The range of policies available to reduce unemployment and their effectiveness

Government and the Macro‑economy – Employment and Unemployment

Learning Objective

Understand the range of policies available to reduce unemployment and evaluate their effectiveness.

Key Concepts

• Unemployment types: frictional, structural, cyclical, seasonal.
• Policy objectives: lower unemployment, maintain price stability, sustain growth.
• Demand‑side vs. supply‑side policies.

Demand‑Side Policies

These policies aim to increase aggregate demand (AD) to stimulate job creation.

1. Expansionary Fiscal Policy

   • Increase government spending (G) or cut taxes (T).
   • Effect on AD: \$AD = C + I + G + (X-M)\$ – raising G shifts AD right.
   • Short‑run impact: higher output and employment.
   • Potential drawback: may increase inflation if economy is near full capacity.

2. Expansionary Monetary Policy

   • Lower interest rates (i) or increase money supply (M).
   • Reduces cost of borrowing, encourages investment (I) and consumption (C).
   • Can be limited when interest rates are already low (liquidity trap).

3. Public Works and Infrastructure Projects

   • Direct creation of jobs in construction, transport, etc.
   • Multiplier effect: \$\Delta Y = \frac{1}{1-MPC} \times \Delta G\$ where MPC is marginal propensity to consume.
   • Effectiveness depends on project timing and relevance to long‑term growth.

Supply‑Side Policies

These policies aim to improve the productive capacity of the economy and reduce structural unemployment.

1. Education and Training

   • Improves skill levels, matches labour to job requirements.
   • Long‑run effect: shifts long‑run aggregate supply (LRAS) right.
   • Time lag: benefits realised after several years.

2. Labour Market Flexibility

   • Reforms such as reducing minimum wage, easing hiring/firing regulations.
   • Increases employers’ willingness to hire.
   • Risk: may lead to lower real wages and income inequality.

3. Tax Incentives for Firms

   • Reduced corporation tax or tax credits for hiring.
   • Encourages expansion and job creation.
   • Effectiveness depends on firms’ confidence and demand conditions.

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

   • Access to finance, reduced red tape.
   • SMEs are major job creators in many economies.
   • Requires effective administration to avoid misuse.

Active Labour‑Market Policies (ALMPs)

Targeted programmes that help unemployed individuals re‑enter work.

• Job‑search assistance and counselling.
• Subsidised employment schemes (e.g., wage subsidies).
• Retraining and apprenticeships.
• Effectiveness varies with programme design, matching quality, and macro‑economic context.

Summary Table – Policies to Reduce Unemployment

Evaluating Effectiveness

When assessing any policy, consider the following criteria:

• Speed of impact – how quickly does the policy affect unemployment?
• Cost‑effectiveness – does the benefit outweigh the fiscal or opportunity cost?
• Side effects – impact on inflation, public debt, income distribution.
• Targeting – does it help the specific type of unemployment (frictional, structural, cyclical)?
• Sustainability – are the gains likely to persist in the long run?

Suggested Diagram

Key Take‑aways

• Demand‑side policies are most effective for reducing cyclical unemployment in the short run.
• Supply‑side measures address structural unemployment but require time to show results.
• Active labour‑market programmes can improve job matching, especially when the economy is near full capacity.
• Policy mix and timing are crucial; over‑reliance on one approach can create new problems (e.g., inflation, fiscal strain).