Introduction

We discussed in the Introduction to Macroeconomics that a large part of macroeconomics is concerned with the growth of an economy’s output – its gross domestic product (“GDP”). GDP is determined by the interaction between aggregate demand (“AD”) and aggregate supply (“AS”).

AD consists of consumer spending, plus investment, plus government spending, plus exports minus imports - C+I+G+(X-M);

AS is an amalgamation of the factors of production within an economy - land, labour, capital, and entrepreneurship.

The availability of labour, and level of employment and wages (which impact consumer spending), therefore affect the shape and positioning of the AD and AS curves - which determines GDP.

Accordingly, unemployment is a key topic and macroeconomic indicator. In this article, we discuss:

1. The economist's definition of unemployment;
2. The measures of unemployment (and their shortfalls);
3. The types of unemployment; and
4. Policies to tackle unemployment.

The economist's definition of unemployment

Within an economy, the Total Labour Force consists of:

1. All those in employment; and
2. Those of working age who are without work, but who are actively seeking work  - this is the economist's definition of unemployment; it is not merely “all of those who are without work”.

The rate of unemployment by the economist’s definition can be expressed as a number (e.g. 1 million people unemployed), or as a rate / percentage of the Total Labour Force (e.g. 2% unemployment).

When it comes to measuring unemployment, economists therefore have to measure two things:

1. The size of the Total Labour Force; and
2. The number of people within the Total Labour Force that are without work but who are actively seeking work.

Having one figure without the other will give an incomplete picture of unemployment.

Note, however, that the definition of unemployment and Total Labour Force does not include those not actively seeking work.

Reasons people might not be seeking work could include (non-exhaustively) because they are wealthy and do not need to work, or they are a stay-at-home parent, or they have been out of work for a long period and are disempowered from seeking work, or they are not incentivised to work at current wage levels when compared to welfare payments.

Official measures of unemployment

In the UK, there are two official measures of unemployment that are used by the government:

1. Claimant Count; and
2. Standardised Unemployment Rate.

Claimant Count – the Claimant Count measures the number of people in receipt of unemployment related benefits and expresses that as a percentage of the working age population. This is easy for the government to measure, however it excludes those of working age seeking work (part of the Total Labour Force) but who are not eligible for unemployment related benefits. Consequently, the Claimant Count figure could change as a result of a change in the eligibility criteria for unemployment related benefits, even if there is no real change in the actual rate of unemployment. The Claimant Count is therefore likely to give a lower figure than the actual rate of unemployment.

Standardised Unemployment Rate – the UK government recognises the shortfalls of the Claimant Count, and has used the Standardised Unemployment Rate as the official measure of unemployment since 1998. This is used by major organisations around the world for measuring and comparing the unemployment rates between countries.

The Standardised Unemployment Rate measures the percentage of people of working age who are without work, are available to start work within two weeks, and are actively seeking employment or waiting to start a job.

In order to measure this, the government conducts national Labour Force Surveys quarterly. These surveys ask a representative cross section of the UK population whether they are employed, unemployed or economically inactive (not seeking work). The figure produced by the Standard Unemployment Rate measure is usually higher than the Claimant Count, because it includes individuals who are seeking work but who are not eligible for unemployment related benefits.

There are also shortfalls in this measure as a policy tool. This is because the Standard Unemployment Rate only considers those actively seeking work at given wage rates. This measure would therefore not include, for example, wealthy people who are not actively seeking employment, and the long-term unemployed on welfare who are not actively seeking work at current wage levels. It may be in the government’s interest to encourage such persons into seeking employment, but the Standardised Unemployment Rate measure says nothing about these demographics.

Types of unemployment

There are two types of unemployment within an economy - equilibrium unemployment and disequilibrium unemployment.

Equilibrium unemployment

Equilibrium unemployment occurs where aggregate supply and aggregate demand for labour intersect at the real wage rate within an economy, but there are other factors which cause people to be unemployed.

Types of equilibrium unemployment include:

1. Frictional unemployment – when people leave their jobs (voluntarily or otherwise), they may be unemployed for a while until they find another. This could occur for a number of reasons, including people not finding a job they want to apply for right away, or not getting hired for a job they do apply for;
2. Structural unemployment – whilst aggregate supply and aggregate demand for labour may intersect at the real wage rate within an economy, certain industries may suffer from a lack of demand, or oversupply, of labour. This could be because the demand for goods or services in that industry have decreased (for example, paper books), or because technology has reduced the demand for workers in that industry (for example, manufacturing, where many processes are now done by machines). Certain industries may be based in particular regions within a country, and where those industries suffer from structural unemployment, this may also result in regional unemployment;
3. Seasonal unemployment – the demand for labour may fluctuate within certain industries depending on season, causing unemployment at various times of the year (for example, the tourism industry in the UK generally requires more workers in the summer than in the winter).

Disequilibrium employment is modelled on figure 1 below, where TLF is the Total Labour Force.

Disequilibrium unemployment

Disequilibrium unemployment occurs when the real wage rate within an economy is higher than the wage rate that should be set by the interaction between aggregate supply and aggregate demand for labour – the equilibrium wage rate. As can be seen in figure 1 below, if the average wage rate was W1, the supply of labour would equal the demand. However, where wages are higher than the equilibrium wage rate, there is a gap between the level of supply of labour at that wage rate, and the level of demand. This is called disequilibrium unemployment.

For disequilibrium unemployment to occur, the aggregate supply of labour must exceed the aggregate demand for labour at the given wage rate in the economy and wages must be sticky downwards - this means that wages in an economy cannot fall to the true equilibrium level due to social and legal constraints. Social constraints could include, for example, because it is unpopular for employers to lower wages, or because trade unions exercise collective bargaining power to prevent this. Legal constraints could include the minimum wage, or laws on redundancy payments which prevent employers from being able to freely reduce their number of employees.

In conjunction with disequilibrium unemployment, the other types of equilibrium unemployment discussed above may also occur.

Disequilibrium unemployment could be caused by a number of factors, including:

1. A fall in AD, resulting in a fall in the demand for labour (fewer workers will be needed to produce the fewer goods and services demanded). A fall in demand for labour will result in a lower equilibrium wage rate, but actual wage levels may not be able to fall to equilibrium levels, resulting in unemployment;
2. Trade unions or the government driving the wage rate up above the equilibrium level. There is a debate around the amount wages can be driven up before unemployment is caused. By driving wages up, workers will have more to spend, demand for goods and services may increase (subject to inflation), and therefore the demand for labour to produce those additional goods and services will also increase, narrowing the equilibrium unemployment gap. However, if wages rise too much, this might cause businesses to reduce staff or move some processes abroad if labour is cheaper there; or
3. A growth in the labour force (e.g. due to immigration or a reduction in unemployment related benefits), resulting in a fall in the equilibrium wage rate but with the real wages unable to fall to true equilibrium levels.

Policy

Economies can use a variety of policies to tackle unemployment.

Policies to tackle equilibrium unemployment

Different policies may be required to tackle the different types of equilibrium unemployment discussed above.

1. Frictional unemployment – improving information on jobs available in the market, how to apply for these, and application skills, can reduce the levels of frictional unemployment by helping those looking for jobs find employment more quickly. Examples of this in the UK include the recruitment of employment specialists into Job Centres, who are tasked with assisting unemployed people find and apply for jobs;
2. Structural – increasing the general transferable skill levels of the working population, and specific retraining of employees in sectors that have been hit by structural unemployment, can help to reduce structural unemployment;
3. Seasonal unemployment – increasing the availability of flexible employment options in the off-seasons can help to reduce seasonal unemployment. In the UK economy, self-employment and freelancer options have grown in recent years through the introduction of ideas such as Uber and Deliveroo, and websites allowing people to advertise freelance work. Zero-hours contracts also offer flexible employment, but these have attracted controversy in recent years.

Policies to tackle disequilibrium unemployment

Disequilibrium unemployment occurs when the aggregate supply of labour outstrips the aggregate demand for labour at the wage rate within an economy, and we discussed 3 reasons this might be the case.

You will recall from our article on Keynesian Aggregate Supply that disequilibrium unemployment indicates that there is spare capacity within an economy - employment can rise without an overall increase in wages / price. In such cases, governments and central banks can seek to increase AD to grow GDP without a disproportionate increase in prices, which should result in an increase demand for labour (to produce the additional goods and services demanded) and therefore a reduction in unemployment.

We discuss demand side policies in further detail in the next few articles, but this could include lowering taxes, lowering interest rates, or increasing spending on public services.

Governments could also try to relax labour laws to make it easier to hire and fire employees, and also to keep wages down. For example, in the UK, labour laws allow employers to use zero-hours contracts - in short, these are contracts where employers can call on workers when required, but there is no obligation to provide work, nor for workers to accept the work they are offered.

Policies to increase Total Labour Force

In some cases, an economy may not have sufficient labour to meet the demands of employers without pushing wages up exponentially. This could apply to the whole of an economy, or to particular sectors only. In these cases, an economy may need to increase its Total Labour Force.

If there are individuals who are unemployed and claiming unemployment benefits, but who are not incentivised to look for work at current wage levels, these individuals do not form part of the Total Labour Force.

It may be in a government’s interest to incentivise this group to look for work by increasing the attractiveness of work or reducing the barriers to employment. This could be done, for example, through reducing unemployment benefits, or increasing the minimum wage. Both options are potentially controversial, and governments have a tough task when deciding how to increase the attractiveness of work.

Governments can also increase the skill levels of those who have been unable to obtain work for long periods and who are disheartened and unwilling to look for work.

Further, governments can encourage immigration to increase the Total Labour Force. This can be targeted at certain sectors where there is a particular shortage of labour. We saw examples of this in the 50s and 60s in the UK, where immigration was encourage to fill a large number of low-paid / "unskilled" jobs.

Conclusion

You should now have an understanding of the significance of employment / unemployment for an economy, the measures and types of unemployment, and policies to reduce it. In summary:

• Unemployment is a key macroeconomic indicator, and the availability of labour and levels of employment and wages impact AD and AS, and therefore GDP;
• The Total Labour Force consists of (1) those who are employed, and (2) those who are without work but who are actively seeking employment (the economist's definition of unemployment);
• Unemployment can be expressed as a number, or a percentage / rate of the Total Labour Force;
• The two main measures of unemployment in the UK are the Claimant Count (number of people obtaining unemployment related benefits) and the Standardised Unemployment Rate (the percentage of people of working age who are without work, are available to start work within two weeks, and are actively seeking employment or waiting to start a job). Each measure has its pros and cons;
• There are two types of unemployment - equilibrium unemployment and disequilibrium unemployment;
• Equilibrium unemployment occurs where the aggregate demand and supply for labour equal, but there are other reasons people might be unemployed, such as frictional, structural, or seasonal unemployment;
• Disequilibrium unemployment occurs where the real wage rate within an economy is higher than the equilibrium wage rate, meaning there is an excess supply of labour at that wage rate versus the labour demanded;
• There are various policies economies can use to tackle different types of unemployment, and also to increase the Total Labour Force.

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