Evaluate the best policy for reducing the level of unemployment in the UK.

[20]

Define unemployment - willing and able to work at the current wage rate but unable to get a
job.

Cyclical unemployment occurs when aggregate supply exceeds the aggregate demand of
labour. This type of unemployment occurs when there is a lack of AD in the economy. When
the economy is experiencing a recession, more and more firms will have to shut down due to
falling demand for and output of goods and services. As a result, many workers will be made
redundant.The wage rate is above equilibrium despite the fall in aggregate demand because
workers resist wage cuts. Cyclical unemployment can thus last a long time if workers
continue to resist wage cuts as it leads to a further fall in AD.

Some solutions to cyclical unemployment rather than lowering the wage rate are demand side
policies. This is because a lower wage rate leads to lower consumption due to less disposable
income, ultimately resulting in lower AD and thus lower demand for labour, creating a
downward spiral.

Therefore, demand-side policies such as expansionary fiscal (reduction of direct taxes and
increasing government spending) or monetary policy (reducing rate of interest and increasing
money supply) would be a greater way to solve the problem as these policies target recession
by shifting aggregate demand to the right , making the equilibrium wage rate at Y where ASL
= ADL. However, a problem arising from using expansionary fiscal policy and monetary
policy would be that too much money supply can lead to inflation because more money is
available to be spent. Lower interest rate and tax might not actually increase borrowing and
consumer spending in the economy if consumer confidence is low
Structural unemployment is a form of involuntary unemployment because of the mismatch
of the skills needed for the available jobs and the unemployed skills. This is caused by
changes in the economy such as deindustrialization, which leaves the unemployed with skills
they can’t use in other industries. Example: a brick worker finds himself unemployed because
his factory closes down and the available jobs are all in the IT department, so his skills don’t
match.

Some policies that can be used are supply side policies:

- Improving education and training may increase workers' occupational mobility and so
reduce structural unemployment. These training schemes need to be focused on skills
and qualifications which would help the unemployed find work in new industries.
However, there may be drawbacks due to government failures, as they may subsidise
the wrong type of training for unemployed workers. Unemployed people may also
feel a lack of confidence in uptaking such courses as they are unsure of the benefits
provided.
- The Government may also be able to subsidise houses to solve the issue of
geographical immobility although it may be costly and time-ineffective.
- The government may also be able to offer incentives for firms to move and relocate to
areas of higher unemployment. However, firms may be reluctant to relocate and there
is a limit to how many jobs can be relocated.

Real wage unemployment occurs when the government sets the minimum wage above the
equilibrium level. This causes the supply of labour to increase and for it to become higher
than demand.
To reduce unemployment created by minimum wage, the government should aim to increase
flexibility in the labour market, which will encourage more workers to accept job offers at the
current wage rate and reduce the need for minimum wages. For example, a greater flexibility
in the number of hours required to work. They could also aim to restrict the power of trade
unions and their ability to influence the labour market and set minimum wages as well as
abolish the national minimum wage set.

However, minimum wages can be beneficial as it encourages workers, giving them incentive
to work for a higher pay hence reducing voluntary unemployment. Abolishment of minimum
wage can also cause voluntary unemployment as workers might refuse to accept the current
wage and will wait until they get a job with a higher pay. If it is a monoposony labour
market, trade unions may reduce unemployment.

Frictional unemployment is a common type of unemployment, it occurs when workers are

in between or in the process of changing jobs.

Policies used to reduce frictional unemployment include increasing the quality and quantity
of job information in the market can also lower frictional unemployment . Internet job
matching websites have the potential to find quicker job vacancies for the unemployed. If the
database is comprehensive for all positions, then workers can more easily see which jobs to
apply to. Reducing unemployment benefits can encourage workers to find a job as workers
have less incentive to stay unemployed if the benefits are low. Reducing income tax can also
encourage more people to work as there will be an increase in disposable income for those
who are working, making it more attractive compared to those who are unemployed.

However, reducing benefits can increase income inequality and poverty. Poverty trap can also
be a problem where income tax reduction may not encourage workers to enter the labor
market if they find themselves worse off after losing the benefits they were originally entitled
to claim.
Evaluation. Is there a ‘best’ policy?
The best policy depends on the type of unemployment prevalent in the UK economy at the
time. If most unemployment is because of deficiency in demand, then demand-side policies
would be better. If unemployment is largely structural, frictional or real-wage in nature, then
SS policies would be the best choice. Given that it is often difficult to accurately classify
unemployment by exact type of cause, then it would seem that we cannot say definitively
which is the best policy.

SS policies may offer a solution as to which policy is best overall as these can have both
demand-side and supply-side effects simultaneously. Examples of these would be a cuts in
direct tax or investment in infrastructure. These would affect multiple types of unemployment
at the same time, which would be an ideal policy if these worked. However, although the
demand-side effects often work quickly, the supply-side policy may take time to be effective.

A further complication exists where someone becomes cyclically unemployed in a recession

but becomes structurally unemployed if they remain unemployed for a long period and
become deskilled. Eg: In 2020-21, a short-term unemployment caused by lockdowns would
end up becoming more permanent– a process referred to as hysteresis.

Conclusion
In reality, governments rarely rely on one policy alone. The government combines monetary,
fiscal and SS policies in order to reduce employment. Total unemployment in the UK is
likely to consist of multiple causes at the same time and therefore it is probably too simplistic
to say that there is one single ‘ best policy’.
Assess whether government intervention is needed to reduce cyclical
unemployment. [20]

Intro:
● Define cyclical unemployment
● Government policy tools used
● The alternative to using government policy to reduce cyclical unemployment is to
leave it to market forces.

Cyclical Unemployment is unemployment due to a period of negative economic growth,

or economic slowdown.

In a recession, cyclical unemployment will tend to rise sharply.

Policies used: expansionary fiscal and monetary policy

The alternative to using government policy to reduce cyclical unemployment is to leave it

to market forces.

Analysis 1: Government intervention is needed

● How expansionary fiscal policy and expansionary monetary policy may reduce
cyclical unemployment

Cyclical unemployment is a short-term problem, caused by a recession. Keynesians believe

prices and wages are relatively inflexible and that the government must help achieve full
employment.

Disequilibrium unemployment (cyclical unemployment)

● When aggregate supply of labour exceeds the aggregate demand of labour

○ Also known as cyclical unemployment
● Wage rate is above the equilibrium level because aggregate demand fell but workers
resist wage cuts

● A diagram showing disequilibrium unemployment with the wage rate being

 above the equilibrium where the AD of labour = AS of labour

In the case of a recession, A decrease in aggregate demand will cause an alteration of

aggregate supply of goods and services. To be able to keep up a stable level of employment
wage cuts should occur. But powerful trade unions will be able to resist any salary cuts.
Companies also fear losing skilled labour and motivation if lowering wages and therefore
rather release unskilled work force and keep wages on a higher level.

Thus, the preferred solution will be to avoid or minimise recessions using expansionary
fiscal and monetary policy.

Monetary policy:
Monetary policy is financial influence implemented by a central bank (in the U.S., this is
the Federal Reserve Bank or the Fed). Monetary policies usually come in the form of lower
interest rates, which increase the total money supply within an economy by allowing banks
and businesses more access to loans—and therefore, more accessible spending power.

Fiscal policy:
If expansionary monetary policy doesn’t adequately lower the unemployment rate,
government agencies will turn to fiscal policy. Fiscal policy is fiscal stimulus implemented
by the national government, and fiscal policies include spending on infrastructure,
proposing tax cuts, increasing the minimum wage, or implementing unemployment benefits
(for instance, unemployment insurance). These methods are designed to inject more
demand into the private economy and strengthen economic activity.

● Keynesian view on why cyclical unemployment can continue in the long run
Keynesians believe that what is true about the short run cannot necessarily be inferred from
what must happen in the long run, and we live in the short run. They often quote Keynes’s
famous statement, “In the long run, we are all dead,” to make the point.

When the economy re-enters an expansionary phase, it is expected that businesses would
start re-hiring the unemployed and that the economy’s unemployment rate would start
declining towards its normal or natural unemployment rate until cyclical unemployment
becomes zero. This is the ideal scenario, of course. However, hysteresis tells a different
story. Hysteresis states that as unemployment increases, more people adjust to a lower
standard of living. As they become accustomed to the lower standard of living, people may
not be as motivated to achieve the previously desired higher living standard. Also, after the
labour market returns to normal, some unemployed people may be disinterested in
returning to the workforce as it becomes more socially acceptable to be or remain
unemployed. Last, and most significantly, employers themselves have undergone
significant pain during a downturn and will be more likely to demand more of the
remaining workers before taking on the larger costs of adding to their workforce.
Hysteresis in unemployment can also be observed when businesses switch to automation
during a market downturn. Workers without the skills required to operate this machinery or
newly installed technology will find themselves unemployable when the economy starts
recovering. In effect, the loss of job skills will cause a movement of workers from the
cyclical unemployment stage to the structural unemployment group. A rise in structural
unemployment will lead to a rise in the natural unemployment rate. In Keynesian theory
there is a certain amount of unemployment which will persist in the long run. It can't be
eliminated by increased demand, but has got to be tackled with structural policies, for
example by retraining miners whose profession is no longer demanded.

Analysis 2: Government intervention is NOT needed

● The new classical economists’ view that government intervention is not

necessary to eliminate cyclical unemployment
● Why the aggregate demand for labour market may to equilibrium
● A diagram showing equilibrium unemployment where the aggregate labour
force is greater than the AS of labour at the going wage rate

The new classical economists’ view that government intervention is not necessary to
eliminate cyclical unemployment. Their idea is that the economy will automatically create
an equilibrium market. They believe that prices and wages are flexible and any
unemployment is only temporary.

When demand decreases, firms will demand for less labour, resulting in an excess supply of
labour. This will trigger wages to fall until equilibrium is restored. They also argued that if
wages fell, the prices of products made by labour would also fall because reduction in
wages causes reduction in costs of production. Employment will in the long run always
return to its `natural' level.

Equilibrium unemployment (natural rate of unemployment)

● Is when the aggregate demand for labour equals the aggregate supply of labour.
● At this point there is no pressure for the real wage rate to change.
● Those willing and able to work with the current wage rate will have a job.
● However some people who are part of the labour force will not have a job because
they are not willing to accept the current wage or due to geographical/ occupational
immobility.
Evaluation:

● The difficulty of determining whether unemployment is cyclical, structural or

frictional.
● The influence of the scale and persistence of cyclical unemployment.
● The influence of how flexible labour markets are

It is difficult to distinguish between frictional, structural, and cyclical unemployment

because they sometimes overlap. People between jobs may take much longer to find a new
job because of the unavailability of suitable employment, job location, or other factors. In
such cases, frictional unemployment may become structural unemployment. If cyclical
unemployment continues for a longer duration, it might become structural unemployment
because people need more skills to become employable again.

Cyclical unemployment is not usually a long-term phenomenon. However, if a recession is

particularly severe, cyclical unemployment can last for a few years. Therefore the needs
of government intervention depends on the length and severity of an economic
contraction. Prices and wages respond slowly to changes in supply and demand. Changes
in demand have the strongest short-term impact on output and employment. Government
intervention is required to reduce the volatility of the business cycle.

It also depends on how flexible the labour market is. Labour market flexibility refers to
a competitive labour market where workers can adapt to changing pay requirements, and
there are flexible hours and working contracts. Flexible labour market policies during the
economic crisis stabilised the unemployment rate. However, workers usually seek
employment protection and there is no convincing evidence that companies themselves
would take the option for a very high degree of flexibility and high labour turnover. They
may prefer a stable employment relationship, and appreciate experience as a transaction
cost, which reduces screening and training costs. Therefore wages are not flexible as the
classical theory asserts. Wages tend to be rigid on the down side because workers will
not accept wages which do not permit them to live adequately. If wages are too low,
unemployment will exist. Therefore government intervention is needed to reduce
unemployment.

Conclusion: