes of explanations:
² Firms do not bene…t from reducing wages (“e¢ciency wages”)
² Unions prevent wages from falling
2
5
Questions considered today
Questions considered today
² What is meant by unemployment?
² How is it measured?
² What is the role of ‡ows and stocks?
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The meaning of unemployment
Question: Who should be counted as unemployed?
² The labour force L: Those people who are employed (E) and those who are unemployed (but
would like to be employed) (U).
² Government statistics: Unemployed = Temporary laid o¤ + actively searching
² Unemployment rate (u): Unemployed as fraction of labour force
u=
U
L
Question: Is the o¢cially reported unemployment rate “correct”?
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O¢cial measures of unemployment
7.1
Claimant unemployment
² Measures those who receive unemployment-related bene…ts (‘job-seeker’s allowance’).
² Main measure used in the UK until 1998.
² Easy to collect, but...
² ...exclude those available for work but not eligible for bene…ts.
² Thus a change in the eligibility conditions changes measured unemployment!
² Some 30 changes since 1979
Categories of people that are ineligible:
² People returning to the workforce (e.g. after raising children)
² Scho ol leavers without jobs
² The temporarily unemployed.
² People seeking part-time jobs as opposed to full-time work.
Conclusion: The claimant statistics may understate the true level of unemployment.
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7.2
Standardised unemployment rates
De…nition: People of working age who are without work, available to start work within two weeks and
actively seeking employment or waiting to take up an appointment.
² Used by ILO and OECD (facilitates international comparison)
² Compiled from National Labour Force Surveys
7.3
Which measure is likely to be higher?
Question: Is the standardised unemployment rate likely to be higher or lower than the claimant unemployment rate?
² Standardised unemployment rate is higher to the extend that it captures people not eligible for
unemployment-related bene…ts...
² ... but lower to the extent that some bene…t recipients are not actively looking for work.
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Stocks and ‡ows
In‡ow: People joining the pool of unemployed
² People made redundant
² People who voluntarily quit
² People who join the labour force
Out‡ow: People who leave the pool of unemployed
² People who …nd jobs
² Leave the labour force
Fig 3.4
² We have that L = E + U:
² Ignoring ‡ows to and from “out of the labour force”.
² Suppose that employed lose jobs at rate s; then in‡ow is sE.
² Suppose that unemployed workers …nd jobs at rate a; then out‡ow is aU .
² Then the unemployment rate u = U=L is stable (i.e. neither increasing nor decreasing) when in‡ow
= out‡ow
sE = aU
But E = L ¡ U so s (L ¡ U ) = aU and
u=
U
s
=
L
(a + s)
Fig 3.5
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² This is informative: the unemployment rate is high when the in‡ow rate s is large relative to the
out‡ow rate a.
Example: Manual and professional workers have similar out‡ow (job-…nding) rates. But manual workers
have a higher in‡ow rate (and thus higher unemployment rate).
Question: What about duration?
² Average duration of unemployment spell is 1=a.
² A proportional increase in s and a does not a¤ect the unemployment rate, but decreases average
duration.
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Equilibrium unemployment
Distinction sometimes used:
Frictional unemployment. The unemployment that occurs as a result of imperfect information in the
labour market. It often takes time for workers to …nd jobs (even though there are vacancies).
² Possible policy remedy: Placement services
Structural unemployment. The unemployment that arises from changes in the pattern of demand or
supply in the economy.
² Factors causing structural unemployment:
– Degree of regional concentration of industry
– The speed of change in the demand and supply in the economy
– The immobility of labour
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The Beveridge Curve
² The Beveridge Curve is another way of looking at unemployment in macro context.
² It takes a closer look at the relation between unemployment and vacancies.
Definition 1 The Beveridge Curve focuses on the e¢ciency of the labour market in matching unemployed job seekers with un…lled job vacancies.
² At the heart of the Beveridge curve is the idea of a matching function, relating the number of
matcher (per period) to the number of unemployed and the number of vacancies.
10.1
Theory
² Here’s one way to derive the Beveridge curve: Let
M = ®M (U; V )
where ® is a matching e¢ciency parameter, U is the number of unemployed, V is the number of
vacancies. (Think of M (¢; ¢) as a production function).
² Assume constant returns to scale (CRS)
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² Let sN be the ‡ow into unemployment (where N is the employed and s is the exogenous rate at
which they become unemployed).
² In steady state, the number going into unemployment = number leaving unemployment, i.e. sN =
M . Hence
sN = ®M (U; V )
Then, using CRS,
s = ®M
µ
U V
;
N N
¶
² Left hand side is …xed. Hence (given ®) when U=N goes up, V =N must go down.
² Thus there should be a negative relationship between the unemployment rate and that vacancy
rate.
Fig 3.6
² If the Beveridge curve were to shift outwards, we’d expect a shift in the long-run unemployment.
10.2
Why would the Beveridge Curve Shift?
² What would a¤ect the matching e¢ciency?
Three possibilities:
1. Employment protection legislation: can reduce employers’ willingness to hire.
2. Lower worker mobility : either occupational or geographic.
3. Active labour market policy (see later lecture): might improve matching.
4. The bene…t system : A¤ects the readiness of unemployed to …ll vacancies.
10.3
What has happened?
² For most countries, the Beveridge curves over the recent decades (since the 1960s), suggesting a
growing mismatch between vacancies and jobseekers.
² Eyeballing the data: marked deterioration in Europe with some very recent improvement.
Fig 3.7
² Using statistics to pick up trends: Nickell et al. (2002) use the following regression to …nd how the
BC has shifted:
ln u t = ® 0 + ® 1 ln u t¡1 + ® 2 ln v t + ® 3 t + ® 4t2 + ® 5 t3
where u t is the unemployment rate, vt is the vacancy rate, and t is time.
² Con…rms shift to the right (and some recent improvement).
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10.4
But what Explains the Shifts?
² Nickell et al. go further and estimate regressions of the following sort:
ln u it = ®it + ¯ 1 ln uit¡1 + ¯ 2 ln v it + ¯ 3 ln sit + °Zit + " it
where sit measures the in‡ow rate, and Z contains the “shifters” listed above.
² Findings:
– Unemployment bene…t duration reduces search intensity ! right shift.
– Owner-occupation rate reduces mobility ! right shift
– Employment protection ! left shift! (Surprising)
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Discussion questions
1. “Unemployment is high because real wages are too high”. Discuss.
2. Discuss problems in de…ning and measuring unemployment.
3. “There are always some vacancies, so any unemployment must be voluntary”. Discuss
4. Explain the distinction between stocks and ‡ows. How can di¤erent ‡ow-levels generate the same
level of unemployment?
References
Layard, R., Nickell, S. & Jackman, R. (1991), Unemployment, Oxford University Press, Oxford.
Nickell, S., Nunziata, L., Ochel, W. & Quintini, G. (2002), ‘The Beveridge curve, unemployment and
wages in the OECD from the 1960s to the 1990s’. Mimeo, Centre for Economic Performance, London
School of Economics and Political Science.
Smith, S. W. (1994), Labour Economics, Routledge, London.
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