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The issue of unemployment is among the serious problems that affects the social and economic balance of a country. Basically, unemployment is an economic problem having severe social consequences. The rate of unemployment directly indicates the economic strength. In this regards, labour economists confront problems in assessment of the rate of unemployment at local, regional and national level. The devastating conditions of the Great Depression in 1930s induced economists to propose theories for explaining the issue of unemployment and suggesting corrective policies (Layard, Layard and Nickell, 2011).
Different economists have presented diverse aspects of unemployment for assessing the social and economic implications of this issue. The focus of this essay is on theoretical explanations of unemployment. Therefore, the paper intends to analyse the issue of unemployment on the basis of different views, reasons and factors. In this essay, the key argument to be assessed is that the unemployment is a big socio-economic issue. In this context, firstly natural rate of unemployment will be discussed. Furthermore, the essay intends to present and contrast the Keynesian view and the NAIRU (Non-Accelerating Inflation Rate of Unemployment) view on unemployment in both their theoretical and empirical analyses. Lastly, the issue of unemployment will be analysed, and probable changes in the governmental interventions will be proposed to deal with the problem. It will add value to the understanding of the issue and highlight its implications on the social and economic prospects.
Natural Rate of Unemployment
In the 1960s, Milton Friedman developed the concept of the natural rate of unemployment of the economic activity. The natural rate of unemployment can be referred to as the rate of unemployment at which there exists equilibrium in the labour market. Real wages meets the free market level at the rate of unemployment, which equilibrates the supply and demand of labour. Basically, it happens due to the supply side factors on the contrary to demand side factors. The concept of natural rate of unemployment includes frictional unemployment, structural unemployment, and surplus unemployment (Weiner, 1986).
Sometimes, the natural rate of unemployment is referred to as NAIRU because the propensity of an increase in inflation is zero in case of unemployment equal to 4%. Furthermore, sometimes, it is referred to as the full employment level of unemployment because there is some unemployment in the labour market stimulated through the supply side factors. Milton Friedman specified some institutional factors for assessment of the natural rate of unemployment, which are skills and education (affects the degree of occupational mobility), hysteresis (increase in unemployment rate due to recession), flexibility in the labour market (influence of trade unions), extent of labour mobility, and accessibility to job information (for evaluating frictional unemployment) (Labonte, 2004).
Keynesian View of Unemployment
One of the key aspects of Keynesian economics is based on the ideology that the macro economy can remain in a state of disequilibrium (or recession) for a substantial period of time. It emphasises on the role of governmental interventions towards overcoming the lack of demand for stimulating reduction in the rate of unemployment and increasing the corresponding growth of the economy. Typically, Keynesian view prescribes that an increase in the level of unemployment contributes towards reduction in the level of income, which also led to a decrease in the level of consumption and output. This implies that the benefits of unemployment are helpful for the job losers in seeking compensation from the reducing level of income (Viner, 1936).
According to Keynes’ classification, the most important type of unemployment is contingent on downward rigidness of monetary wages which is considered to be cyclical unemployment or demand deficit unemployment. It is involuntary unemployment that occurs because of the lack of demand, which is related to the transformation of the economy over the period of business cycle. In case of recession, it is expected that the level of unemployment will rise due to the worker lay-offs and closing of business units, which results into a decline in demand. It can also prevail in the case of constant economic performance below the capacity over a long run (Viner, 1936).
Key theoretical explanations behind the prospects of Keynesian economics are based on variations in the economic factors. Keynes demonstrates that "Given the psychology of the public, the level of output and employment as a whole depends on the amount of investment." (Keynes, p.221). Firstly, in case of a rise in the savings as compared to investment, there occurs the situation of recession. According to the classical theory, a reduction in investment level contributes towards lowering of interest rates, which will induce a decrease in savings and improvise the investment capability (this stimulates the economy to reach at a new equilibrium level of full employment). In contrast to this, Keynesian view exemplifies that such equilibrium is less likely to happen because of various factors. Some of them include liquidity trap, multiplier effect, excessive supply of savings, animal spirits, etc (Smith and Zoega, 2009).
In case of high savings and low level of consumer spending, firms will sustain a high stock level of unsold items and will focus on reducing investment. The idea of multiplier effect was proposed by Keynes. It emphasises on reduction in the investment capacity of a firm contribute towards loss of job, which also reduces spending by affecting people in the economy. Therefore, Keynes also stressed on the relevance of confidence and expectations. Generally, Keynes theory emphasises on the fact that investment is helpful in assessment of the effective demand, which establishes the gateway for determining unemployment. This indicates that the role of labour market is not worth considering (Keynes, 1937).
Further elaboration of general theory proposed by Keynes reflects propositions of New Keynesian models, which supports the role of labour market institutions in determining the natural rate of unemployment and the relative adjustment in the level of unemployment towards it. Irrespective of the strong relationship among the investment and unemployment, investment is usually not acknowledged to be the key variable that gives a rise to the issue of high level of unemployment. In OECD countries, investment and expectations play a pivotal role in evolution of unemployment in the economy over the long run (Smith and Zoega, 2009).
NAIRU View of Unemployment
During 1970s, the concept of NAIRU has been included in the field of macroeconomics. It is a building block of the basic theory of macroeconomics. The traditional concept of economics stresses on the fact that the supply of money has an effect on the rate of inflation and unemployment. NAIRU is synonymous with the concept of natural rate of unemployment. It can change with respect to the changes in labour market conditions and changes in the economic conditions (at broad level). Diverse economic conditions affect the rate of inflation and unemployment. In regards to this, evaluation of unemployment rate in stable inflation easily is noteworthy (Weiner, 1986).
NAIRU model is difficult to be explained as Ball and Mankiw state" The practical application of this concept, however, is less straightforward. The value of NAIRU is hard to measure, largely because it changes over time." (Ball and Mankiw, p.134). Its value is difficult to be measured due to the existence of consistent changes that took place over time. The key ideology of NAIRU perspective emphasises on wage rigidities. It remains uninfluenced from the monetary policy, but it is affected by the rigidity in the labour market and hindering economic conditions. The reason behind this is that rigidity in the labour market reduces the productivity of the labour and capacity utilisation to a great extent.
As per explanation of Ball and Mankiw (2002), NAIRU perspective acknowledges the existence of unemployment due to wage rigidity and wait unemployment. Wage rigidity comes into the existence due to the failure of monetary wages in sustaining equilibrium under the supply and demand mechanism of labour market. It stimulates an imbalance in the employment status within the economy. A rise in the level of unemployment will have no implications on the consumption in case it is expected to influence the income receipts (Ball and Mankiw, 2002).
Consistent changes in the NAIRU over time can be due to demographic conditions and governmental policy. Furthermore, variations in the productivity level stimulate a shift in the trade-off of unemployment and inflation. NAIRU is modified to include Keynesian features as this model is based on supply-side effects of capital accumulation and social norms in wage bargaining (Stockhammer and Klaer, 2010). Ball and Mankiw (2002) also elaborate that the concept of NAIRU is also important for the economists for assessing the shifts in demand (monetary policy based fluctuations) over a short run, which drive unemployment and inflation in opposite directions. This makes NAIRU eminent to be used in policymaking decisions at broader level.
The Issue of Unemployment
Keynesian and NAIRU views are different with respect to unemployment and its relative influences on the real output. In a typical way, Keynesian view specifies that unemployment lead to a fall in the proportion of income, which results into a decrease in consumption and output. However, NAIRU view follows the PIH (Permanent income hypothesis) as prescribed by Milton Friedman. Keynesian view stresses on demand deficiency to be the most important cause of unemployment, while NAIRU view stresses on wage rigidity to be the cause of unemployment. The differences in the two views can be analysed by defining a case of decline in the demand for labour. It results into a decrease in the level of employment and income receipts (Friedman, 1968).
According to the Keynesian view, by reducing the monetary wages, the level of unemployment can be reduced. But, the specifications for monetary wages are managed under the institutional datum. In such a case, compensation for unemployment is important to procure reductions in the level of consumption. As compared to this, the NAIRU view specifies that the impact of a decline in employment and income receipts is partial on the output up to the declination level of income. In case people become unsuccessful in revising the expectations (with respect to permanent income); the output does not get affected. The reason behind this is that monetary wages are sticky, which signifies that the labour supply follows the function of permanent income and real wage. In such a case compensation for unemployment paves way for smooth income receipts without affecting the consumption level (Nickell, 1998).
An important distinction among the Keynesian and NAIRU view is clear from the above discussion. Keynesian view exemplifies the fact that an increase in the level of unemployment compensation has an accelerating impact on the economy. In contrast to this, NAIRU view explains that this kind of variations have no or little (if any) influence on the economy. During 2008-2013, the recession prospects depict the prominence of Keynesianism due to similarities with the great depression that occurred in 1930s (Smith and Zoega, 2009).
GDP of the countries confronted extremely steep fall. The influence of recession lasted long and stimulated a loss of approximately 8.3 million jobs. In the United Kingdom (UK) and United States (US), there was a rapid increase in the level of government borrowing followed by a low degree of bond yields. There was a decline in the job turnover, which raised the level of unemployment across the world (ECB, 2012). Apart from the view of the economists and theories, another important aspect of unemployment is related to the structural issue of unemployment among youth. In this context, economists emphasise on the fact that the natural rate of unemployment can be repressed through the active governmental interventions. It is a major socio-economic issue, which is essential to be dealt with great care.
Key policies for reduction of the natural rate of unemployment intend to eliminate imperfections from the labour market. Different reform actions are undertaken by the governments of different countries. Some of the reform oriented actions include relaxation of employment laws, promotion of labour migration, reformation of trade unions (for reduction of collective bargaining and barriers to mobility of labour), and reformation of welfare benefits system. Therefore, it is essential for government policies to be focused on establishment of flexible and competitive labour markets for dealing with the issue of unemployment (Layard, Layard and Nickell, 2011).
It can be interpreted from the above discussion that the issue of unemployment is significant one for assessing the macroeconomic perspective. It has severe economic and social consequences, which are essential to be handled with great care for constructive growth and development of the economy. There are different perspectives about the issue of unemployment as proposed by the economists. The concept of natural rate of unemployment specifies the level of unemployment and inflation to be in equilibrium. The rate of inflation becomes constant for one year and another at the natural rate, which signifies constancy in the economy.
Keynesian view of unemployment signifies the impact of unemployment on the income and consumption level of people, which also stimulates a decline in the aggregate output. Demand deficiency leads to a rise in unemployment over a period of time (business cycle). It has significant influence on the economy of a country. In contrast to this, NAIRU view is in compliance to the concept of natural rate of unemployment. According to this perspective, unemployment level does not have significant impact on the economy because of existence of equilibrium position (in the level of inflation). It stresses on wage rigidity as the main cause of unemployment in the labour market. It is difficult to assess the level of NAIRU at a certain point of time due to consistent variations in the economic conditions.
The issue of unemployment holds pivotal place in development of the economy of a country because it adversely stimulates imperfections in the macroeconomic perspective. It is an important socio-economic issue that has to be managed optimally for sustaining a balance within the labour market and managing demand-supply mechanism of labour in accordance to the social, legal, and economic norms. Therefore, it is important for the governments of different countries to develop constructive policy based interventions for dealing with the issue of unemployment.
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