Why is it difficult to agree what constitutes full employment?
Discuss the view that imperfections in the labour market are the main cause of unemployment in the United Kingdom.
Full employment is defined as the full utilisation of all available labour, land and capital resources. It is one of the main objectives of macroeconomic policy. Economists disagree however, over what constitutes full employment.
Both classical and Keynesian economists agree that the economy can be at less than full employment in the short run. Classical economists argue that the economy will always be at full employment in the long run, but Keynesians disagree. They say that an economy can always have unemployment present. This is really a disagreement about what is meant by the long run.
in the long run, all markets will be in equilibrium. If there is unemployment in the short run, wages will fall until the demand and supply for labour are equal. Some classical economists argue that this will happen almost immediately. Most would say that it takes some years for wage rates to fall far enough to eliminate unemployment. Keynesian economists argue that mass unemployment will take decades to eliminate if left to market forces, and that wage rates will only fall over long periods of time.
Classical economists argue that the economy will automatically stabilise at full employment in the long run. They define this as the level of employment where everyone who wants a job at the prevailing wage rate will have one. It is assumed that all prices are variable in the long run. Classical economists say that the long run aggregate supply curve is vertical because it shows the economy at full capacity. If the economy operates at less than full employment in the short run there will be downwards pressure on wages, and this will result in employers taking on more workers. Wage rates will fall until the demand and supply of labour are equated. At this wage rate, there will be no unemployment. in other words, the economy will be at full employment. Furthermore, if the economy operates at a level above full capacity in the short run by workings working overtime, wage prices will rise and firms will lay off some of their workers.
The conclusion that the classical economists come to is that the economy will always be at full employment. There can be no unemployment in the market in the long run if markets are free. This is true for the labour market, and also for the markets for land and capital.
Keynesians disagree with classical economists over the shape of the long run aggregate supply schedule. They believe that it is possible for the economy to be in long run equilibrium at less than full employment output.
A further complication as to what constitutes full employment is the problem of underemployment. Many workers who work part-time would rather have a full-time job, but are unable to find one.
Classical economists have the view that unemployment is caused mostly by imperfections in the labour market, that prevent it from clearing. They would therefore argue that the only way to reduce unemployment is to take measures to improve the flexibility of the labour market, allowing it to operate more efficiently. However, the labour market does in reality suffer from various frictions and rigidities. Classical economists say that these rigidities are the main cause of unemployment.
Frictions in the labour market result in frictional unemployment. The labour market is not a perfect market. It takes time for workers to move between jobs in a dynamic economy where both the labour force and the jobs on offer are continually changing. Workers will spend time familiarising themselves with the job market even though this will incur various costs. The labour force also includes people whose physical or mental handicaps make them almost unemployable, and this is an example of an imperfection in the labour market which might result in unemployment. Not everyone can do every job which is available in an economy. Some jobs require workers to undertake long periods of study, or training. Jobs may also require people to have certain innate skills, or to have passed certain examinations or received specific certificates. In an economy where the pattern of demand determines the jobs which are available, there is likely to be some mismatching of skills, because the supply of labour is not able to respond immediately to a change in demand.
The labour force could be thought of as evolving rather than adapting. It takes time for the workforce to adapt o a change in demand within the economy. The demand for a certain skill may not necessarily change because the good or service which that skill is used to produce changes, but could also change if the method of production of that good or service changed. The introduction of technology may mean that fewer people are required to produce the required amount of a good. Although technology will not cause unemployment in the long run, because it will result in new jobs being created and workers applying their skills in other jobs where they can maximise their productivity, it may initially result in a large number of people being made unemployed, and finding that the skills that they have are not suitable for application to the jobs that are available.
In the long run, the pattern of demand and production is always changing. In recent decades industries such as textiles and heavy engineering have been declining in the UK, as we have lost our comparative advantage in the production of these goods. People who are highly skilled in these industries may find that their skills are no longer demanded. They will then have to either retrain in the skills that are demanded, take unskilled unemployment or else come to terms with being unemployed.
It is not just changes in demand for labour in specific skills that might prevent the labour market from clearing. Structural unemployment can also result from changes in demand for labour in certain regions. Some workers may find that their skills are demanded in other regions, but are not able to move easily to that area. It can also take a long time, and be very expensive to relocate. The immobility of labour is another imperfection in the labour market that results in unemployment.
Classical economists say that, if wages are allowed to adjust to changes in supply and demand for labour, that the market will be in long run equilibrium at the full employment level of national income. However, in the economy there may be agents acting to prevent real wages from adjusting. Classical economists say that the actions of trade unions, who act to push the level of real wages above the market equilibrium rate, and minimum wage legislation, can prevent the labour market from clearing, and are a cause of unemployment. Such economists would sight the inflexibility of wages as an imperfection of the labour market, which results in unemployment. This type of unemployment is often called classical unemployment.
Unemployment is sometimes divided into voluntary and involuntary unemployment. Voluntary unemployment is not considered significant because the voluntary unemployed decide that the extra leisure time that they have as a result of being unemployed is worth more than the utility that they would gain from working, and earning the prevailing wage. The voluntary unemployed choose to be unemployed. However, when people would like to have a job, but cannot get one there is a serious problem. Economists disagree as to whether the structurally unemployed should be considered as involuntarily unemployed. Some would argue that, because they could retrain or relocate, that they are unemployed by choice. Some even argue that the structurally unemployed could have avoided being unemployed at all if they had taken a wage cut to retain the competitiveness of their previous occupation. Classical unemployment can also be considered as voluntary, the argument being that workers as a whole have chosen, through their unions, to push wages above the market clearing rate.
I have argued that there are a number of imperfections in the labour market, that prevent the flexibility of wages, and prevent the market from equilibrating at the full employment level of national income, hence causing unemployment. However, these are not the only causes of unemployment. Some economists, notable John Maynard Keynes, believe that unemployment can be caused as a result of insufficient demand in the market for goods and services. Keynes said that unemployment was “demand-deficient” in nature. He also said that wages were “sticky-downwards” and would therefore not fall to equilibrium levels automatically. He was also a proponent of demand management. The Keynesian school of economists say that, as no automatic tendency exists to return the economy to full employment, the government should use some sort of expansionary demand management, to increase the demand for goods, and hence the demand for labour.
It is important to introduce the concept of the natural rate of unemployment. In a perfect and competitive labour market, wages would be flexible and adjust to clear the market. Classical, frictional and structural unemployment, which all might be classified as voluntary, are often collected together and designated as forming the natural rate of unemployment. It is not possible for the government to eliminate this unemployment through demand management techniques. The best that the government can do when using these techniques is to get unemployment down to the natural rate if unemployment arises because there is insufficient demand in the economy. Any attempt to push unemployment below this level would risk creating excess demand in the economy, and accelerating inflation.
The causes of unemployment are numerous. Much unemployment is natural in the sense that it results from imperfections in the labour market, which cannot be eliminated through demand management techniques. The only way to reduce the natural rate of unemployment is through the adoption of supply side measures. However, unemployment can also arise because of demand side factors. Economists disagree over the proportion of unemployment which can be considered as forming the natural rate, and how much is attributable to other factors.