In economics, everything finally comes back to unemployment. However much attention the experts and politicians pay to a country’s gross domestic product, inflation, interest rates or wealth, the simple question of whether people do or do not have jobs remains central. The objective of full employment is usually one of the first manifesto pledges made by political parties around the world—though the extent to which they stick to such a promise can vary wildly.
Governments’ resolve to tackle unemployment is understandable, given the trauma associated with losing one’s job, yet it is the ability of companies to hire and fire as they evolve that makes the free market such a dynamic way to run an economy. If a real-estate agent sees its business drying up amid a housing slump, it can try to economize by cutting back on marketing or office costs, but these are as nothing compared with the savings it can make by laying off staff. It is the interplay between these two forces—the government’s desire to see as many people in work as possible and companies’ need to stay afloat—that shapes not just the labor market but the fate of the wider economy.
A tale of two labor markets Compare the experience of Europe and the United States. In most of Europe, labor-market laws restrict a company’s ability to fire its workers and ensure that it pays employees a minimum wage. But, as US Economist Thomas Sowell put it in his work Basic Economics, “Job security policies save the jobs of existing workers, but at the cost of reducing the flexibility and efficiency of the economy as a whole, thereby inhibiting the creation of new jobs for other workers.” Because of this, Europe has tended to create jobs at a far slower rate than the United States, where the labor market is significantly more flexible.
Unemployment pays
All too often governments can actually encourage people to remain unemployed by making their unemployment insurance more attractive than it ought to be.
A study by Harvard economist Martin Feldstein showed that for some people it pays not to have a job. Consider someone who could work for $10 an hour or collect unemployment benefit of $8 an hour. On the benefit they pay tax of 18 percent, and so receive $6.56 after this has been deducted. If that person were working, he or she would pay 18 percent income tax and 7.5 percent in social security contributions, leaving him or her with a net salary of $7.45. Comparing this with what they would receive if they claimed benefit, one may well decide that a day of leisure is worth more than the extra 89 cents an hour the job would pay. Governments are constantly trying to strike a balance between encouraging people to get back into work and compensating them for losing their jobs.
Definition of unemployment In its very broadest sense unemployment simply means the state of not having a job. However, for economists this is an inadequate definition. There is a big difference between a temporary office worker who is merely between jobs for a few weeks (“frictional unemployment”) and a factory mechanic whose skills are no longer in demand because his industry has moved most of its production overseas. The former will soon be back in work contributing to private-sector economic output; the latter may need to be retrained, often at the expense of the state over a significant period of time.
Unemployment rates
(percentage of working population) at the end of 2008
France 7.9
United States 7.6
Germany 7.2
United Kingdom 6.3
Japan 3.9
Source: Office for National Statistics
To try to distinguish between different situations, economists have devised various classifications of unemployment. According to the International Labour Organization (ILO) the strict definition of unemployment is when someone is out of work but actively seeking to get back into the labor market. The percentage of workers in the US who met this description in 2008 was 6.5 percent, compared with 5.6 percent in the UK and 7 percent in the European Union. There is another category for those who are long-term unemployed, which is usually a far bigger proportion (at 21 percent in the UK) since it includes students, pensioners, stay-at-home mothers and those who are too sick or disabled to work. Economists also distinguish between the ages of those who are employed—and with good reason. Studies show that if you are out of a job for a long period in your teens or early twenties you are much more likely to slip into the ranks of the long-term or permanently unemployed thereafter.
Measures of joblessness There are two ways to measure unemployment. The traditional way is to count the number of people claiming unemployment benefits. The problem with this is that not everyone who is out of work and looking for a job will claim these payments—often for reasons of pride, occasionally due to apathy, and sometimes because they suspect they are not eligible. The modern, and arguably more comprehensive, way to measure unemployment is to survey a representative slice of the population—in the UK this consists of 60,000 people from all backgrounds—on their current working situation.
Unemployment levels tend to ebb and flow along with the wider economy. In the United States during the Great Depression they hit levels of 25 percent. However, the jobless rate never drops to zero. In fact, for all governments’ good intentions about bringing down unemployment, the rate has rarely dipped beneath 4 percent of the working population, even when the economy has been powering ahead.
In practice, full employment is impossible, partly because people need time to seek out the right job even when it’s available and partly because, as an economy develops and technology advances, some workers will inevitably lack the skills necessary to take on particular jobs. Often, unemployment is higher than it would otherwise be because, owing to minimum-wage laws or the wage-bargaining power of unions, firms have to pay their workers higher wages than they can strictly afford. Similarly, the existence of unemployment benefit can encourage some to remain unemployed rather than work. Countries therefore have what economists call “the natural rate of unemployment”—quite simply, the long-run average unemployment rate.
One of Britain’s most famous economists, A.W. Phillips, detected an uncanny relationship between unemployment levels and inflation. If unemployment falls below a certain level, it will push wages, and hence inflation, higher as companies become prepared to pay more to get hold of staff. The opposite is true with high unemployment, which tends to push down inflation. In economic parlance, there is a negative correlation between inflation and unemployment. Phillips’s theory gave birth to one of the most enduring models in economics—the Phillips Curve, which graphically illustrates this negative correlation. If you want to keep unemployment at, say, 4 percent, then—it shows—you will have to settle for inflation of 6 percent. If you want to restrict inflation to 2 percent, you will have to accept an unemployment level of 7 percent.
“Probably the single most important macroeconomic relationship is the Phillips Curve.”
George Akerlof, Nobel Prize-winning economist
Together with Edmund Phelps, renowned economist Milton Friedman took this idea a step further, devising the theory of the “non-accelerating inflation rate of unemployment” (NAIRU). The thrust of this is that although policymakers can follow the Phillips Curve to bring down unemployment in the short run, eventually unemployment will creep back up toward its natural rate (meanwhile efforts to boost the economy by cutting interest rates will generate extra inflation, but that’s another story).
Politicians still promise people more jobs and higher employment than is realistic. However, it is up to economists to come up with the dismal retort that full employment is practically impossible.
the condensed idea
Zero unemployment is impossible
| timeline | |
|---|---|
| 1933 | Unemployment in the US hits 25 percent during the Great Depression |
| 1970s | Unemployment rises sharply in the face of oil shocks |
| 1979 | Conservative Party is voted into power in the UK following an advertising campaign proclaiming: “Labour Isn’t Working” |