fa_p10-16 vol4-4 prolonged unemployment

10 THE UNEMPLOYMENT ISSUE THE UNEMPLOYMENT ISSUE 11

SKILLS CONTENTBUSTER ESSAYS ARTICLES

Unemployment soared in the developed economies after 2007 (see Figure 1) as GDP growth collapsed and even fell negative. From Figure

2, we see how unemployment and GDP growth of the UK, the US, and Euro Area varied. As the economy contracts and output falls, firms fire more workers than they hire as they are expecting to produce less while goods surpluses are still idling in warehouses without any prospects of

FIGURE 1 UNEMPLOYMENT IN SELECTED ECONOMIES (2004–2009)

For GDP growth to turn negative means that the dollar value of GDP was in fact shrinking. When economies experience six consecutive months of fall in GDP or negative growth, we term the situation to be a recession.

Source: World Bank World Development Indicators


MACROECONOMICS

What is considered long term unemployment? What are the causes of long term unemployment? Why long term unemployment is considered harmful to society? Are there any differences in the causes of long term unemployment between countries? What are some of the solutions that governments are attempting to deal with long term unemployment?

KEY POINTS OF QUERY

being sold. Officially, the ‘Great Recession’ is taken to be the period between December 2007 and June 2009. Over that a year and half, the economy of the USA alone lost 8.4 million jobs.

Economists normally understand unemployment as a flow rather than a stock of workers. High unemployment simply suggests that more people are being separated from their jobs relative to jobless people finding work. While there might be a proportion of the labour force unemployed

at any one time, the actual individuals unemployed are different, reflecting that people enter and leave jobs continuously. Yet there is an increasing proportion of this ‘dynamic pool’ that is actually stagnant. It is thus necessary to distinguish between short-term unemployment and long-term unemployment.

Short-term unemployment refers to labour without work because they are transiting between jobs. It could be a voluntary break of a few months or an involuntary one resulting from frictions in the labour market involving a

FIGURE 2 UNEMPLOYMENT AND GDP GROWTH FOR THE UK, THE USA AND THE EURO AREA

At the depth of the recession, countries such as Spain experienced 18% unemployment rates. That is nine times higher than the 3% unemployment rates that indicate a healthy economy.

search. In any case, even if it’s involuntary, the phase of unemployment is short and not expected to bring about any long-term consequences on the career or earnings of the worker.

Long-term unemployment, on the other hand, is defined as being in the

Source: World Bank World Development Indicators

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state of unemployment over a long period, often a year or more. As a convention, we define this period to be a year—a definition adopted by the World Bank’s dataset in the figures presented. We have come to realize that this turns out to be a rather relaxed definition, since the US Bureau of Labour Statistics defines this period to be six months or more (mainly because unemployment benefits expire after that). Whatever the time

period selected, the need to distinguish between short-term and long-term unemployment emerges from the fact that prolonged unemployment has a greater cost on society. More importantly, it has more detrimental consequences to individuals in this pool than in the case of short-term unemployment. As mentioned earlier and demonstrated in Figure 3, this pool of workers are increasing as a proportion of the total unemployed even as the percentage of unemployed in the labour force is expanding.

Traditionally, long-term unemployment is understood to be caused by structural shifts and labour market rigidities that

discourage employers from hiring and firing. Long periods of output contraction can also lead to long-term unemployment, such as during the Great Depression. As such, policy-makers have always believed that wise policies can prevent the problem of prolonged unemployment, yet the recent crisis seems to be changing this belief. In this article, we’ll explore the causes of the recent bout of prolonged unemployment, the consequences, and some of the potential options policy-makers may have to alleviate the problem.

STRUCTURAL OR DEMAND-DEFICIENT?Prior to the recent downturn, Europe had already been suffering from what was considered ‘chronic high unemployment’ involving a large proportion of unemployed that had been jobless for more than a year. Over the decade from 1999, the global economy suffered little major downturns and Europe saw several big economies, like Germany, France, Spain, and Italy growing steadily. Yet unemployment in these economies remained high, reflecting the structural nature this prolonged unemployment experienced. As the conventional rhetoric of American policy-makers suggests, the labour regulations in Europe disincentivize hiring as much as it seeks to prevent lay-offs. This creates a sort of ‘insider-outsider’ situation where labour is unionized

with high wages and good working conditions while the unemployed languish without jobs.

Generous unemployment benefits make it harder to cut unemployment as the ‘outsiders’ of the job market

become more fussy with the opportunities that come their way. As observed in Figure 3, more than 40% of the unemployed in the Euro Area were those without a job for more than a year. The subsequent fall observed was a result of a rising number of fresh unemployed following the crisis pushing up the unemployment figures sufficiently for the long-term unemployed to decline.

However, on the other side of the Atlantic in the US, the newly unemployed were increasingly suffering from the sort of prolonged unemployment that plagued the Europeans. This was brought about by the Great Recession and we naturally imagined that it must be a result of deficient demand for output in the economy. Indeed, when the crisis first struck, the greatest worry was that the heavily indebted would no longer be able to obtain credit to finance their expenditures, resulting in a lack of demand for goods and services. Households were not only forced to cut back consumption in order to repay their debts but were also encouraged to save and to reduce dependence on credit. This would suggest a significant loss of aggregate demand.

Yet even as output recovered and in the absence of the sort of labour market rigidities American politicians had always criticize, it turned out that the Great Recession was the beginning of a more fundamental structural shift as job recovery occurred in sectors of the economy that were growing all the while rather than established industries that shed the most jobs during the recession. As Figures 4 suggests, the job figures with the previously large

FIGURE 3 LONG-TERM UNEMPLOYED AS A PROPORTION OF TOTAL UNEMPLOYMENT

THE PROLONGED UNEMPLOYMENT WE OBSERVE IS THEREFORE A RESULT OF THE UNRESOLVED STRUCTURAL ISSUES COMBINED WITH A SLUGGISH RECOVERY DUE TO CREDIT CONTRACTION.

Even as the percentage of long-term unemployment falls from 2006 onwards for the Euro region, this may not be anything to celebrate. This is because despite a falling percentage of long-term unemployed, given that the total number of employed is increasing rapidly, it means then that the total absolute number of unemployed may actually be rising, boding a pessimistic situation that is contrary to what is shown by the percentages.

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Here we see one practical problem in using unemployment data collected, which is the definition of unemployed chosen. The data collected is directly influenced by the definition of long-term unemployed used.


MACROECONOMICS

will require significant retraining, even if they’re keen to take up a role in healthcare.

Besides, there’s also an issue of the wage differentials that were glaring during the boom. The relatively large size of the Health and Education sectors should obviously be able to accommodate a significant number of highly educated individuals leaving the Financial Services sector. Nevertheless, one would expect the loss in earnings to be too distasteful for them to bear. Many would rather

take on part-time employment while waiting for the finance industry to recover than to consider a career switch into teaching.

This issue plagues not only the US economy but also parts of the Southern European economy facing soaring unemployment (see Spain in Figure 1). The recession didn’t only result in deficiency in demand, but also exposed structural issues that had been accumulating in the economy but were masked by

the boom. Employers and governments took the opportunity to exercise greater austerity and prudence that, while enhancing efficiency and productivity, resulted in the dislocation of a huge proportion of the workforce. It is as

if these jobs were put on life support because there was enough growth generated to pay for it, but when the recession set in, the inevitable demise arrived. The prolonged unemployment we observe is therefore a result of the unresolved structural issues combined with a sluggish recovery due to credit contraction. The extension of unemployment benefits and other handouts that forms part of the stimulus package also aggravates the problem somewhat.

THE JOBLESS CROWDAs of late 2011, more than 6 million Americans were unemployed for six months or longer, and 4.5 million of them had been out of work for above a year. That was a particular concern for the US, even though Europe appeared to be suffering even worse long-term unemployment (See Figure 6). This was because the US doesn’t have the sort of social safety nets found in Europe and the population structure of the US is much more youthful than Europe, which implies that the growth in the size of the labour force is much higher. This makes the consequences of prolonged unemployment in the US more severe than in Europe.

One of the most common and destructive consequence of prolonged unemployment is that individuals become demoralized and give up their job search. As a result, by 2010 a number of workers (equivalent to 1.4% of the US labour force) had dropped out of job search altogether. They were thus no longer classified as unemployed. This means that Figure 6 actually underestimates the actual prolonged unemployment.

employers, such as financial services and automobile manufacturing, showed no signs of returning to previous levels of employment. Output was obviously recovering through improvements in productivity and efficiency in those industries. The boom had generated largesse particularly in the finance industry and the recession enabled cuts to be forced throughout the industry after rounds of consolidation.

Yet the sectors where employment is recovering or growing appear to be

radically different from these sectors where jobs are lost. Employment in the Health and Education sectors has been rising throughout the entire recession period while Internet-related Information Services appear to be gaining jobs after a slow start. While there’s a huge job loss unmatched by job creation, there are certainly vacancies unfilled that haven’t resulted in job creation because of the deep mismatch between the skills of those freshly unemployed in 2008 and the vacancies available then and subsequently. The technical expertise required in Automobile Manufacturing is decidedly different from those expected of IT professionals dealing with online publishing. Likewise, those in the Construction sector fired after the bursting of the housing bubble

FIGURE 4 EMPLOYMENT FIGURES IN FINANCIAL SERVICES AND AUTO MANUFACTURING IN THE UNITED STATES

FIGURE 5 EMPLOYMENT FIGURES IN HEALTH & EDUCATION & INTERNET & OTHER INFORMATION SERVICES IN THE UNITED STATES

To nail down the exact cause of unemployment based on macroeconomic data is often difficult. As unemployment numbers spiked during the recession, many economists think that the unemployment was linked to a fall in AD. However, as growth recovered and unemployment continued to linger, doubts started surfacing and people started to look deeper at complementary data, such as growth in employment by sectors shown in Figure 5, to get a more realistic answer to the cause of unemployment.

When things are going well and there is a loss of efficiency or a loss of comparative advantage in a given sector, the sector doesn’t get hit as badly, since demand for goods and services worldwide tends to be high and all firms grow. However, when world demand falls, only competitive firms continue to survive, exposing structural problems that were hidden.

A person is defined as being part of the unemployed statistics provided that person is actively seeking work. However, if the person isn’t actively looking for work, it will cause unemployment figures to fall.

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Prolonged unemployment also results in the deterioration of the specialized skills that unemployed workers possess since they aren’t in use and the unemployed have little opportunity to practice. Dropping out of the labour market worsens the problem, since even more general skills are lost in the process. Often, these workers switch to receiving disability benefits in part because of the adverse health consequences that a spell of prolonged unemployment can have.

Massive long-term unemployment puts pressure on a government to expand or extend unemployment benefits, which can itself be detrimental to the incentive of the unemployed. Unemployment benefits serve to provide the jobless with a guaranteed minimum level of standard of living while they search for work. At the same time, they act as an automatic stabilizer for the economy by holding up aggregate demand as the economy contracts. That being said, if benefits become long term, they can prevent workers from trying a line of work different from their original jobs for fear that they may not like it while losing their benefits in the process. As a result, they continue searching for jobs there simply aren’t vacancies for. In other words, prolonging benefits slows down the structural adjustment that has to be made at an individual level.

At the same time, if benefits are sufficiently high, the unemployed may choose to stay unemployed over a longer period in order to finish receiving their benefits before accepting a job offer. This

is especially adverse during a period of falling wages, where workers realize that the offers being received are lower than their previous wages. Thus, they choose to get by without work on their unemployment benefits in the hope of securing a better offer.

Research has also revealed that health problems and mortality increases are strongly correlated with prolonged

unemployment and the associated decline in income. Likewise, high youth unemployment is strongly correlated with higher crime rates. Past studies have also

suggested that a parent’s losing their job can have a negative impact on the schooling outcomes of their children and subsequently worse labour market outcomes when they grow up. Therefore, society suffers greatly from the initial bout of prolonged unemployment of a significantly proportion of the labour force.

Evidently, unemployment and disability benefits can take a toll on the society as the number of handouts rises. The fiscal burden then ties up the state’s resources available to assist in the growth of the economy. It would be far wiser to invest in policies that would help ease the problem of prolonged unemployment before it becomes severe enough to take a toll on the state finances.

OPTIONS AND SOLUTIONSYears of faith in the flexibility of the labour market in the US made it difficult for policy-makers to come up with approaches to deal with the prolonged unemployment situation. A prominently featured programme was ‘Georgia Works’, a scheme pioneered in the state of Georgia that offered to match unemployed receiving benefits to employers who would take them on for eight weeks of training with no obligation to hire them afterward. It was mentioned by President Obama in one of his speeches about job losses. The function of such a programme was to allow the jobless to try something new (while receiving on-the-job training) while not losing their unemployment benefits.

Ostensibly, this benefits small firms who are looking to hire trained workers but don’t have the budget to provide training to someone who is completely new to the work. Yet it is open to abuse as firms looking for short-term help may take an unemployed worker on as additional free labour instead of actually providing training.

A similar approach is to offer ‘unemployment benefits’ in the form of a temporary, gradually diminishing wage-loss supplement. The government allows the unemployed to claim a proportion of the wage cut they have to take in their new job. The benefit shrinks gradually to prevent over-dependence while encouraging the unemployed to accept a job offer that pays less. It works on the assumption that employers often offer lower wages during recessions but would

FIGURE 6 LONG-TERM UNEMPLOYED AS A PROPORTION OF TOTAL UNEMPLOYMENT

Government spending on unemployment benefits actually can be seen as good, as it helps boost income levels and prevents AD from falling further. This increase in government spending on unemployment benefits is known as an automatic stabilizer. It’s automatic because once the government sets it in place the level of government spending moves in line with GDP and unemployment. A fall in GDP and rise in unemployment will mean more government spending, since the total number of benefits given out has risen. This additional government spending helps to prevent AD from falling further.

Not feeling the loss of income since there are still unemployment benefits available, reduces the incentive for the unemployed to look into new areas of employment. There is greater resistance to looking for jobs or moving to jobs requiring new skills.

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MACROECONOMICS

be happy to raise the salary of someone they have come to find suitable for the job.

Unemployment benefits can also be made conditional to participation in some sort of retraining programme, since there are apparent structural elements underlying a spell of prolonged unemployment. Returning to having a job requires a worker to do something different from what he or she had previously been doing. Retraining helps in part to alleviate the structural mismatch that exists in the economy.

GLOBALISATION TO THE RESCUE?In the background of these looms the belief that globalisation is destroying jobs for the developed economies. Jobs are continually being exported to call centers in Bangladesh, outsourced to IT service firms in India, or created by First World firms, but in China. Back home, migrants are taking the available jobs and causing further difficulties in the search for jobs in the labour market for those with prolonged unemployment. This belief is especially strong in America, where jobs at home are increasingly being filled by migrants from across the border or lost to emerging markets.

The structural issues, the wage gap, and the sense that globalisation destroys jobs are actually symptoms of increasing specialization of labour across international borders. This means that a huge proportion of labour has to move across borders in search of work matching their expertise and wage expectations. The relative immobility of labour, however, results in widespread dislocation of labour and thus prolonged unemployment.

In response to the claim that migrants are taking the jobs of Americans, the United Farm Workers union started a ‘Take Our Jobs’ campaign where they invited American citizens to work on farms with the associated harsh working conditions and meager wages the migrants earn. Out of more than 5,000 applicants to the programme, only a handful actually went to work in the farms, and none of them continued once they got a taste of the actual work and realized that they’d be receiving minimum wage without further benefits. The co-existence of large numbers of undocumented migrant workers and high unemployment reflects a deep structural problem. It is believed that if American citizens took those farm

jobs, they could increase pressure to improve working conditions on farms and also raise the wages of those workers. Alas, the citizens expected improvements before they were willing to take the jobs.

Widespread prolonged unemployment poses a huge challenge to the modern state. In this era, the state has established the legitimacy of intervening in the economy by attempting to ensure that its citizens have work to feed and clothe themselves. Employment not only defines the identity of the modern person, but it is also the single most significant way an individual is plugged into the economy and participates in the production of output. No matter how an economy may be growing, the unemployed are not getting a share of the growth (at least without redistribution policies in place). At best, they are relegated to the position of beggars waiting for a handout from the state. While the state trudges on in search of solutions to the problem, the populace must accept the new configuration of the global economy and understand the trade-offs associated with it.

Perhaps it would be wise for governments to open their borders to immigrants while encouraging their own

UNITED FARM WORKERS’ TAKE OUR JOBS CAMPAIGN

Source: http://crooksandliars.com/jackie-mahendra/fed-farm-workers-team-colbert-want

16 THE UNEMPLOYMENT ISSUE THE UNEMPLOYMENT ISSUE PB

citizens to emigrate to look for work. Liberalization of the labour markets and migration would not only improve efficiency in the economy but also reduce the economy’s dependence on state governments when it comes to generating jobs and ensuring employment. There would be complex social issues to tackle and strong resistance to overcome, but throwing out the proposal for public discourse would be a start.

Lawrence F. Katz, Dr. Till M. von Wachter, Diana Furchtgott-Roth (2010, April 29) Testimonies for “Long-term Unemployment: Causes, Consequences and Solutions”. United States Joint Economic Committee Hearing.

Michael Reich (2010, June). High Unemployment after the Great Recession: Why? What Can We Do? Center on Wage and Employment Dynamics Policy Brief June 2010. Institute for Research on Labor and Employment, University of California, Berkeley.

Gerald Mayer (2010, December 20). The Trend in Long-Term Unemployment and Characteristics of Workers Unemployed for More than 99 Weeks. Congressional Research Service.

The long term unemployed: The ravages of time (2011, October 1). The Economist. Statistics from World Bank Databank and US Bureau of Labor Statistics

REFERENCES

Provided these local workers are equipped with the right skills demanded in other foreign markets.


fa_p10-16 vol4-4 prolonged unemployment

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