Unemployment within the Labour Market Is Primarily Voluntary - Essay Example

Unemployment within the labour market is primarily voluntary. This paper elaborates the fact that unemployment within the labour market is primarily voluntary based on views and models of various economists and studies since 1930 recession period. A broad perspective of types of unemployment in the labour market has been highlighted based on classical views, Keynesian theory, neo-classical models and new-Keynesian theories. It further explains the rational expectations of labour markets to predict behaviour of economy, from a macroeconomic view. Through these models and theories, factors contributing to unemployment and their impact have been exposed. The paper concludes with the role of various entities in controlling voluntary unemployment. Classical economists viewed labour market similar to other markets based on supply and demand in that price would adjust to ensure that quantity demanded equaled quantity supplied. However, labour market differs in setting price and quantity of supply and demand. In case of labour market, effective supply of labour is a challenge as it depends on factors such as time, skills, wages and availability. A rise in overall wages may not result in more supply of labour; on the contrary, may lead to less supply of labour or no change in labour. Within the overall labour market, particular segments are assumed to be subject to more normal rules of supply and demand as workers are likely to change jobs due to various reasons, particularly in response to differing wage rates leading to unemployment for certain period of time. Unemployment is one of the serious problems that can affect people directly or indirectly, in any nation. Every country faces this problem; however, it widely varies in proportion. Labour economics is one of the important sections of market economics, besides financial market and product market, and is studied at micro and macro levels. While, microeconomics of labour market deal with role of individuals and individual firms in the labour market, macroeconomics looks at the interrelations of labour market, the goods market, the money market, and the foreign trade market. Understanding of labour market is the centre feature of any macroeconomic theory. In the classical view of the labor market, all unemployment is voluntary. When the economy goes into a recession and the demand for labor falls, the wage rate will decline and people will opt out of the labor force. However, the classical theory could not explain situations the 1930 recession thoroughly. Economics has various definitions of voluntary and involuntary unemployment, attributed to various factors. Economists of the Keynesian theory emphasize unemployment resulting from deficit in demand for goods and services. The Neo-Keynesians direct unemployment to structural problems, inefficiencies and imperfections inherent in labour markets. Classical and neoclassical economists have a very different view focusing on the stringencies imposed on the labour market such as minimum wage laws, taxes, and other regulations that may discourage the hiring of workers. Unemployment is also viewed primarily voluntary based on their preferences of higher wages etc, the frictional unemployment. Involuntary unemployment is attributed to socioeconomic factors such as market structure, government intervention, demand in market etc. Involuntary unemployment, to a certain extent, depends on the choices made by the individual in the past, legislative or economic choices made by the labour unions or political parties. In any case, unemployment termed as involuntary, also at some point, can be seen as voluntary unemployment. To explain the recession of 1930 and behaviour of market, Keynes undertook extensive study on economics. Thus, evolution of macroeconomics is traced to Keynesian revolution which emphasized on unemployment resulting from deficient aggregate effective demand for goods, due to excessive saving or excessive demand for liquidity (Fine, B, 1998; p 23). In Keynesian economics, any level of unemployment beyond the natural rate is most likely due to insufficient demand in the overall economy. During a recession, aggregate expenditure is deficient causing the underutilization of inputs, including labour. Aggregate expenditure can be increased, according to Keynes, by increasing consumption spending, increasing investment spending, and increasing government spending, or increasing the net of exports minus imports. Aggregate expenditure depends on income, price level, and the expected rate of inflation. This is explained in the Walras-Keynes-Phillips model and through the Phillips curve (Tobin, J et al 1991; p.54). Keynes view on labour market focused on unemployment situation of labour, which could result due to wages sliding downwards. This means, workers would not appreciate wage cuts, and would opt out of employment with the pretext of resistance. In the Keynesian view, this is termed as demand deficient unemployment because whenever demand for labour falls, as in case of recession, fall in wage rate should be experienced; however, wage being sticky downwards, unemployment would persist. According to the theories of labour supply, voluntary unemployment arising from workers’ own decisions shows an impact on the multiplier with a reduction in aggregate demand for commodities. This further forces the employer to lay off workers. These result in a deteriorating labour market, due to fall in demand market resulting in demand deficient unemployment which further follows a wave of voluntary quitting (Bhaskar, K & Murray, D, 1976; p 268). Very often, workers quit for higher wages/income. A state of excessive demand in labour market is proportionate to new wage offers and job placements. Evidences have also shown that many workers who voluntarily quit, have jobs lined up, and hence do not fall under the unemployed bracket. Keynesian’s view of demand deficit unemployment can be understood in manner following. If workers decide to quit only for highest wages, he will expect to remain unemployed till the time he gets the right offer. However, microeconomics suggests that workers focus is not limited to ‘only’ higher wages. Workers would continue search until the marginal cost of continuing the search is equal to the marginal benefit derived. Time factor plays a vital role in this activity, and thus, unemployment may now become inevitable where information has to be sought for. Neo-classical economics have emphasized on unemployment being more voluntary, than the Keynesian studies. Here again, the reason for voluntary unemployment is attributed to income generation. The same reason in the Keynesian view explains that involuntary unemployment is caused due to workers unable to find work at the prevailing wage at jobs they are will and qualified to take. On the other hand, neo-classical theory opposes this statement because these theorists believe that there is no such thing as a prevailing wage because pay rates for the same kind of work vary widely among different employers. In the neo-classical view of unemployment during conditions of recession, many theorists believed that layoffs increase and quits decline. Evidences state that most of the firms offer lower pay during these conditions; and workers to whom lower pay is not acceptable, volunteer to quit. Modes of the neo-classical view highlight the fact that buyers and sellers of labour do not have the right knowledge of trading opportunities, resulting in extended unemployment period. This is a consequence of delays in matching people to open positions, mainly caused due towage rate bargaining between the employers and individual employees or due to fixed wage components by the employers and adjusted to suit the people so as to ensure an adequate supply of labour (Bewley, T. 2002; p 4). Nature of labour market can be explained as lacking in transparency and homogeneity. The neo-classical theory looks at this nature of labour market as the causal factors of disequilibrium resulting from vacancies and unemployed people at any given point. Neither workers nor employers have complete knowledge about the market. In order to maximize their income, some workers always prefer to remain unemployed for a while, until they get the right job (Rothschild, K 1993; p.21). Thus, unemployment is resultant of imperfect information. As workers themselves do not want to take up the jobs present in the market or the jobs offered to them, due to their own preferences of higher income, it leads to natural unemployment, which again is voluntary in nature. As explained by Rothschild (1993; p 22), the Keynesian theory does not support involuntary unemployment in any sense; the deviations from the natural unemployment depicted in the Phillip’s curve are only a transitory phenomenon caused by uncertainty in times of shifting inflation rates. Rising inflation rates cause workers to believe that wages have also gone up, thus hastening their job search for better pay; in turn, settling for lower pay by mistake. This situation may be true in case of deflation, leading to real wage deterioration resulting in extended search periods. Thus, this lapse of period leads to unemployment. After a while, when the workers realize their mistake, will try to orient themselves on real wages irrespective of degree of inflation, thus unemployment returning to its natural level. Thus, in the neo-classical view, there is no involuntary unemployment. Theory of job search contributes significantly to the explanation of short-term ‘natural’ unemployment. Rational job search is usually preceded by voluntary unemployment. It is also a resultant of market matching, or worker-retention. Rothschild (1993; p 21) also argues that though wage levels, working conditions, and career opportunities play an important role in choice between different job opportunities, they are insignificant in case of choice between employment and voluntary unemployment. Search unemployment again is due to illusions of real wages. Though the search theory relates to higher wages, it does not necessarily mean unemployment as the workers tend to hop jobs with no time lag between the change; thus, ruling out possibility of unemployment. However, every worker requires certain period of time to reach his potential productivity, and this time can lead to loss of productivity. This transition phase again points to virtual unemployment for the employer. Many economists have argued for a migratory pattern for the natural rate of unemployment. These arguments, based on efficiency wages, menu costs etc were pursued as new Keynesians theories. These focus on the imperfect knowledge of labour market, and supply side of labour market. Contrary to the Keynesian concept, they do not take into account the demand determined equilibrium of labour market. Contrary to the thinking of neoclassical economists that ‘general equilibrium is strong on its existence but weak on how it comes about,’ (Rotheim, R 1998; p.51) the new-Keynesian economists have theorized based on the outliers of those equilibria. The new-Keynesian perception of unemployment occurring as a result of imperfection in the labour market illustrates this phenomenon based on methodologies related to wage policies. According to this phenomenon, some natural rate of unemployment exists due to the market and governmental policies that prevent the real wage from falling to the extent necessary for the labour markets to clear (Rotheim J 1998; p 101). While, the traditional Keynesian approach explained situations of excessive supply or demand for labour for particular firm, but was unable to address unemployment in the economy as a whole. Role of the rational expectations in labour market has been one of the main focus areas of the neo-classical analyses aimed to identify the ability of labour and its distribution to various jobs to derive optimum results. This model considers assumptions and expectations of workers, consumers and firms based on past experiences and devises future expectations in an unbiased systematic manner. Initially proposed by John F Muth (1961) and later developed by Robert E Lucas and others, makes optimal forecast of the future. This model hypothesizes that all available information is taken into account in forming expectations. In case of labour market, this behaviour focuses on three factors: firstly, attaining economically most advantageous job; secondly, accumulating the best labour ability through education and training; thirdly, accumulating information, and adopting all possible measures to retain the best labour (Ishikawa, T, 2001; p 178). Another expectation of the rational suppliers and demanders at the individual level lies in the real wage rigidity in an aggregate labour market. At one end, it is believed that labour productivity will shrink in case of low wages, and productivity will increase in case of higher wages. This, in view of unemployment, may only make the firms realize that lower wages will only reduce the productivity, increase the turnover, and reduce the profits. On the other hand, the supply side of labour would behave in a different manner. A rational individual may reject a low wage if he believes that better pay job will become available in the near future. This depends a lot on the information gained. Thus, it addresses the imperfect information to an extent. This again leads, primarily, to voluntary unemployment. While rational expectations theory has helped to explain fluctuations in output and employment or, at best voluntary unemployment, the theory based on search, efficiency wage and implicit contract has explained involuntary unemployment too. Rational expectations theory is important in labour market assessment as it is based on expectations. If business people can understand the importance of expansionary government policy, they can expand their output in anticipation to those effects rather than waiting for the rise in demand to be obvious in market. Thus, the rational expectations models focus on instantaneous clearing of the markets, thus making unemployment voluntary, and thus natural (Snowdon, B & Vane, H 1997; p 305). In conclusion, Lucas argues that voluntary and involuntary unemployment exist side by side. He disapproves Keynes explanation of two distinct unemployment, i.e., voluntary and involuntary. He also states that unemployment, viewed as an activity among others, should be viewed as voluntary since alternative activities are always present (De Vroey, M 2004; p 406). Nature of unemployment varies according to the market. For example, unemployment in unhampered market is always, again, voluntary. Thus, unemployment resulting from wage bargaining or real-wage settlement issues can only be voluntary when workers are not ready to settle for lower wages. All frictional unemployment is voluntary because people opt for unemployment while looking for jobs that suit their needs and abilities. Even all structural unemployment is voluntary because there is always some basic job that is available that anyone could take in the absence of excess supply of labour over demand. Ultimately, any theory is built on a vision-the perspective by which reality is interpreted. That vision guides us in choosing assumptions and interpreting results. Vision allows us to make the leap of faith necessary to believe that our theory is more than a set of tautological relations. Addressing the voluntary unemployment issue is vital for firms and also for economy as a whole. This can be achieved by enabling well balanced lives in harmony with market fluctuations. As this may not be possible from a monetary point of view, government and organizations can adopt appropriate employment policies to address the needs of workers. Good labour market and financial market prospects are directly proportional to healthy macroeconomic growth. In the opposite case, i.e., during economic slowdown and financial instability, negative impact on employment cannot be avoided. In such situations, firms, working unions and the governments should work together to bring about the right social cohesion. Role of government also lies in strengthening labour market supply and demand matching through well-coordinated job placement, unemployment benefits and active labour market services. References Bewley, T. Why Wages Dont Fall During a Recession. Published by Harvard University Press, 2002. Retrieved from, http://books.google.co.in/books?id=8fW22hrnY0oC&pg=PA3&lpg=PA3&dq=neoclassical+view+of+voluntary+unemployment&source=bl&ots=kMQBfLx9nb&sig=YKINmznEUEuy_taSHOBQYDMYiho&hl=en&ei=-HLcSYmNA4ry6gPKy9ywDA&sa=X&oi=book_result&ct=result&resnum=1#PPA4,M1 Bhaskar, K and Murray, D. Macroeconomic systems. Published by Taylor & Francis, 1976. Retrieved from, http://books.google.co.in/books?id=kz0OAAAAQAAJ&pg=PA71&lpg=PA71&dq=Keynesianism+view+on+the+labour+market&source=bl&ots=DAQRGJ3qZc&sig=ZTnfbTWgk1POfDZFhxgdN5_Pvm0&hl=en&ei=ZmHcSdDpLKf06gOm1r2pDA&sa=X&oi=book_result&ct=result&resnum=8#PPA269,M1 De Vroey, M. Lucas on involuntary unemployment. Cambridge journal of economics, 2004, 28, 397-411. Retrieved from http://cje.oxfordjournals.org/cgi/reprint/28/3/397?ijkey=kyowMjeYbGSM6&keytype=ref&siteid=cameco Fine, B. Labour Market Theory: A Constructive Reassessment, Published by Routledge, 1998. Retrieved from http://books.google.co.in/books?id=d4oDL9ItDSsC&pg=PA90&dq=macroeconomics+Labour+market#PPA23,M1 Ishikawa, T. Income and Wealth. Published by Oxford University Press, 2001. Retrieved from http://books.google.co.in/books?id=4JSl9_6v-NwC&pg=PA178&dq=Neo+Classic+view+on+labour+market Rotheim, J. New Keynesian Economics/post Keynesian Alternatives. Published by Routledge, 1998. http://books.google.co.in/books?id=EZs_8OdY8c8C&printsec=frontcover#PPA51,M1 Rothschild, K. Employment, Wages, and Income Distribution: Critical Essays in Economics. Published by Routledge, 1993. Retrieved from http://books.google.co.in/books?id=2o5iQqhue30C&pg=PA23&dq=neoclassical+view+of+voluntary+unemployment&lr=#PPA21,M1 Snowdon, B and Vane, H. A Macroeconomics Reader. Published by Routledge, 1997. Retrieved from http://books.google.co.in/books?id=wFueGK0vjDwC&pg=PA305&dq=rational+expectations+theory+voluntary+unemployment&lr= Tobin, J, Brainard, W, Nordhaus, W, Watts, H. Money, macroeconomics, and economic policy: essays in honor of James Tobin. Edition 2. Published by MIT Press, 1991. http://books.google.co.in/books?id=dahiA2ryJH0C&pg=PA55&dq=Aggregate+expenditure+Keynes+labour+market&lr=#PPA54,M1 Read More