policies to reduce unemployment and their effectiveness

Employment and Unemployment

1. Key Definitions

• Unemployment: Persons who are willing and able to work, are actively seeking work, but are not employed.
• Labour force (L): All employed persons + all unemployed persons (aged 16 + in the UK).
• Unemployment rate (U %): $$U\%=\frac{U_t}{L}\times100$$ where \(U_t\) = number of unemployed people.

2. Measuring Unemployment – Issues & Adjustments

• Standard ONS measures (UK):
  1. Unemployment rate (U %).
  2. Long‑term unemployment (≥ 12 months).
  3. Youth unemployment rate (16‑24 years).
• Measurement problems:
  • Discouraged workers are classified as “inactive”, so the official rate may under‑state true unemployment.
  • Part‑time workers who want full‑time work are counted as employed (under‑employment).
  • Seasonal fluctuations – e.g., tourism, agriculture.
• Worked example (discouraged workers):

  Suppose a country has 1 000 000 people in the labour force. Officially 90 000 are unemployed, giving a rate of 9 %.

  If 20 000 discouraged workers are added to the unemployed count, the revised rate is:

  $$U\%=\frac{90\,000+20\,000}{1\,000\,000}\times100=11\%$$

  This illustrates how the definition changes the reported figure.

3. Natural Rate of Unemployment (NRU) & Hysteresis

• NRU = frictional unemployment + structural unemployment when the labour market is in equilibrium.
• Hysteresis: Prolonged high unemployment can raise the NRU by eroding skills, reducing labour‑force participation, or changing expectations.
• Phillips‑curve illustration (SR vs LR):
  • Short‑run Phillips curve (down‑sloping) shows a trade‑off between unemployment and inflation.
  • Long‑run Phillips curve is vertical at the NRU – no permanent trade‑off.
  • Hysteresis shifts the LR curve rightward, raising the NRU.

4. Types of Unemployment

5. Consequences of Unemployment

• Output gap – actual GDP < potential GDP.
• Higher government spending on benefits → fiscal pressure and higher public debt.
• Potential rise in crime and social problems.
• Pressure on wages and inflation (short‑run Phillips‑curve trade‑off).
• Loss of human capital and possible increase in the NRU (hysteresis).

Policy Objectives (Cambridge macro‑policy framework)

Demand‑Side (Macroeconomic) Policies

6.1 Fiscal Policy

• Expansionary stimulus – increase government spending (G) or cut taxes (T) to shift AD rightward.
• Multiplier (optional box):
  $$\Delta Y = \frac{1}{1-MPC(1-t)+m}\,\Delta G$$ (where *m* = marginal propensity to import). Not required for the exam; useful for deeper understanding.
• Potential benefits: Quick impact on output and employment; can target lagging sectors (e.g., construction via public‑works).
• Risks: Higher public debt, possible crowding‑out of private investment, inflation if the economy is near full capacity.
• UK example: “Build Back Better” (2021) – £12 bn of infrastructure spending aimed at reducing post‑COVID cyclical unemployment.

6.2 Monetary Policy

• Expansionary easing – lower policy interest rate (i) or conduct quantitative easing (QE) to increase the money supply and shift AD right.
• Transmission mechanism: lower i → cheaper borrowing → higher investment (I) and consumption (C).
• Advantages: Low direct fiscal cost; can be implemented rapidly by the central bank.
• Limitations: Liquidity trap when rates are near zero; effectiveness depends on business confidence; may fuel asset‑price inflation.
• UK example: Bank of England’s rate cuts to 0.1 % in 2020 to support the labour market.

6.3 Direct Job‑Creation (Public‑Works)

• Government funds specific projects (roads, schools, renewable‑energy installations) that employ labour directly.
• Often combined with training components to raise skill levels.
• Short‑run impact: Immediate jobs and a multiplier through local wage spending.
• Long‑run concern: Risk of “dead‑weight” jobs if projects are not productive or are quickly finished.

Supply‑Side (Structural) Policies

7.1 Human‑Capital Development

• Education, vocational training, apprenticeships, and sector‑specific qualifications aligned with market needs.
• Time lag: benefits usually appear after 1‑3 years.

7.2 Wage & Employment Subsidies

• Government pays part of the wage (e.g., “Youth Contract” in the UK, “Job‑Keeper” in Ireland).
• Reduces the marginal cost of hiring marginal workers, encouraging firms to expand staff.
• Potential distortion: may keep wages artificially low and create dependency on subsidies.

7.3 Labour‑Market Flexibility & Institutions

• Reducing statutory minimum wages, easing dismissal procedures, relaxing employment‑protection legislation.
• Goal: lower hiring costs and increase turnover speed.
• Criticism: can increase job insecurity, widen income inequality, and weaken collective bargaining.
• Institutions to consider: trade unions, minimum‑wage legislation, employment‑rights law – all affect wage‑setting in both perfect and imperfect labour markets (A‑Level 8.3).

7.4 Tax Incentives & Infrastructure Investment

• Reduced corporation tax, accelerated capital allowances, R&D tax credits – encourage firms to invest and create jobs.
• Long‑run infrastructure (transport, broadband, green energy) improves productivity and can make the economy more labour‑intensive.

7.5 Active Labour‑Market Policies (ALMPs)

• Job‑search assistance, counselling, job‑matching services, subsidised employment schemes.
• Most effective when combined with training and when targeted at long‑term unemployed.

7.6 Green / Sustainable Structural Policies

• Investment in renewable energy, energy‑efficiency retrofits, and low‑carbon transport.
• Addresses the “sustainable growth” objective and can create new green‑skill jobs.

International Dimension

• Expansionary fiscal or monetary stimulus can affect the balance of payments (BOP):
  • Higher domestic demand may increase imports, widening the current‑account deficit.
  • Capital inflows can appreciate the exchange rate, reducing export competitiveness.
• Exchange‑rate effects:
  • Monetary easing tends to depreciate the currency, supporting exports but raising import prices.
  • Conversely, fiscal consolidation can appreciate the currency, harming export‑oriented sectors.
• Developing‑country context:
  • Structural reforms (e.g., improving education, infrastructure) are crucial for moving from a low‑skill, agriculture‑based economy to a higher‑skill manufacturing or services economy.
  • External aid and foreign direct investment (FDI) can complement domestic policies, but dependence on volatile capital flows creates policy‑mix challenges.

Effectiveness – Short‑Run vs Long‑Run

8.1 AD/AS Analysis (textual diagram)

• In a recessionary gap, an outward shift of AD (via fiscal or monetary easing) moves the economy from point A (high unemployment, below‑potential output) to point B (higher output, lower unemployment).
• As the economy approaches potential output (point C), further AD expansion creates inflationary pressure without reducing unemployment – the Phillips‑curve vertical segment is reached.
• Supply‑side reforms shift the long‑run aggregate supply (LRAS) rightward, lowering the natural rate of unemployment and raising potential output.

8.2 Comparative Effectiveness

8.3 Government Failure & Trade‑offs (expanded)

• Information problems: Mis‑targeting of subsidies or training programmes because policymakers lack up‑to‑date labour‑market data.
  • Example: A youth‑subsidy scheme that pays firms to hire 18‑25‑year‑olds, but most of the hires would have been made anyway.
• Implementation lag: Time between policy decision and impact on the labour market (e.g., construction of a new highway may take 3 years before jobs appear).
• Political economy: Policies may be retained for electoral reasons even when the economy is near full employment, leading to overheating.
  • Example: Continuation of large‑scale infrastructure spending after the recession has ended, fuelling inflation.
• Rent‑seeking & capture: Interest groups lobby for policies that benefit them rather than the whole economy.
  • Example: Industry‑specific tax breaks that create “dead‑weight” jobs without raising overall productivity.
• Externalities: Public‑works may generate positive spill‑overs (better transport) but also negative ones (environmental damage, congestion).

Exam‑Focused Summary Points

1. Define unemployment, the unemployment rate, and differentiate the six main types (including seasonal & technological). Link each type to the underlying macro‑economic concept.
2. Explain measurement issues (discouraged workers, under‑employment, seasonal adjustment) and illustrate with a worked example; define the natural rate of unemployment and hysteresis, and sketch the short‑run/long‑run Phillips curve.
3. Show how expansionary fiscal and monetary policy shift AD rightward and reduce cyclical unemployment; use a simple AD/AS diagram (point A → B).
4. Discuss supply‑side tools (training, wage subsidies, deregulation, tax incentives, ALMPs, green investment) and how they address structural unemployment and the NRU.
5. Evaluate short‑run vs long‑run effectiveness, using the evaluation criteria column (inflation, public debt, income inequality, government failure, BOP/exchange‑rate effects).
6. Conclude that a balanced mix – short‑run demand stimulus together with long‑run structural reforms (including sustainable and equitable policies) – offers the most robust strategy for achieving low, stable unemployment.