Unemployment University of Wisconsin Charles Engel: Unemployment University of Wisconsin Charles Engel 6
In this chapter, you will learn…: In this chapter, you will learn… …about the natural rate of unemployment:
what it means
what causes it
understanding its behavior in the real world
Natural rate of unemployment: Natural rate of unemployment Natural rate of unemployment: The average 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.
Actual and natural rates of unemployment in the U.S., 1960-2006: Actual and natural rates of unemployment in the U.S., 1960-2006 Percent of labor force 0 2 4 6 8 10 12 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
A first model of the natural rate: A first model of the natural rate Notation:
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
(See reading by Wu on different measures of employment.)
Assumptions:: Assumptions: 1. L is exogenously fixed.
2. During any given month,
s = fraction of employed workers that become separated from their jobs
s is called the rate of job separations
f = fraction of unemployed workers that find jobs
f is called the rate of job finding
s and f are exogenous
The transitions between employment and unemployment: The transitions between employment and unemployment Employed Unemployed
The steady state condition: The steady state condition Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant.
The steady-state condition is: s E = f U
Finding the “equilibrium” U rate: Finding the “equilibrium” U rate f U = s E
= s (L – U )
= s L – s U
Solve for U/L:
(f + s) U = s L
so,
Example:: Example: Each month,
1% of employed workers lose their jobs (s = 0.01)
19% of unemployed workers find jobs (f = 0.19)
Find the natural rate of unemployment:
Policy implication: Policy implication A policy will reduce the natural rate of unemployment only if it lowers s or increases f.
Why is there unemployment?: Why is there unemployment? If job finding were instantaneous (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:
1. job search
2. wage rigidity
Job search & frictional unemployment: Job search & frictional unemployment frictional 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
Sectoral shifts: Sectoral shifts def: Changes in the composition of demand among industries or regions.
example: Technological change more 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
CASE STUDY: Structural change over the long run: CASE STUDY: Structural change over the long run
More examples of sectoral shifts: 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. In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.
Public policy and job search: 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.
Unemployment insurance (UI): 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
Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment.
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. Benefits of UI
Why is there unemployment?: Why is there unemployment? Two reasons why f < 1:
1. job search
2. wage rigidity DONE Next The natural rate of unemployment:
Unemployment from real wage rigidity: Unemployment from real wage rigidity If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around.
Unemployment from real wage rigidity: Unemployment from real wage rigidity Then, firms must ration the scarce jobs among workers. Structural unemployment: The unemployment resulting from real wage rigidity and job rationing. If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around.
Reasons for wage rigidity: Reasons for wage rigidity 1. Minimum wage laws
2. Labor unions
3. Efficiency wages
1. The minimum wage: 1. The minimum wage The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers.
Studies: a 10% increase in min. wage reduces teen unemployment by 1-3%
But, the min. wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the min. wage.
2. Labor unions: 2. Labor unions Unions exercise monopoly power to secure higher wages for their members.
When the union wage exceeds the eq’m wage, unemployment results.
Insiders: Employed union workers whose interest is to keep wages high.
Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them.
Union membership and wage ratios by industry, 2005: 105,508 Private sector (total) 20,381 Government (total) 14,045 Health care 3,312 Education 10,951 Professional services 6,304 Finance, insurance 4,379 Transportation 14,973 Retail trade 15,518 Manufacturing 600 Mining 8,053 Construction wage ratio U % of total # employed (1000s) industry wage ratio = 100(union wage)/(nonunion wage) slide 25 Union membership and wage ratios by industry, 2005
3. Efficiency wage theory: 3. Efficiency wage theory Theories in which higher wages increase worker productivity by:
attracting higher quality job applicants
increasing worker effort, reducing “shirking”
reducing turnover, which is costly to firms
improving health of workers (in developing countries)
Firms willingly pay above-equilibrium wages to raise productivity.
Result: structural unemployment.
The duration of U.S. unemployment, average over 1/1990-5/2006: The duration of U.S. unemployment, average over 1/1990-5/2006
The duration of unemployment: The duration of unemployment The data:
More spells of unemployment are short-term than medium-term or long-term.
Yet, most of the total time spent unemployed is attributable to the long-term unemployed.
This long-term unemployment is probably structural and/or due to sectoral shifts among vastly different industries.
Knowing this is important because it can help us craft policies that are more likely to work.
TREND: The natural rate rises during 1960-1984, then falls during 1985-2006: TREND: The natural rate rises during 1960-1984, then falls during 1985-2006
EXPLAINING THE TREND: The minimum wage: EXPLAINING THE TREND: The minimum wage 0 1 2 3 4 5 6 7 8 9 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Dollars per hour minimum wage in current dollars minimum wage in 2006 dollars The trend in the real minimum wage is similar to that of the natural rate of unemployment.
EXPLAINING THE TREND: Union membership: EXPLAINING THE TREND: Union membership Since the early 1980s, the natural rate of unemploy-ment and union membership have both fallen.
But, from 1950s to about 1980, the natural rate rose while union membership fell.
EXPLAINING THE TREND: Demographics: EXPLAINING THE TREND: Demographics 1970s: The Baby Boomers were young. Young workers change jobs more frequently (high value of s).
Late 1980s through today: Baby Boomers aged. Middle-aged workers change jobs less often (low s).
Our reading by Valletta and Hodges also suggests that trends in the educational levels of the workforce can account for a falling natural rat of unemployment.
Unemployment in Europe, 1960-2005: slide 33 Unemployment in Europe, 1960-2005 Percent of labor force 0 3 6 9 12 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
The rise in European unemployment: The rise in European unemployment Shock Technological progress has shifted labor demand from unskilled to skilled workers in recent decades.
Effect in United States An increase in the “skill premium” – the wage gap between skilled and unskilled workers.
Effect in Europe Higher unemployment, due to generous govt benefits for unemployed workers and strong union presence.
Percent of workers covered by collective bargaining: Percent of workers covered by collective bargaining
Chapter Summary: Chapter Summary 1. The natural rate of unemployment
the long-run average or “steady state” rate of unemployment
depends on the rates of job separation and job finding
2. Frictional unemployment
due to the time it takes to match workers with jobs
may be increased by unemployment insurance
CHAPTER 6 Unemployment slide 36
Chapter Summary: Chapter Summary 3. Structural unemployment
results from wage rigidity: the real wage remains above the equilibrium level
caused by: minimum wage, unions, efficiency wages
4. Duration of unemployment
most spells are short term
but most weeks of unemployment are attributable to a small number of long-term unemployed persons CHAPTER 6 Unemployment slide 37
Chapter Summary: Chapter Summary 5. Behavior of the natural rate in the U.S.
rose from 1960 to early 1980s, then fell
possible explanations: trends in real minimum wage, union membership, prevalence of sectoral shifts, and aging of the Baby Boomers CHAPTER 6 Unemployment slide 38
Chapter Summary: Chapter Summary 6. European unemployment
has risen sharply since 1970
probably due to generous unemployment benefits, strong union presence, and a technology-driven shift in demand away from unskilled workers CHAPTER 6 Unemployment slide 39