Unemployment in Pakistan

ASSIGNMENT # 3 MACRO
The basic solution for decreasing the natural rate of unemployment is creating new jobs and opportunities. Usually, a healthy economic growth rate is of 2-3% and this is sufficient to create the 150,000 new jobs per year needed to keep unemployment from rising. When unemployment rises above 6-7% and stays there, it means that the economy isn't strong enough to create sufficient new jobs without intervention. That's when the government is expected to step in and provide solutions.
WHAT IS THE NATURAL RATE OF UNEMPLOYMENT

The Natural Rate of Unemployment is the rate of unemployment when the labor market is in equilibrium. It is the difference between those who would like a job at the current wage rate and those who are willing and able to take a job.The Natural Rate of Unemployment will therefore include: frictional unemployment structural unemployment
E.g. a worker who is not able to get a job because he doesn’t have the right skills

The natural rate of unemployment is unemployment caused by the supply side factors rather than demand side factors of macroeconomics. Monetarists argue that the Natural Rate of Unemployment occurs when the Long Run Phillips Curve crosses the x axis

What Determines the Natural Rate of Unemployment?

M. Freidman argued the Natural rate of unemployment would be determined by institutional factors such as:
Availability of job information. A factor in determining frictional unemployment
Skills and Education. The quality of education and retraining schemes will influence the level of occupational mobilities.
Degree of labour mobility
Flexibility of the labour market E.g. powerful trades unions may be able to restrict the supply of labour to certain labour markets
A rise in unemployment caused by a recession may cause the natural rate of unemployment to increase. This is because when workers are unemployed for a time period they become deskilled and demotivated and are less able to get new jobs. Explaining Changing Natural Rates of Unemployment
It has been argued that the UK has seen a fall in the natural rate of unemployment since the 1980s (even when growth was 5% in 1988 Unemployment was 1.6 million) This has been explained by:
1. Increased labour market flexibilities e.g. unions less powerful
2. Privatisation has helped increased competitiveness of industry leading to more flexible labour markets
3. Better education and Training
4. The New Deal has made it more difficult to remain on benefits
Natural Rate of Unemployment in EU
The rest of the EU has seen a rise in the natural rate of unemployment in the 1990s this could have caused by:
1. Rigidity in EU labour markets e.g. min wages, max working week
2. Restrictions on closing factories and mandatory severance pay for workers made unemployed, this makes firms more reluctant to set up in these countries
3. High degrees of unionisation resulting in wage rigidity
4. Generous benefits which lessen the pain of unemployment
5. Hysteresis effects. The cyclical recessions of the 1970s and 1980s had long lasting effects resulting in more unemployment. However this does not appear to have effected the UK
6. Growing competition from Asian countries
However the rising unemployment may not just be due to the Natural rate increasing but also due to lower economic growth. Therefore part of the unemployment is cyclical.
NAIRU and Non-Accelerating Rate of Unemployment

A very similar concept to the natural rate of unemployment is the NAIRU – non-accelerating rate of unemployment.
This is the rate of unemployment consistent with a stable rate of inflation. If you try to reduce unemployment by increasing aggregate demand, then you will get a higher rate of inflation.
The natural rate of unemployment can also be illustrated using the Monetarist view of the Phillips Curve. Monetarists argue that the LRAS is inelastic. Thus increased AD only causes a temporary increase in output and a temporary fall in unemployment.
If there is an increase in AD, firms pay higher wages to workers in order to increase in output, this increase in nominal wages encourage workers to supply more labour and therefore unemployment falls.
However the increase in AD also causes inflation to increase and therefore real wages do not actually increased but remain the same. Later workers realise that the increase in wages was only nominal and not a real increase.
Therefore they no longer work overtime. Therefore the supply of labour falls and unemployment returns to its original or Natural rate of unemployment. It is only possible to reduce unemployment by causing an increase in the rate of inflation. Therefore the natural rate is also known as the NAIRU (non accelerating rate of unemployment.
This model assumes workers do not correctly predict the rate of inflation but have adaptive expectations.
(Some economists argue workers will correctly predict higher AD causes higher inflation and therefore there will not be even a short term fall in unemployment , this is know as rational expectations.)

Discuss some of the factors that might cause the natural rate of unemployment to change over time.
The Natural rate of unemployment occurs when the labour market is in equilibarium; it is mainly composed of frictional and structural unemployment. Therefore factors that affect these types of unemployment will alter the natural rate.
It is argued the level of unemployed benefits can affect the level of frictional unemployment. If the ratio of benefits to paid employment is high then there is little incentive to take a job. For example, since the early 1980s unemployment benefits have been index linked ( this means risen in line with inflation). Wages have tended to rise faster than inflation therefore the difference between benefits and paid employment has grown increasing the incentive to get a job and therefore reducing the natural rate of unemployment in the UK. Similarly the wages of the lowest paid will greatly affect the incentives to take a job. In the UK the government has introduced a national minimum wage and it has steadily increased. This has made work relatively more attractive compared to staying on benefits. Also the New Deal has been introduced to try and encourage the unemployed back into work. The New Deal involves giving workers retraining schemes and interviews to help them find work. Also if workers are offered a job after 6 months they have to accept it or risk losing benefits and hence they will be not counted as unemployed. This has helped reduce the natural rate. A key factor affecting structural unemployment is the geographical and occupational mobility of labour. If workers were more mobile this would help reduce unemployment caused by a mismatch of skills and geographical location. For example in the past decade, the north south divide has been reduced in the UK, this is due to regeneration in areas, which used to suffer high unemployment. New industries have taken the place of former heavy industry which have closed down, this has enabled a reduction in geographical unemployment. If workers became more skilled through education and retraining this would help reduce occupational immobility’s. To some extent the New Deal has helped retrain workers and give them the necessary skills to be effective in the labour market thus reducing structural unemployment. The flexibility of the labour market is also a key feature for determining the natural rate. For example, if restrictive practices of trades unions were reduced or minimum wages abolished, then labour markets will becomes more flexible thus firms are likely to be more able and willing to hire workers. Arguably the UK labour market has become more flexible in recent years to some extent explaining the fall in the natural rate. However the EU has seen rises in the natural rate, this is often blamed on inflexible working practices such as a max working week, restrictions on firing workers and minimum wages. Another potential cause of the natural rate is the Hysteresis hypothesis this states that if unemployment increases (e.g. during a recession) then it is likely to remain high for a considerable period, this is because workers become de-motivated and de-skilled whilst remaining unemployed and therefore find it difficult to get a job in the future. For example after the recession of 1981 unemployment in the UK stayed close to 3 million for a long period despite a long period of growth, however this didn’t happen after the 1991 recession.

Introduction
The natural rate of unemployment (NRU) is defined as the equilibrium rate of unemployment i.e. the rate of unemployment where real wages have found their free market level
It is where the aggregate supply of labour is in balance with the aggregate demand for labour.
At the natural rate, all those wanting to work at the prevailing real wage rate have found employment and there is no involuntary unemployment
There remains some voluntary unemployment as some people remain out of a job searching for work offering higher real wages or better conditions.
Consider the next diagram. At the real wage rate W1, E1 workers are employed. But at this prevailing wage rate, the total labour force exceeds than the employed labour force.
The natural rate of unemployment = AB and consists of frictional and structural unemployment.
The government might try to reduce the natural rate by bringing down the horizontal distance between the supply of labour and the labour force curve.

Any supply-side policy that can increase the number of people willing of working age that are willing and able to find employment in the labour market will shift the labour supply curve to the right, thus narrowing the gap. This is shown in the second diagram.

Policies to reduce the natural rate of unemployment focus on removing “labour market imperfections”. E.g. a government wanting to achieve a lower equilibrium rate of unemployment might:
Reform the system of welfare benefits to reduce the risk of the “poverty trap” – where some people find themselves in a poverty trap, whereby it’s not worth getting a job
Reform trade unions to reduce their collective bargaining power and also reducing some of the barriers to labour mobility put up by professional bodies and associations which have the effect of limiting the supply of labour into an occupation
Reducing income tax to improve the incentives to look for and accept paid work
Adopting a more relaxed approach to labour migration to help fill job vacancies
Relax employment laws to reduce the costs for businesses wanting to employ extra workers
Economists who believe that the natural rate of unemployment can be reduced argue that government policies should seek to make labour markets more competitive and flexible.
The structural problem of youth unemployment

Youth unemployment rates are higher than for the rest of the working population. Nearly 4 people out of 10 who are unemployed are aged between 16 and 24.
NEETs: NEET stands for Not in Employment, Education or Training
Reasons for higher youth unemployment
1. Human capital: A number of students leave school or college with few qualifications and therefore lack the human capital needed to find secure employment
2. Experience: Younger workers have less experience in the labour market and employers may decide to employ someone with a track record in work that is perceived to be more productive. In recruitment freeze, younger workers often miss out because of the experience factor.
3. Training costs: Some employers may not want to cover the extra costs of training younger workers – preferring instead to take a free-ride on employees who have received training in their previous job
4. Apprenticeships: There has been a decline in the number of apprenticeships available for people leaving school aged 16. High quality vocational education makes younger workers more employable.
5. Benefit reforms: Some economists believe that youth unemployment is partly the result of the benefits system and that claiming benefit should be made harder for those who have not taken paid work after leaving school or college. For example, unemployment benefits could rise according to how many years a person has been working and paying national insurance.

An OECD report into youth unemployment published recently made this telling observation
‘A lack of qualifications makes it hard to get a firm foothold in the labour market. In 2005, one year after leaving education, only 45% of young people who left school without an upper secondary qualification – A levels or five good GCSEs or the vocational equivalent – were employed compared with 67% of their higher-qualified counterparts. In the same year, 20% of young people without an upper secondary qualification were neither in employment nor in education or training, more than twice the share among their more educated counterparts.’
Youth unemployment is a major structural problem in the UK labour market
Some economists are calling for a rise in government spending on schools and colleges, whilst others want the government to lower employer national insurance contributions for businesses that take on and train younger workers
In the long run, such measures will pay dividends because of the economic and social costs if we suffer another generation of younger people with limited employment opportunities

Policies for Reducing Unemployment
By Tejvan Pettinger on November 14, 2011 in economics
There are two main strategies for reducing unemployment -
Demand side policies to reduce demand-deficient unemployment (unemployment caused by recession)
Supply side policies to reduce structural unemployment / (the natural rate of unemployment)
Demand Side Policies
Demand side policies are important when there is a recession and rise in cyclical unemployment. (e.g. after 1991 recession and after 2008 recession)
1. Fiscal Policy
Fiscal policy can decrease unemployment by helping to increase aggregate demand and the rate of economic growth. The government will need to pursue expansionary fiscal policy; this involves cutting taxes and increasing government spending. Lower taxes increase disposable income (e.g. VAT cut to 15% in 2008) and therefore help to increase consumption, leading to higher aggregate demand (AD).
With an increase in AD, there will be an increase in Real GDP (as long as there is spare capacity in the economy.) If firms produce more, there will be an increase in demand for workers and therefore lower demand-deficient unemployment. Also, with higher aggregate demand and strong economic growth, fewer firms will go bankrupt meaning fewer job losses.
Keynes was a strong advocate of expansionary fiscal policy during a prolonged recession. He argue that in a recession, resources (both capital and labour) are idle, therefore the government should intervene and create additional demand to reduce unemployment.
Impact of Higher AD on Economy

However,
1. It depends on other components of AD. e.g. if confidence is low, cutting taxes may not increase consumer spending because people prefer to save. Also, people may not spend tax cuts, if they will soon be reversed.
2. Fiscal policy may have time lags. E.g. a decision to increase government spending may take a long time to have an effect on increasing AD.
3. If the economy is close to full capacity an increase in AD will only cause inflation. Expansionary fiscal policy will only reduce unemployment if there is an output gap.
4. Expansionary fiscal policy will require higher government borrowing – this may not be possible for countries with high levels of debt, and rising bond yields.
5. In the long run expansionary fiscal policy may cause crowding out, i.e. the government increase spending but because they borrow from private sector, they have less to spend and therefore AD doesn’t increase. However, Keynesians argue crowding out will not occur in a liquidity trap.
2. Monetary Policy
Monetary policy would involve cutting interest rates. Lower rates decrease the cost of borrowing and encourage people to spend and invest. This increases AD and should also help to increase GDP and reduce demand deficient unemployment.
Also lower interest rates will reduce exchange rate and make exports more competitive.
In some cases, lower interest rates may be ineffective in boosting demand. In this case, Central Banks may resort to Quantitative easing. This is an attempt to increase money supply and boost aggregate demand. See: Quantitative easing.
Evaluation
Similar problems to fiscal policy. e.g. it depends on other components of AD.
Lower interest rates may not help boost spending, if banks are still reluctant to lend.
Demand side policies can help to reduce demand deficient unemployment e.g. in a recession. However, they cannot reduce supply side unemployment. Therefore, their effectiveness depends on the type of unemployment that occurs.
Supply Side Policies for Reducing Unemployment
Supply side policies deal with more micro-economic issues. They don’t aim to boost overall Aggregate Demand, but seek to overcome imperfections in the labour market and reduce unemployment caused by supply side factors. Supply side unemployment includes:
Frictional
Structural
Classical (real wage)
Policies to Reduce Supply Side Unemployment
1. Education and Training. The aim is to give the long term unemployed new skills which enable them to find jobs in developing industries, e.g. retrain unemployed steel workers to have basic I.T. skills which helps them find work in service sector. – However, despite providing education and training schemes, the unemployed may be unable or unwilling to learn new skills. At best it will take several years to reduce unemployment.
2. Reduce Power of trades unions. If unions are able to bargain for wages above the market clearing level, they will cause real wage unemployment. In this case reducing influence of trades unions (or reducing Minimum wages) will help solve this real wage unemployment.
3. Employment Subsidies. Firms could be given tax breaks or subsidies for taking on long term unemployed. This helps give them new confidence and on the job training. However, it will be quite expensive and it may encourage firms to simply replace current workers with the long term unemployment in order to benefit from the tax breaks.
4. Improve Labour Market Flexibility. It is argued that higher structural rates of unemployment in Europe is due to restrictive labour markets which discourages firms from employing workers in the first place. For example, abolishing maximum working weeks and making it easier to hire and fire workers may encourage more job creation. However, increased labour market flexibility could cause a rise in temporary employment and greater job insecurity.
5. Stricter Benefit requirements. Governments could take a more pro-active role in making the unemployed accept a job or risk losing benefits. After a certain time period the government could guarantee some kind of public sector job (e.g. cleaning streets). This could significantly reduce unemployment. However, it may mean the government end up employing thousands of people in un-productive tasks which is very expensive. Also, if you make it difficult to claim benefits, you may reduce the claimant count, but not the International Labour force survey. See: measures of unemployment
6. Improved Geographical Mobility. Often unemployed is more concentrated in certain regions. To overcome this geographical unemployment, the government could give tax breaks to firms who set up in depressed areas. Alternatively, they can give financial assistance to unemployed workers who move to areas with high employment. (e.g. help with renting in London)