Employment and Unemployment

The labour force is all people of working age who are either employed or actively seeking work (1) — that is, the employed plus the unemployed; it excludes those not available for work, such as children, retirees, full-time students and those not seeking a job (1).

Unemployment rate = (unemployed ÷ labour force) × 100 (1) = (2.4 ÷ 30) × 100 (1) = 8% (2). So 8% of the labour force is unemployed.

A recession is a period of falling real GDP, and it causes unemployment through a fall in demand. In a recession, households and firms spend less, so aggregate (total) demand falls. Because firms are selling fewer goods and services, they cut back production. With less to produce, firms need fewer workers, so they make workers redundant and stop hiring — this is cyclical (demand-deficient) unemployment. The newly unemployed then have less income to spend, which reduces demand further and can cause even more job losses (a downward multiplier effect). Some firms may also go out of business entirely, adding to unemployment. So a recession causes unemployment because lower demand leads firms to produce less and therefore employ fewer workers.

Structural unemployment is caused by a skills mismatch — the unemployed lack the skills that available jobs require — so policy must close that gap. Retraining and education: the government can fund retraining and vocational schemes that give workers the skills demanded by growing industries (e.g. digital or technical skills), so they become employable and can fill vacancies that previously went unfilled. Improving information and mobility: providing better job-information services and help with relocation (e.g. housing support) lets workers move to where the jobs are, improving the matching of workers to vacancies. Subsidising firms to take on and train the long-term unemployed can also help. These are supply-side measures that tackle the cause of structural unemployment rather than the symptom. The main limitation is time — retraining takes years to work, so the effect is gradual. So a government reduces structural unemployment mainly by giving workers the skills firms need and helping them move to where jobs are.

Demand-side policies can reduce unemployment, but whether they are the best way depends on its cause. Why they work: during a recession, unemployment is mainly cyclical — caused by low aggregate demand. By cutting interest rates or increasing government spending and lowering taxes, the government raises total demand, so firms sell and produce more and need to hire more workers; this can reduce cyclical unemployment relatively quickly, helped by the multiplier. Limits: demand-side policy does nothing to cure structural unemployment, where the problem is a skills mismatch rather than a lack of demand; if the economy is near full capacity, boosting demand causes inflation rather than jobs; government borrowing has an opportunity cost and may raise debt; and there are time lags. Judgement: demand-side policies are the best way to reduce cyclical unemployment caused by a downturn, because they raise demand and create jobs quickly. But they are not best for structural unemployment, which needs supply-side measures like retraining. So the best policy depends on the type of unemployment, and a combination is often required. Demand-side policy is therefore best only when unemployment is due to deficient demand.

Whether a government should pay unemployment benefits involves a trade-off between welfare and incentives. Arguments for paying benefits: they provide a safety net, preventing the unemployed and their families from falling into severe poverty, hunger or homelessness; they maintain people's spending power, which supports aggregate demand during a recession (helping to limit the downturn); and they give the unemployed time to search for a suitable job rather than taking the first available, improving job matching. They also reduce social problems linked to poverty. Arguments against / drawbacks: generous benefits are expensive, adding to the budget deficit and requiring higher taxes; if benefits are too high or too easy to claim, they may weaken the incentive to work (the gap between benefits and wages narrows), creating voluntary unemployment and dependency. Judgement: a government should pay unemployment benefits, because the humanitarian and demand-supporting case is strong — leaving the unemployed with nothing would cause serious hardship and could deepen a recession. However, benefits should be set at a level that supports people without removing the incentive to work, and ideally combined with help to find jobs and retrain. So the question is not whether to pay benefits but how to design them — enough to prevent poverty, not so much as to discourage work.