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We now turn our attention to the labour market and consider why people find themselves out of work and cannot find a paid job. Unemployment imposes heavy economic and social costs; we look at which policies are likely to be most effective in keeping unemployment as low as possible.

Defining and measuring unemployment

Officially, the unemployed are people who are registered as able, available and willing to work at the going wage rate but who cannot find work despite an active search for work. This last point is important for to be classified as unemployed, one must show evidence of being active in the labour market.
 
There are two main measures of unemployment in the UK:

1. The Claimant Count measure of unemployment includes those unemployed people who are eligible to claim the Job Seeker's Allowance (JSA) or who have enough National Insurance Credits. People who satisfy the criteria receive the JSA for six months before moving onto special employment measures including the New Deal Programme. The Claimant Count is a “head-count” of people claiming unemployment benefit.
2. The Labour Force Survey covers those who are without any kind of job including part time work but who have looked for work in the past month and are able to start work in the next two weeks. The figure also includes those people who have found a job and are waiting to start in the next two weeks.

On average, the labour force survey measure has exceeded the claimant count by about 400,000 in recent years. Because it is a survey (albeit a large one and one that provides a rich source of data on the employment status of thousands of households across the UK), we must remember that there will always be a sampling error in the data. The Labour Force Survey measure is the internationally agreed definition of unemployment and therefore the measure that best allows cross-country comparisons of unemployment levels.

The most recent changes in claimant count and labour force survey measures of unemployment are summarised in the chart above and the table below.

In 2005, the UK had one of the lowest rates of unemployment among the major developed nations. Although the Netherlands and Ireland both have unemployment rates below that of the UK, we have one of the lowest rates in the European Union. Indeed for the Euro Zone as a whole the rate of unemployment has been persistently high in recent years – never lower than eight per cent and now rising to nearly nine per cent. Unemployment is a major economic, social and political problem in countries such as Poland, Germany, Spain and France – although the Spanish have succeeded in bringing their unemployment down from high levels over the last few years.

Main causess of unemployment

We now consider some of the main underlying causes of people being out of work

Frictional Unemployment

Frictional unemployment is transitional unemployment due to people moving between jobs:
For example, redundant workers or workers entering the labour market for the first time (such as university graduates) may take time to find appropriate jobs at wage rates they are prepared to accept.  Many are unemployed for a short time whilst involved in job search. Imperfect information in the labour market may make frictional unemployment worse if the jobless are unaware of the available jobs. Incentives problems can also cause some frictional unemployment as some people actively looking for a new job may opt not to accept paid employment if they believe the tax and benefit system will reduce the net increase in income from taking work. When this happens there are disincentives for the unemployed to accept work.

Structural Unemployment

Structural unemployment occurs when there is a long run decline in demand in an industry leading to a reduction in employment perhaps because of increasing international competition. Globalisation is a fact of life – and inevitably it leads to changes in the patterns of trade between countries over time. Britain for example has probably now lost for good, its cost advantage in manufacturing goods such as motor cars, household goods and audio-visual equipment. Manufacturing industry has lost over 400,000 jobs in the last five years alone. Many of these workers may suffer from a period of structural unemployment, particularly if they are in regions of above-average unemployment rates where job opportunities are scarce. The decline in manufacturing industry jobs is shown in the next chart.

There is often a mismatch between the skills required for job vacancies and the skills and experience that unemployed workers have – this is a problem associated with structural unemployment

Structural unemployment exists where there is a mismatch between their skills and the requirements of the new job opportunities. Many of the unemployed from manufacturing industry (e.g. in coal, steel and engineering) have found it difficult to find new work without an investment in re-training. This problem is one of occupational immobility of labour

Cyclical Unemployment: 

Cyclical unemployment is involuntary unemployment due to a lack of demand for goods and services. This is also known as Keynesian "demand deficient" unemployment. When there is a recession or a severe slowdown in economic growth, we see a rising unemployment because of plant closures, business failures and an increase in worker lay-offs and redundancies. This is due to a fall in demand leading to a contraction in output across many industries. A downturn in demand is often the stimulus for businesses to rationalise their operations by cutting employment in order to control costs and restore some of their lost profitability.

Cyclical unemployment and the output gap

Real wage unemployment:

This is considered to be the result of real wages being above their market clearing level leading to an excess supply of labour. Some economists believe that the minimum wage risks creating unemployment in industries where international competition from low-labour cost producers is severe. As yet, there is relatively little evidence that the minimum wage has created rising unemployment on the scale that was feared.

Hidden unemployment

Undoubtedly there are thousands of people who by any reasonable definition are unemployed, but who are not picked up by the official unemployment statistics. Many have become discouraged workers and have stopped actively searching for work.

The economic and social costs of unemployment

High unemployment is widely recognised to create substantial costs for individuals and for the economy as a whole. Some of these costs are difficult to measure, especially the longer-term social costs of a high level of unemployment. Some of the costs are summarised below:

1. Loss of income: Unemployment normally results in a loss of income. The majority of the unemployed experience a decline in their living standards and are worse off out of work
2. Loss of national output: Unemployment involves a loss of potential national output (i.e. GDP operating below potential) and represents an inefficient use of scarce resources. If some people choose to leave the labour market permanently because they have lost the motivation to search for work, this can have a negative effect on long run aggregate supply (LRAS) and thereby damage the economy’s growth potential
3. Fiscal costs: The government loses out because of a fall in tax revenues and higher spending on welfare payments for families with people out of work. The result can be an increase in the budget deficit which then increases the risk that the government will have to raise taxation or scale back plans for public spending on public and merit goods
4. Social costs: Rising unemployment is linked to social deprivation. There is a relationship with crime, and social dislocation (increased divorce rates, worsening health and lower life expectancy). Areas of high unemployment see falling real incomes and a worsening in inequalities of income and wealth

Some countries are more successful than others in reducing the scale of unemployment. In the long term, effective policies are required for both the demand and the supply side of the economy so that enough new jobs are created and that people possess the skills and incentives to take those jobs.

In general the most effective policies are those that:

1. Stimulate an improvement in the human capital of the workforce – so that more of the unemployed have the skills to take up the available jobs. Policies normally concentrate on improving the occupational mobility of labour. The pattern of employment in any modern economy is always changing, so people need to have sufficient flexibility to adapt to structural changes in industries over the years
2. Improve incentives for people to search and then accept paid work – this may require reforms of the tax and benefits system for example a reduction in the starting rate of income tax (an incentive for people in lower paid jobs). Or perhaps a change in welfare benefits such that people who find work do not experience a sharp withdrawal of benefits because they are now earning more. The reality is that simply cutting welfare benefits across the board makes little difference to the unemployment figures – because of the complex nature of most unemployment. But targeted measures to improve incentives, including the linking of welfare benefits to participation in work experience programmes which is part of the New Deal programme or lower tax rates for people on low incomes might have an impact.
3. Employment subsidies: Government subsidies for those firms that take on the long-term unemployed will create an incentive for businesses to increase the size of their workforce. Employment subsidies may also be available for overseas firms locating in the UK as part of the government’s regional policy. Labour’s New Deal programme works by offering subsidised jobs and training to the long-term unemployed. It differs from previous job creation schemes, in that people who refuse to comply can have their benefits stopped. According to the government's own figures, more than 40% of the jobs gained through the New Deal are short-term.
4. Achieve a sustained period of economic growth – this requires that aggregate demand is sufficiently high for businesses to be looking to expand their workforce. The Keynesian theory of unemployment emphasises the argument that if monetary and fiscal policy does not keep demand at a high enough level, then the economy is less likely to be able to sustain a high rate of employment. However, not every increase in aggregate demand and production has to be met by employing more labour. Each year we expect to see a rise in labour productivity (more output per worker employed). And, businesses may decide to increase production by making greater use of capital inputs such as extra units of machinery. A growing economy creates jobs for people entering the labour market for the first time. And, it provides employment opportunities for people unemployed and looking for work.

Policies used in the UK to reduce unemployment

Evaluation points on unemployment policies

1. There are always cyclical fluctuations in employment. If growth can be sustained and monetary and fiscal policy can avoid a large negative output gap then it should be possible to create a steady flow of new jobs
2. Demand and supply-side policies need to work in tandem for unemployment to fall in the long term. Simply boosting demand if the root cause of unemployment is structural is an ineffective way of tackling the problem. If demand is stimulated too much, the main risk becomes one of rising inflation (i.e. the trade-off between these two objectives may worsen)
3. Full-employment does not mean zero unemployment! There will always be some frictional unemployment – it may be useful to have a small surplus pool of labour available
4. There are still large regional differences in unemployment levels and pockets of deep-rooted long-term unemployment in many areas, which causes significant economic and external costs

Recent trends in UK unemployment

The main explanation behind the decline in unemployment has been economic growth. Labour as a factor input has a derived demand - so rising production generates a higher demand for labour. These employment-creation effects have not been uniform throughout regions and industries.

Other factors that have helped bring down the unemployment rate include:

1. Demographic factors – there has been a slower growth of the population of working age than at a similar stage of the last economic cycle in the early 1980s. This has lead to a slowdown in the numbers of people of working age entering the UK labour market.
2. Expansion of further and higher education - there is a trend for more young people choosing to delay their entry into the labour market and remain in full-time post-16 further and higher education to boost their qualifications. Government policies have an explicit aim of increasing the participation rate of 18 year-olds in higher education. This puts less pressure on the number of new entrants into the labour force looking for work.
3. "Discouraged worker effects" due to structural unemployment: Some workers have given up active job search, in the process become economically inactive and moved onto permanent sickness and invalidity benefits or early retirement. The precise number of people involved is difficult to calculate with accuracy – it probably affects several thousand people.
4. Employment creation from foreign investment: The British economy has been successful in attracting billions of pounds worth of inward investment from overseas companies.  A high proportion of this has gone into building new plants in the UK and this has created thousands of new jobs helping to offset some of the regional disparities in unemployment.
5. Increased investment in worker training: This seems to have reduced structural unemployment. Labour shortages are problematic in some industries, notably in areas where house prices are high and unemployment rates have fallen below 2%. But taking the economy as a whole, it seems that shortages of labour have not proved to be as difficult as in previous phases of economic expansion. The main shortages are in highly skilled jobs and in areas where living costs are well above the national average. The government has suffered from a shortage of workers in key public sector jobs.
6. Increased flexibility in the labour market: This has made it easier for businesses to hire workers and match their desired labour input to planned production. The number of part-time workers on short-term contracts has grown by many thousands. There has also been greater functional flexibility with workers expected to perform a number of tasks within the business.

Can the UK achieve full-employment?

The British labour market has performed well in the last decade raising hopes that low unemployment be maintained for the foreseeable future. There is still much to be done to reduce unemployment in economically depressed areas. Although the average rate of unemployment has come down, jobless rates in excess of 10% are a feature of many towns and cities. And youth unemployment remains a serious problem.  The sustained fall in unemployment has encouraged optimism that Britain can reach full-employment in the near future. Indeed, in some regions and towns and cities, full-employment is already a reality. The UK unemployment rate started to rise again in 2005 and 2006 albeit at a gentle rate.

Economists agree that unemployment cannot fall to zero since there will always be frictional unemployment caused by people moving into the labour market and others switching between jobs. Full-employment might be defined as when the labour market has reached a state of equilibrium - i.e. when those who are willing and able to work at going wage rates are able to find work.

Another interpretation of full-employment is when the total of people out of work matches the number of unfilled job vacancies. The problem with this is that estimates of the scale of job vacancies vary considerably. The true number of jobs available is probably three times the official published figure.

Skills Shortages

The prospect of reaching full-employment is diminished by the continuing problem of skills shortages.  Skills shortages have been a recurrent problem in manufacturing jobs, but the problem has widened to new economy businesses and also the public services (including education and the NHS)