Unemployment Problem the UK - Essay Example

Taming the Unemployment Problem the UK Way Introduction The unemployment problem spares no economies, developing or developed. In struggling economies, the problem occurs naturally because job creation is at a standstill when economic activity is low or limited, thus leaving many people unemployed. For developed countries, unemployment also poses a challenge even when economic activity is high because of the intricate and interrelated workings of various factors which will be discussed herein. This has been the experience of the First World countries within the OECD whose unemployment figures started to breach the ILO standard in the early 1960s. Nickell, S. (2003) Based on the ILO definition, unemployment becomes a problem when the number of unemployed individuals reaches 1.5 per cent over the official employment rates. (An unemployed person in this configuration is someone without work who is actively looking for work and is available to take up the job anytime.) Such a type of unemployment situation really badgered OECD countries in the aftermath of the first oil shock in 1973 and of the second in 1979 as well. By 1983 going into 1988, many of these countries were experiencing double-digit unemployment rates for the first time in two decades. These include Spain (19.6 per cent), Ireland (16.1 per cent), Belgium (11.3 per cent), United Kingdom (10.9 per cent) and Netherlands (10.5 per cent). Even Canada was getting close to the breaking the benchmark at 9.9 per cent, as did the United States (7.1 percent), Australia (8.4 per cent), Denmark (9.0 per cent), France (9.8 per cent) and Portugal (7.6 per cent). Only Austria, Norway, Sweden, New Zealand and Japan managed to hold down unemployment at below 4 per cent. Nickell, S. & Quintini, G. (2001) But the real story lies in how these countries met the challenge head-on and succeeded in overcoming it. On that basis, Austria and Norway are considered the best performers for keeping their unemployment rates below 5 per cent until 1999. From 3.6 per cent in 1983-88, unemployment in Austria rose slightly to 3.7 per cent in 1989-94, 4.2 percent in 1995-97, 4.7 per cent in 1998 and 4.5 per cent in 199. In Norway, the figure was 2.7 per cent in 1983-88, 5.5 pre cent in 1989-94, 4.7 per cent in 1995-97, 3.3 per cent in 1998 and leveling off at 2.9 per cent in 1999. In terms of pulling a rabbit out of the hat, however, the handling of the problem in the Netherlands and UK was found the most impressive. From a high of 10.9 per cent in 1983-88, for example, UK brought down the unemployment figure to 8.9 per cent in 1989-94, 8.0 per cent in 1995-97, 6.3 per cent in 1998 and 6.2 per cent in 1999. The Netherlands achieved the same feat in more or less the same dramatic fashion. Theoretical and Empirical Background The level of unemployment is determined by the aggregate demand and the equilibrium rate, the relative unemployment rate of particular groups, and non-employment. Nickell, S. & Van Ours, J. (1999) Unemployment drops when the economy's output expands faster than its growth potential and shoots up when the economy contracts. When unemployment falls, the government concerned can easily stop it in its tracks by expanding or loosening up its fiscal and monetary policy. Such a policy expansion is induced by a situation in which unemployment gets too high and inflation falls, while a tightened up policy is needed when unemployment gets too low to pull up inflation. Any government facing an unemployment problem has to perform a balancing act to find the equilibrium unemployment rate, the baseline level of unemployment which is neither too low nor too high but has a stabilizing effect on inflation. Equilibrium unemployment is also the level consistent with stable inflation and a zero balance of payments deficit, which no monetary, fiscal or exchange rate policy can alter. The rate of this baseline level of unemployment may rise because of factors that systematically put inflationary pressure on the labour market at a given level of unemployment. Such factors include anything that tends to shift the Beveridge Curve, the downward sloping equilibrium relationship between job vacancies and unemployment. Equilibrium unemployment may be influenced by the following factors: 1) Benefits and active labour market policies - unemployment benefits impact on the effective supply of labour by lengthening the unemployment duration of individuals. 2) Unions, wage setting and minimum wages - trade unions exert pressure to raise wages which in turn increases the equilibrium unemployment rate. The more workers are covered by such collecting bargaining, the bigger the effect. 3) Institutional mechanisms which require management and unions in the collective bargaining process to take into account the macroeconomic and employment implications of the bargains they take up. 4) Labour taxes (payroll, income and consumption taxes) and commodity prices - these three taxes affect the wedge between the real value of a worker the employer (which influences labour demand) and the real consumption wage of a worker (which influences labour supply). These taxes also affect commodity prices in the case of imported goods, such that when prices of imported commodities rise, wages must rise to compensate and for workers to keep their real after-tax purchasing power. 5) Skills mismatch - a situation where companies have vacancies for skilled workers, say, and most of the unemployed looking for work are unskilled. When this happens, companies will experience shortages of skilled labour to raise inflation at any given level of unemployment. In the process, equilibrium unemployment goes up and the Beveridge Curve will shift out. 6) Employment protection - this covers all government policies regarding job security and the use of fixed contracts. If such laws are made more stringent, these tend to raise labour costs in general and labour turnover in particular. If the workers pressure the companies to bear the said increase in labour costs, this will raise equilibrium unemployment the way taxes do. But if wages are allowed to adjust to compensate the companies, equilibrium unemployment will remain unchanged. All these factors came into play in UK from the late 1960s to the 1980s such that altogether they influenced 20 per cent of the changes in the country's equilibrium unemployment made possible during that period. From an equilibrium unemployment level that fluctuated around 2.5 per cent in the 1960s, this figure climbed as unions become stronger and the workers tried to keep their living their standards insulated from the 1973 oil shock. The first time unemployment rose, it did not reach the equilibrium rate of about 7.5 per cent at the cost of rising inflation and the BOP deficit. But at the onset of the 1980s in the wake of the second oil crisis in 1979, unemployment rose over the equilibrium rate of about 10 per cent with inflation falling and the balance of payments posting a large surplus. As unemployment fell away from a stable equilibrium rate the late 1980s, inflation began to shoot up and the BOP went into deficit again. More recently, the equilibrium rate appears to have fallen with actual unemployment figures keeping in step. The principle at work here is that, as earlier mentioned, inflation starts to rise when economic activity gets too high and unemployment gets too low. In the same vein, inflation starts to fall when unemployment gets too low. In practice, things are a bit more complicated with a high exchange rate capable of suppressing inflationary pressure itself by basically enhancing the effective level of foreign competition facing a country's companies as well as by making imports cheaper. Thus, if the foreign exchange rate is high - which usually shows in the form of a larger trade deficit - this may prevent inflation from going up even if unemployment is below the equilibrium rate. This emphasises that there is a three-way trade-off between unemployment, changes in inflation and the balance of payments. Equilibrium unemployment, despite its name, may change significantly from one decade to the next. The thing is, it cannot be altered by any monetary intervention which only serves to change the way in which actual unemployment fluctuates around the equilibrium rate. Any factor that affects inflationary pressure in the labour market at a given level of unemployment can influence equilibrium unemployment although this process takes times. This factor includes changes in the power of trade unions, operation of the benefit system, match between the skill requirements in job vacancies and the available skills of unemployed job hunters, labour taxes, product market competition and minimum wages. The UK Labour Market From the macroeconomic view, the UK labour market has been "remarkably healthy" in recent years. Nickell, S. & Quintini, G. (2001) This view is based on the fact that since 1977, 1) unemployment has reached its lowest level for a generation, 2) inflation remained low with inflation expectations among the key wage bargainers also stable, and 3) the real wage growth is consistently positive. On unemployment, records show that it reached a high 30 per cent in 1970 and then dropped in dramatic fashion to 25 per cent in 1976, 20 per cent in 1982, 15 per cent in 1988, 10 per cent in 1994 and 5 per cent in 2000. This was complemented by a downward trend in real wage growth which fell from 8 per cent in 1998 to 6 per cent in 1990, 4 per cent 1992, 2 per cent in 1994, 0 per cent in 1996 and then 4 per cent in 2000. Meanwhile, the inflation rate dropped from 30 per cent in 1970 to 25 per cent in 1976, 20 per cent in 1982, 15 per cent in 1988, 10 per cent in 1994 and 5 per cent in 2000. The inflation expectations figure exhibit the same movement: 8 per cent in 1988, 7 per cent in 1990, 6 per cent in 1992, reaching only 2 per cent in 2000. This controlled movements in unemployment, real wage growth, inflation and inflation expectations reflect just as positively in UK's estimates of equilibrium unemployment as it compares with the BOP deficit and inflationary changes. In the period 1969-73, equilibrium unemployment was placed at 3.8 per cent, and the change in inflation on a per annum basis was 1.5 percent, while the BOP deficit in terms of potential GDP was a negative 0.7 per cent. The equilibrium unemployment rate ballooned to 9.5 per cent in the troublesome period 1981-86 accompanied by an 11.3 per cent increase in unemployment. However, the inflationary changes and BOP deficit remained negative at 1.2 per cent and 1.3 per cent, respectively. These figures tapered down in 1997-2000, to 5.7 per cent for equilibrium unemployment, negative 0.4 per cent for change in inflation and 0.5 per cent for the BOP deficit. For a brief period in late 1980s UK went into a panic mood when inflation as measured by the increase in prices of the country's output, which acts as GDP deflator, catapulted from only 2.5 per cent in 1986 to 7.6 per cent in 1990. The other problem areas include the headline RPI rate hitting double figures for just one month, the trade imbalance reaching 4 per cent of GDP, and short-term interest rate leaping from 8 per cent to 15 percent in 1998. The main problem in the UK labour market is its large pool of working-age people who lack the skills to command wages that would provide adequately for themselves and their dependents. This sector of the labour market is the largest among both the OECD and European countries. (Nickell, S. & Quintini, G. (2001) The UK Strategy In response to this challenge, the UK government came up with the New Deal policy, a series of new welfare-to-work initiatives for young, long-term unemployed, older unemployed, single parents and disability benefit recipients. The strategy also sought to enhance labour supply in selected target groups. It has been implemented by phases based on a set of carefully considered priorities. The key feature of this policy is the strategy to equip every citizen with marketable skills through the development of appropriate education and training systems. The idea is to encourage work by providing additional resources to low-skill workers. Under the New Deal policy, resource assistance has been allotted for the following groups: young people aged 18-24 who have been out of work for six months, aged 25-50 adults out of work for two years, people over 50 who have been on any benefit for six months, single parents and the disabled. Assistance will come in the form of training, job search, subsidized employment, etc. While the assistance programs for the other groups are on the pilot stage, the New Deal policy for young people has been on the way. Nickell and Quintini cite the Van Reenen (2000) evaluation showing that the program assisting young people has been generating 20,000 extra jobs each year since its inception. its impact on the labour market is expected to be considerable but there is no evidence of it as yet. The other strategies in the New Deal policy mix is the strengthening of the operational structures of the existing benefit systems and the reduction in their coverage "to make unemployment less attractive then work;" the imposition of the National Minimum Wage (NMW); setting of new procedures for trade union recognition; improved tax benefit schemes to improve labour supply; and significant changes in the competition policy. Reforms in the competition policy were introduced through the 1998 Competition Act which strengthened UK's anti-trust system, increased product market competition and raised the share of labour in the total output. The New Deal program also set up measures to offset the "tax effects" brought on by additional business costs imposed by legislation. The changes made in the benefit system effectively reduced UK's equilibrium unemployment rate but in the view of outsiders, these also could have plunged households into poverty which happens when the breadwinner loses his job. In Denmark, it was noted, such benefit system was reformed not by reducing the generous level of existing benefits but by providing a system of job search assistance accompanied by sanctions if the people involved do not fulfill their responsibilities to look for and accept work. This particular strategy is believed responsible for the current dynamism of the Danish labour market, with unemployment pegged down at only 5 per cent. But notwithstanding the doubts on the effectiveness of a reduction in the benefit system, UK made the measure work in pulling down the equilibrium unemployment rate. Industrial relations experts outside UK reacted the same way when the NMW was introduced as part of the 1999 Employment Relation Act, fixing relatively low levels in the workers' take-home pay. It was predicted that the measure would yield a 0.6 per cent increase in equilibrium unemployment and a 1.2 per cent increase in union membership to mess up things. Sometime after the strategy was implemented in mid-2000, studies found no noticeable impact on equilibrium unemployment and, on the feared increase in union membership, it is believed unlikely that this will be enough to offset the losses from closures, de-recognitions and retirements. Nickell & Quintini (2001) What happened was the workings of the labour market ensured that employees receive new benefits to recover the portion of their wages taken away by the NMW law. These benefits come from such measures as working time directives, parental leave and rights of part-timers which were initiated by UK businesses. On the part of the UK government, it replaced the Family Credit system and the Disability Working Allowance facility with more generous versions: the Working Families Tax Credit (WFTC) and the Disabled Persons Tax Credit (DPTC). Whereas the old family credit program covered only low-income earners, the WFTC increased both the coverage and credit amounts which becomes available even to young children through a new child care credit. Other important changes introduced as part of the New Deal initiative involved the reduction or removal of the following benefits: unemployment assistance, additional housing assistance, entitlements for 16-17-year-olds, mortgage interest for people below 60, jobseekers allowance. The actual level of benefits in relation to earnings also declined dramatically because of the following moves: abolition of the earning-related supplements and switch in indexation from the basis of earnings to price basis. This also had a hand in the drop equilibrium unemployment in UK, together with the restructuring of the wage bargaining process. In the past, wage fixing in UK as in most European countries was determined by trade union collective bargaining, which is often uncoordinated and adversarial. This tends to put pressure on inflation to go up at given levels of market slack and leads to higher level of equilibrium unemployment. Trade union legislations were passed moving the balance of power away from employees, making it less easy and attractive to join a union. As a result, practically all the workers in new establishments put after 1990 were non-unionised. The coverage of trade unionism in UK, which was a high 70 per cent in 1975 dwindled to 64 per cent in 1980, 40 percent in 1990, and 35.8 per cent in 1998-1999. As old business establishments give way to the new, unionization diminished and there is no question that this contributed to the decline in inflationary pressures at given levels of labour market slack and hence to the fall in equilibrium unemployment. . Conclusion Unemployment in UK started its upward spiral in the late 1960s and early 1970s, shooting up significantly after the first oil shock in 1974, again after the second oil shock in 1979 when it reached 10 per cent. This came down rapidly in the Lawson boom of the late 1980s, posting a steady decline that leveled off at only 6 per cent in 1990. By rights, this downward trend could have been interrupted by the recession in 1991-93 but it had no significant effects such that starting 1993, unemployment gradually subsided to only 6 per cent by 2000, its lowest level since the 1970s. What happened was the institutional changes implemented in UK starting early 1980s effectively brought down equilibrium unemployment by 3.76 per cent which was near the 4.1 per cent decline achieved from 1981-83 to 1995-98. These changes involved the wage bargaining process which affected union coverage, density and coordination; replacement of the unemployment benefit ratio; adoption of active labour market policies; and reduction of the tax wedge. The effects of a more coordinated wage bargaining process were found negligible but the collapse of trade unionism in terms of coverage and density was considered a major factor in the fall of unemployment. With less union activism and industrial disputes, there have been less disruptions in the labour market too. Initially, the more active labour policies adopted by government, which involved an increase in the amount and duration of unemployment benefits, had no effects but it showed its contribution starting 1998. The remainder of the credit for the decline in equilibrium unemployment was accounted for by the reduction in generosity of the benefit system and the fall in the tax wedge which combined for 1.2 per cent. As for the tightening of monetary policy this had a deleterious effect on unemployment and inflation at the early stages of its implementation in 1990 when unemployment rose to 10 per cent and the GDP price inflation down to 2.7 per cent. Bothered by this development, the government left the European Exchange Rate Mechanism and loosened its monetary policy anew. As a result, short-term interest rates dropped from 10 per cent to 6.5 per cent in 1992. Unemployment then started to fall and GDP inflation rising in 1994, peaking in 1996. Since then, UK unemployment has been falling, with inflation also stable and falling. References: S Nickell and G Quintini. "The Recent Performance of the UK Labour Market." Oxford Review of Economic Policy 18(2), 2002, sections I and II S Nickell and J Van Ours. "The Netherlands and the United Kingdom: a European Unemployment Miracle" Economic Policy April 2000, sections 1 and 4.1 S Nickell. "Has UK Labour Market Performance Changed" 2001, Oxford Bulletin of Economics and Statistics Vol. 63 (Special Issue) 2001, sections I - IV S Nickell. "A Picture of European Unemployment : Success and Failure" London School of Economics Centre for Economic Performance Discussion paper 05777, 2003 R Layard, S Nickell and R Jackman. "Tackling Unemployment: Europe's Successes and Failures." London School of Economics Centre for Economic Performance "CentrePiece" Spring 2005 - a summary version of Nickell (2003) Read More