The range of policies available to reduce unemployment and their effectiveness

Government and the Macro‑economy – Employment and Unemployment

Learning Objective (AO1‑AO3)

Students will be able to:

• Define and distinguish the different types of unemployment.
• Explain how unemployment is measured and discuss its limitations.
• Identify the range of demand‑side, supply‑side and active‑labour‑market policies (ALMPs) that can be used to reduce unemployment.
• Analyse the likely short‑run and long‑run effectiveness of each policy, using the IGCSE (0455) syllabus criteria.
• Evaluate policies in terms of speed of impact, cost‑effectiveness, side‑effects and sustainability.

Key Concepts

Types of Unemployment

• Frictional – short‑term job search after leaving a job or entering the labour market.
• Structural – mismatch between workers’ skills/locations and the requirements of available jobs.
• Cyclical (or Keynesian) – caused by a fall in aggregate demand during a recession.
• Seasonal – linked to regular, predictable changes in demand (e.g., tourism, agriculture).

Measurement of Unemployment

Unemployment rate:

$$U = \frac{\text{Number of unemployed}}{\text{Labour force}} \times 100$$

• Labour force = employed + unemployed (people aged 16 + who are actively seeking work).
• Issues to remember for the syllabus:
  • Under‑employment (part‑time workers wanting more hours).
  • Hidden or unregistered unemployment (e.g., informal sector).
  • Discouraged workers – not counted because they have stopped looking.

Policy Objectives

• Reduce unemployment (especially cyclical, structural and frictional).
• Maintain price stability (avoid demand‑pull inflation).
• Support sustainable economic growth (increase potential output).

Demand‑side vs. Supply‑side Policies

• Demand‑side – aim to raise aggregate demand (AD) and are most useful for tackling cyclical unemployment in the short run.
• Supply‑side – aim to increase the economy’s productive capacity (LRAS) and are targeted at structural and frictional unemployment.

Consequences of Unemployment

Demand‑Side Policies

Designed to boost AD and therefore output and employment in the short run. They are most effective against cyclical unemployment.

1. Expansionary Fiscal Policy

• Increase government spending (G) or cut taxes (T).
• AD equation: $$AD = C + I + G + (X-M)$$ – raising G or raising C via tax cuts shifts AD right.
• Short‑run impact: higher output, lower unemployment.
• Potential drawbacks: larger budget deficit, higher public debt, risk of demand‑pull inflation if the economy is near full capacity.
• Example (Cambridge syllabus): a temporary “stimulus package” that funds road building and cuts income tax for low‑income households.

2. Expansionary Monetary Policy

• Lower policy interest rates or increase the money supply (M).
• Cheaper borrowing raises investment (I) and consumption (C).
• Effectiveness falls in a liquidity trap (rates already near zero).
• Possible side‑effects: asset‑price bubbles, depreciation of the domestic currency, higher import prices.
• Example: the central bank cuts the base rate from 2 % to 0.5 % and conducts open‑market purchases of government bonds.

3. Public‑Works and Direct Government Employment

• Construction of roads, schools, hospitals, or temporary public‑sector jobs.
• Multiplier effect: $$\Delta Y = \frac{1}{1-MPC}\times\Delta G$$ (MPC = marginal propensity to consume).
• Immediate job creation; also improves long‑run productive capacity.
• Risks: “white‑elephant” projects, long planning times, fiscal cost.
• Relevant syllabus point: “government‑run job‑creation schemes” (e.g., a summer youth employment programme).

Supply‑Side Policies

Target the structural determinants of unemployment and raise long‑run aggregate supply (LRAS). Their effects are usually felt over several years.

1. Education, Training & Apprenticeships

• Raise skill levels and improve the match between labour and job requirements.
• Long‑run effect: right‑ward shift of LRAS (higher potential output).
• Time lag: benefits appear after several years.
• Cambridge example: government‑funded vocational colleges that focus on digital‑technology skills.

2. Labour‑Market Flexibility Reforms

• Reduce statutory minimum wage, ease hiring/firing regulations, introduce flexible working hours.
• Specific syllabus items:
  • National Minimum Wage (NMW) – lowering it reduces labour costs.
  • Wage‑subsidy schemes – the state pays part of the wage for the long‑term unemployed.
• Potential downsides: lower real wages, increased income inequality, political opposition.

3. Tax Incentives for Firms

• Reduced corporation tax, investment tax credits, or tax relief for hiring new staff.
• Encourages expansion and job creation, especially when business confidence is high.
• Effectiveness depends on the level of aggregate demand; may reduce tax revenue.

4. Support for Small & Medium‑Sized Enterprises (SMEs)

• Improved access to finance, reduced red‑tape, advisory services and mentoring.
• SMEs are the biggest source of new jobs in most economies.
• Requires robust administration to avoid misuse of funds.

Active Labour‑Market Policies (ALMPs)

Targeted programmes that help unemployed individuals re‑enter work quickly. They complement both demand‑ and supply‑side measures.

• Job‑search assistance, counselling, online matching portals (e.g., national job‑centre websites).
• Subsidised employment schemes – wage subsidies, work‑experience placements, “green‑jobs” pilots.
• Retraining, apprenticeships and sector‑specific skill programmes.
• Effectiveness varies with design, matching quality and the overall macro‑economic context.

Link to Inflation – The Phillips‑Curve Trade‑off

When AD is shifted right in an economy close to full capacity, the price level tends to rise. This illustrates the short‑run inverse relationship between unemployment and inflation (Phillips curve). Policy makers must therefore balance the desire for lower unemployment against the risk of demand‑pull inflation.

Link to Economic Growth

• Supply‑side measures (education, SME support, labour‑market reforms) increase LRAS, raising long‑run potential output and supporting sustainable growth.
• Demand‑side measures give a short‑run boost to GDP but can generate inflation if used excessively.

Evaluation Framework (AO2‑AO3)

When assessing any policy, consider the following criteria:

• Speed of impact – How quickly does the policy affect unemployment?
• Cost‑effectiveness – Do the benefits outweigh the fiscal or opportunity costs?
• Targeting – Which type(s) of unemployment does it address (cyclical, structural, frictional, seasonal)?
• Side‑effects – Impact on inflation, public debt, income distribution, and long‑run growth.
• Sustainability – Are the gains likely to persist after the policy is withdrawn?
• Administrative feasibility – Is the policy easy to implement and monitor?

Suggested Diagrams

• AD‑AS diagram showing a left‑shift of AD (recession) and the right‑shift after a demand‑side stimulus. Mark the output gap and the movement of equilibrium unemployment.
• Inset Phillips‑curve illustrating the short‑run trade‑off between unemployment and inflation.
• LRAS shift diagram to demonstrate the long‑run effect of supply‑side policies.

Summary Table – Policies to Reduce Unemployment

Policy	Policy Type	Primary Objective	Advantages	Disadvantages / Limitations	Typical Effectiveness
Expansionary Fiscal Policy (higher G or lower T)	Demand‑side	Raise AD → higher output & employment	Quick impact; can be directed at labour‑intensive sectors	Higher public debt; inflation risk near full capacity	Short‑run (months‑a year)
Expansionary Monetary Policy (lower i, higher M)	Demand‑side	Stimulate investment & consumption	Rapid implementation via central bank; works when credit is tight	Limited when rates are near zero; possible asset‑price bubbles	Short‑run (quarters)
Public‑Works / Direct Government Employment	Demand‑side	Immediate job creation & multiplier effects	Visible benefits; improves infrastructure and long‑run productivity	Long planning horizon; risk of inefficient “white‑elephant” projects	Medium‑term (1‑2 years)
Education, Training & Apprenticeships	Supply‑side	Reduce structural & frictional unemployment	Builds human capital; supports long‑run growth	Long lag (3‑5 years); must match skills to market demand	Long‑run
Labour‑Market Flexibility (NMW changes, wage subsidies, deregulation)	Supply‑side	Make hiring easier, lower frictional unemployment	Reduces labour costs; encourages firm expansion	May lower real wages, increase inequality; political resistance	Medium‑term (1‑3 years)
Tax Incentives for Hiring	Supply‑side	Encourage firms to increase staff	Targeted, time‑limited, easy to administer	Reduces tax revenue; effectiveness depends on demand conditions	Medium‑term
Support for SMEs (finance, red‑tape reduction)	Supply‑side	Boost job creation by the sector that creates most jobs	Improves access to finance; reduces administrative burden	Requires effective oversight; risk of misallocation	Medium‑ to long‑term
Active Labour‑Market Policies (ALMPs)	Active‑labour‑market	Improve matching efficiency, assist specific groups	Can be tailored; helps reduce long‑term unemployment	Administrative costs; success varies with macro‑economic context	Short‑ to medium‑term

Key Take‑aways

• Demand‑side policies are most effective for reducing cyclical unemployment quickly, but they can create inflation if the economy is near full capacity.
• Supply‑side measures target structural and frictional unemployment; they raise LRAS and support long‑run growth but have long implementation lags.
• Active labour‑market programmes improve the efficiency of job matching and are especially useful when the economy is close to full employment.
• A balanced mix of policies, timed appropriately, is essential; over‑reliance on any single approach may generate new problems such as inflation, fiscal strain, or greater inequality.