1. Unemployment and Labor Force Participation
Chapter 10
© 2010 WORTH PUBLISHERS MODERN PRINCIPLES: MACROECONOMICS COWEN AND TABARROK

2. Introduction A Recurring Story in American History
Many jobs have disappeared- and been replaced by new jobs….

3. Chapter Outline Defining Unemployment Frictional Unemployment
Structural Unemployment
Cyclical Unemployment
Labor Force Participation
Takeaway
See the Invisible Hand Blog (click) for more examples

4. Click here for the current U.S. unemployment rate

5. Defining Unemployment
Measuring Unemployment
A person is counted as unemployed if they…
Are 16 years of age or older.
Are not institutionalized (e.g., not in prison).
Are not in the military.
Are looking for work.
The unemployment rate is the % of the labor force without a job
The latest unemployment numbers are found at

6. Defining Unemployment
Unemployed worker: an adult who does not have a job but is looking for work.
Labor force: all workers, employed plus unemployed
Labor force participation rate: the percentage of adults in the labor force

7. In your country, there are 24 million people in the labor force. 21
In your country, there are 24 million people in the labor force million people are employed. What is the unemployment rate in your country?
10.4%
2.5%
89.6%
21.5%

8. In your country, there are 24 million people in the labor force. 21
In your country, there are 24 million people in the labor force million people are employed. What is the unemployment rate in your country?
10.4%
2.5%
89.6%
21.5%

9. Defining Unemployment
How Good an Indicator Is the Unemployment Rate?
Does not account for discouraged workers.
discouraged workers : workers that have given up looking for work who would still like to have a job.
account for 0.3% of the labor force.
For long recessions the number of discouraged workers will be higher.
Implication: In recessions that last a long time, the unemployment rate is not as good an indicator.
Instructor Note: The BLS definition of discouraged worker is: (a) Workers who have not looked for a job in the past four weeks, (b) but are available for work and who have looked for work in the past 12 months.

10. Defining Unemployment
How Good an Indicator Is the Unemployment Rate?
Doesn’t measure the quality of jobs or how well people are matched to their jobs.
Examples:
An overqualified worker, or one with a part-time job (who wants to work full-time) is counted as fully employed.
Economists also look at other indicators:
Labor force participation rate
Number of full-time jobs
Average wages

11. Defining Unemployment
There are three types of unemployment:
Frictional
Structural
Cyclical

12. Frictional Unemployment
Frictional unemployment: Short-term unemployment caused by difficulties of matching employee to employer.
Scarcity of information creates frictional unemployment.
Matching people to jobs takes time….

13. Frictional Unemployment
Usually doesn’t last very long.
2005: 35% of unemployment lasted less than 5 weeks.
Is a large share of total unemployment because:
the U.S. economy is dynamic.
“Creative Destruction”-Joseph Schumpeter.
progress is about creating new jobs and destroying old jobs.
it takes time to adjust to innovation and the job creation/destruction that ensues:

14. Structural Unemployment
Structural Unemployment: Persistent, long-term unemployment caused by long-lasting shocks or permanent changes in the economy.
Causes:
Large shocks that take a long time for the economy to restructure.
Oil shocks: fuel alternatives take time to create.
New information technologies: create new industries and cause the disappearance of others.
Globalization: decline of manufacturing and the rise of the service economy.

15. Structural Unemployment
Structural unemployment, if it lasts long enough, brings significant human costs.
At some point unemployment can become chronic.
The longer a worker is out of work, his or her skills atrophy.
Hiring managers are wary of hiring workers who have been unemployed for a long time.
Who would you rather hire: a worker looking to switch jobs or a worker who has been unemployed for five years?
Result: Unemployment can become a trap.

16. Duration of U.S. Unemployment
Most unemployment is short duration

17. Structural Unemployment
Labor Regulations and Structural Unemployment
In the U.S. unemployment increases with a shock, then declines.
In Europe unemployment has increased with shocks but has not declined.
Note:
You might want to point out that in the period all of these economies felt the shocks that we have been talking about. Also the U.S. economy went through a “double-dip” recession as the Fed ran a tight monetary policy to bring down the inflation rate. This contraction of the U.S. economies also affected the other countries.
The point is that the European economies never completely recovered from the shock. Of the European economies only Spain had a lower unemployment rate in than it did in

18. Structural Unemployment
Unemployment rates in the U.S. and Europe differ because of differences in labor regulations.
Unemployment benefits are more generous in Europe.
Unemployment benefits last longer in Europe.
Minimum wages are higher in Europe and unions are stronger.
The higher the minimum wage is above the market wage, the greater unemployment will be.
Unions have the same effect.

19. Structural Unemployment
Instructor Note: Benefits are more generous in Europe and last longer. Implication: Unemployment benefits reduce the incentive for workers to search for and take new jobs.

20. Structural Unemployment
Union: an association of workers that bargains collectively with employers over wages, benefits, and working conditions.
Unions take many forms: some act to increase wages simply by restricting entry into a profession with licensing requirements.

21. Structural Unemployment
Median Wage: the wage such that ½ of all workers earn wages below the median and ½ of all workers earn wages above the median.
Minimum wages in Europe are higher than the U.S. (France= 40% higher)
European minimum wages are also higher relative to their median wage than the U.S.
Result: minimum wage creates more unemployment in Europe than it does in the U.S.
Minimum wage in Europe affects more workers than U.S. minimum wage does.

22. Structural Unemployment
Effect of Minimum Wage on Unemployment
Wage
Supply of Labor
Unemployment
Minimum
wage
Result:
Minimum wage causes unemployment
Market
wage
Instructor Note:
The minimum wage is only effective if it is above the market wage. The higher skilled labor markets are not affected because the minimum wage is below the market wage.
To the extent unions can increase labor costs by demanding higher wages and benefits, the effect on employment is the same.
The higher minimum wage and stronger unions help explain why structural unemployment is higher in Europe than the U.S.
Demand
for labor
Quantity
Of Labor
Employment
with minimum
wage
Labor supplied
with minimum
wage
Market
employment

23. Structural Unemployment
Potential Effect of Unions on Unemployment
Wage
Supply of Labor
Unemployment
Union
wage
Result:
Certain types of unions can cause unemployment
Market
wage
Instructor Note:
Obviously a fuller discussion of
Demand
for labor
Quantity
Of Labor
Employment
with Union
Labor supplied
with union wage
Market
employment

24. Structural Unemployment
Employment Protection Laws
The U.S. uses the employment at-will doctrine.
employment at-will doctrine: an employee may quit and an employer may fire for any reason.
many exceptions: race, religion, sex, sexual orientation, national origin, age, or handicap status.
most basic U.S. employment law.

25. Structural Unemployment
World Bank “rigidity of employment index”
summarizes hiring and firing costs
the higher the index, the greater the costs

26. Bottom line: it’s not easy to change employment law.
Can you spot the differences?
Unemployed teens (outsiders) want France to adopt At-Will employment to make it easier for firms to hire, and riot in 2005.
Then France proposed the changes, and employed teens (insiders) rioted against the changes in 2006.
France capitulated.
Bottom line: it’s not easy to change employment law.

27. Structural Unemployment
In summary, European labor regulations:
create valuable insurance for workers with a full-time job.
make labor markets less flexible and dynamic.
increase the duration of unemployment.
increase unemployment rates among young, minority, or otherwise “riskier” workers.
Is miminum wage a force for good or a force for bad? Yes.

28. Structural Unemployment
Labor Regulations to Reduce Structural Unemployment
Europe has begun to change its labor laws.
Reducing unemployment benefits
Adopting active labor market policies: work tests, job search assistance and job retraining programs focus on getting unemployed workers back to work.
Allowing exceptions to collective bargaining agreements.

29. Structural Unemployment
Factors that Affect Structural Unemployment
Large, long-lasting shocks like:
Oil shocks
Shift from manufacturing to services
Globalization and global competition
Fundamental technology (computers/Internet)
Labor regulations
Unemployment benefits
Minimum wages
Powerful unions
Employment protection laws

30. Cyclical Unemployment
Cyclical Unemployment: unemployment correlated with the business cycle
Lower growth is usually correlated with higher unemployment for two reasons:
When GDP falls, firms lay off workers.
Idle labor and capital → economic growth is not being maximized → ↓ ability of the economy to create more jobs.
Instructor Note: This is a “vicious circle” argument. When the economy slows down, unemployment rises. Rising unemployment implies idle capital and labor and growth slows even more.

31. Cyclical Unemployment
Unemployment increases during a recession
Instructor Note:
Recessions are shaded.
Unemployment is a lagging indicator. In each case the unemployment rate begins to increase before the recession begins and it continues to rise after the recession ends.

32. Cyclical Unemployment
Faster growth in Real GDP decreases unemployment
Instructor Note:
The left axis is the percentage change in the unemployment rate.
The graph shows that the lower the rate of GDP growth not only will the unemployment rate rise but the rate at which it rises increases.

33. Cyclical Unemployment
What causes cyclical unemployment?
Non “Keynesians”: Caused by real shocks that require a reallocation of resources.
Cyclical unemployment is just another example of frictional and structural unemployment.
“Keynesians”: Caused by deficiencies in aggregate demand.
For now: consider it a mismatch between the aggregate level of wages and the level of prices.

34. Cyclical Unemployment
The Natural Unemployment Rate: Structural plus frictional unemployment.
Instructor Note:
It is clear that cyclical unemployment is much more volatile than the natural unemployment rate. Some reasons for this might be:
Frictional unemployment results from the inability of the labor market to instantly match job seekers with available jobs, and the movement of people in out of the labor market. It is likely that changes in these factors if they change will change at a relatively slower rate.
Also, the ageing of the labor force results in lower frictional unemployment because older workers are less likely to leave and return to the labor force for education or family reasons. This helps explain the decline in the natural rate of unemployment since This process is also a gradual one.
Structural unemployment results to large extent from technical change which proceeds at a more steady pace.
Note: Total unemployment changes much quicker than the natural unemployment rate.

35. Labor Force Participation
Measuring the labor force participation rate
The % of the adult (16+) non-institutionalized civilian population who are working or actively looking for work.
Example, U.S. 2009:
Labor Force
Participation
Rate
Labor Force
Participation
Rate

36. Labor Force Participation
What determines the labor force participation rate?
Lifecycle Effects and Demographics
Baby Boomers: people born during the high birth-rate years,
Implication: As the U.S. labor force ages, the participation rate will fall

37. Labor Force Participation
Labor force participation varies significantly across countries.
Males, age 55-64, 1998 data from OECD Statistics

38. Labor Force Participation
Differences in Incentives
Taxes and Benefits
Taxes discourage work and benefits encourage non-work.
Many countries penalize workers who work past the normal early retirement age.
Netherlands in the 1990s: Working past the age of 60 meant losing one year of government retirement benefits.
Result: Individual working past age 60 after paying payroll taxes made less money than a worker who retired.

39. Labor Force Participation
Labor force participation declines with higher taxes.
Males, age 55-64, 2005 data from OECD Statistics

40. Labor Force Participation
Differences in Incentives
Incentives and the rise in female labor force participation:
: number of women aged in the paid labor force increased from 35% to 75%.
What caused this?
Cultural factors
Rise of feminism
Growing acceptance of equality
Move from a manufacturing to a service economy.

41. Female Labor Force Participation

42. Female Labor Force Participation, Professions

43. Labor Force Participation
Differences in Incentives
How “the pill” increased female labor force participation:
lowered the:
cost of earning a professional degree.
uncertainty about the consequences of sex.
Result: the pill lowered the costs and increased the incentive of women to invest in a long-term education.

44. Key Concepts Unemployed Median Wage Labor Force Union
Unemployment Rate
Employment At-Will Doctrine
Labor Force Participation Rate
Active Labor market Policies
Discouraged workers
Cyclical Unemployment
Frictional Unemployment
Natural Unemployment
Structural Unemployment
Rate Baby Boomers

45. Which of the following individuals can be counted as unemployed?
Darren, a ten-year-old child
Nazma, a stay-at-home mom
Moesha, a full-time college student
None of the answers is correct.

46. Which of the following individuals can be counted as unemployed?
Darren, a ten-year-old child
Nazma, a stay-at-home mom
Moesha, a full-time college student
None of the answers is correct.

47. Adult population
200 million
Labor force
150 million
Employed persons
million
Discouraged workers
10.5 million
According to the accompanying labor data, the unemployment rate is _________ and the labor force participation rate is __________.
7%; 60.4%
0.7%; 99.3%
5.6%; 69.4%
7.5%; 75%

48. Adult population
200 million
Labor force
150 million
Employed persons
million
Discouraged workers
10.5 million
According to the accompanying labor data, the unemployment rate is _________ and the labor force participation rate is __________.
7%; 60.4%
0.7%; 99.3%
5.6%; 69.4%
7.5%; 75%

49. II. workers who are overqualified for their work.
According to the Bureau of Labor Statistics, unemployment includes :
I. discouraged workers.
II. workers who are overqualified for their work.
III. workers who have a part-time job but want a full-time job.
I and II only
II and III only
I, II, and III only
None of the answers are correct.

50. II. workers who are overqualified for their work.
According to the Bureau of Labor Statistics, unemployment includes :
I. discouraged workers.
II. workers who are overqualified for their work.
III. workers who have a part-time job but want a full-time job.
I and II only
II and III only
I, II, and III only
None of the answers are correct.

51. Jasmine has recently moved to Florida because she loves the warm climate there. Because she is new to the area, she will need to spend a few weeks looking for a new job. This is an example of:
frictional unemployment.
cyclical unemployment.
structural unemployment.
underemployment.

52. Jasmine has recently moved to Florida because she loves the warm climate there. Because she is new to the area, she will need to spend a few weeks looking for a new job. This is an example of:
frictional unemployment.
cyclical unemployment.
structural unemployment.
underemployment.