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Chapter 6: Natural rate of unemployment . Natural rate of unemployment: The average rate of unemployment around which the economy fluctuates. . In a , the actual unemployment rate rises above the natural rate. . In a boom, the actual unemployment rate falls below the natural rate.

CHAPTER 1 The Science of 0 CHAPTER 6 Unemployment 1

Actual and natural rates of unemployment A first model of the natural rate in the U.S., 1960-2009 12 Notation: Unemployment rate 10 L = # of workers in labor force

8 E = # of employed workers labor force f 6 U = # of unemployed U/L = unemployment rate

Percent o 4 Natural rate of unemployment

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0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 CHAPTER 6 Unemployment 3

Assumptions: The transitions between and unemployment

1. L is exogenously fixed. s E 2. During any given month, s = rate of separations, the fraction of employed workers that b ecome separat ed f rom th ei r j o bs Employed Unemployed f = rate of job finding, fraction of unemployed workers that find s and f are exogenous f U

CHAPTER 6 Unemployment 4 CHAPTER 6 Unemployment 5

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The steady state condition Finding the “equilibrium” U rate

. Definition: the labor market is in f U = sE steady state, or long-run equilibrium, if the unemployment rate is constant. = s(L –U ) . The steady-state condition is: = sL – sU s E = f U Solve for U/L: (f + s)U = sL # of employed people who # of unemployed so, Us lose or leave people who find  their jobs jobs Lsf

CHAPTER 6 Unemployment 6 CHAPTER 6 Unemployment 7

Example: Policy implication

. A policy will reduce the natural rate of . Each month, unemployment only if it lowers s or increases f. . 1% of employed workers lose their jobs (s = 0.01) . 19% of unemployed workers find jobs (f = 0. 19) . Find the natural rate of unemployment: Us 001.  0. 05, or 5% Lsf001.. 019

CHAPTER 6 Unemployment 8 CHAPTER 6 Unemployment 9

Why is there unemployment? Job search & frictional unemployment

. If job finding were instantaneous (f = 1), . frictional unemployment: caused by the time then all spells of unemployment would be brief, it takes workers to search for a job and the natural rate would be near zero. . occurs even when are flexible and there are enough jobs to go around . There are two reasons why f < 1: 1. job search . occurs because 2. wage rigidity . workers have different abilities, preferences . jobs have different skill requirements . geographic mobility of workers not instantaneous . flow of information about vacancies and job candidates is imperfect CHAPTER 6 Unemployment 10 CHAPTER 6 Unemployment 11

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CASE STUDY: Sectoral shifts Structural change over the long run

. def: Changes in the composition of demand Agriculture Manufacturing among industries or regions. 1960 2006 Other industry . example: Technological change Services more jobs repairing computers, 57.9% 76.5% fewer jobs repairing typewriters . example: A new international trade agreement labor demand increases in export sectors, 4.2% decreases in import-competing sectors 1.1%

. These scenarios result in frictional unemployment 9.9% 13.9% 28.0% 8.5%

CHAPTER 6 Unemployment 12

More examples of sectoral shifts Public policy and job search

. Industrial revolution (1800s): Govt programs affecting unemployment include: agriculture declines, manufacturing soars . Govt employment agencies . Energy crisis (1970s): disseminate info about job openings to better demand shifts from larger cars to smaller ones match workers & jobs. . Public job programs . HlthHealth care spen ding as %fGDP% of GDP: help workers displaced from declining industries 1960: 5.2% 2000: 13.8% get skills needed for jobs in growing industries. 1980: 9.1% 2007: 16.2% In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.

CHAPTER 6 Unemployment 14 CHAPTER 6 Unemployment 15

Unemployment insurance (UI) Benefits of UI

. UI pays part of a worker’s former wages for a limited time after losing his/her job. . By allowing workers more time to search, UI may lead to better matches between . UI increases search unemployment, jobs and workers, because it reduces . the opportunity cost of being unemployed which would lead to greater productivity and higher incomes. . the urgency of finding work . f . Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment. CHAPTER 6 Unemployment 16 CHAPTER 6 Unemployment 17

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Why is there unemployment? Unemployment from real rigidity

Real Supply Us The natural rate of unemployment:  If real wage is wage Lsf stuck above Unemployment its eq’m level, . Two reasons why f < 1: then there Rigid aren’ t enough real DONE 1. job search jobs to go wage Next  2. wage rigidity around. Demand

Labor Amount of Amount of labor labor hired willing to work CHAPTER 6 Unemployment 18 CHAPTER 6 Unemployment 19

Unemployment from real wage rigidity Reasons for wage rigidity

If real wage is 1. laws stuck above Then, firms must ration the its eq’m level, scarce jobs among workers. 2. Labor unions then there aren’ t enough 3. jobs to go Efficiency wages around. : The unemployment resulting from real wage rigidity and job rationing.

CHAPTER 6 Unemployment 20 CHAPTER 6 Unemployment 21

1. The minimum wage 2. Labor unions

. The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers. . Unions exercise monopoly power to secure higher wages for their members. . Studies: a 10% increase in min. wage . When the union wage exceeds the eq’m wage, reduces teen unemployment by 1-3% unemppyloyment results. . But, the min. wage cannot explain the . Insiders: Employed union workers whose interest majority of the natural rate of unemployment, is to keep wages high. as most workers’ wages are well above the min. wage. . Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them.

CHAPTER 6 Unemployment 22 CHAPTER 6 Unemployment 23

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Union membership and wage ratios by industry, 2008 3. Efficiency wage theory # employed U % of wage industry (1000s) total ratio . Theories in which higher wages increase worker Private sector (total) 108,073 7.6% 123.2 productivity by: Government (total) 21,305 36.8 120.5 Construction 7,652 15.6 151.8 . attracting higher quality job applicants Mining 776 6.9 102.1 . increasing worker effort, reducing “shirking” Manufacturing 15,131 11.4 108.6 . reducing , which is costly to firms Retail trade 14,987 5.2 106.6 . improving health of workers Transportation 4,639 21.3 126.3 (in developing countries) Finance, insurance 6,536 1.3 88.7 . Firms willingly pay above-equilibrium wages to Professional services 11,967 2.1 97.4 raise productivity. 3,657 13.8 117.1 Health care 15,184 8.0 116.0 . Result: structural unemployment. CHAPTER 6 25 wage ratio = 100(union wage)/(nonunion wage) slide 24 Unemployment

NOW YOU TRY: The duration of U.S. unemployment, Question for Discussion average, Jan 1960 – June 2009 time spent # of unemployed . Use the material we’ve just covered to come unemployed persons in group up with a policy or policies # of weeks by this group (% of all to try to reduce the natural rate of unemployed (% of time spent unemployed unemployed unemppyloyment. persons) by all groups) . Note whether your policy targets frictional or structural unemployment. 1-4 42% 8.1% 5-14 30% 21.5%

15 or more 27% 70.4%

TREND: The natural rate rises over 1960-84, The duration of unemployment then falls over 1985-2005 . The data: 9

. More spells of unemployment are short-term 8 than medium-term or long-term. . Yet, most of the total time spent unemployed is 7 labor force

attributable to the long-term unemployed. f . This long-term unemployment is probably 6 structural and/or due to sectoral shifts among Percent o 5 vastly different industries.

. Knowing this is important because it can help us 4 craft policies that are more likely to work. 3 CHAPTER 6 Unemployment 28 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

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EXPLAINING THE TREND: The real minimum wage EXPLAINING THE TREND: The minimum wage and natural u-rate have Union membership $9 similar trends. Since early 1980s, the natural rate $8 Union membership selected years and union $7 membership year percent of labor force have both fallen. $6 minimum wage

er hour 1930 12% in 2009 dollars But, from 1950s p $5 1945 35% to about 1980, $4 the natural rate 1954 35% Dollars $3 rose while union minimum wage in 1970 27% membership fell. $2 current dollars 1983 20.1% $1 2008 12.4% $0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

2006-present: EXPLAINING THE TREND: oil price volatility increases – EXPLAINING THE TREND: Sectoral shifts will the natural u-rate rise again? Demographics 140 1986-2005: oil prices less . 1970s: 120 volatile, so fewer sectoral shifts The Baby Boomers were young. Young workers change jobs more frequently 100 1970-1986: volatile (high value of s). oil prices create Price per 80 barrel of oil, jarring sectoral shifts . La te 1980 s th roug h to day: in 2009 60 Baby Boomers aged. Middle-aged workers dollars change jobs less often (low s). 40

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0 33 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 CHAPTER 6 Unemployment

Unemployment in Europe, 1960-2008 Why unemployment rose in Europe 13 but not the U.S. 12 Shock 11 Technological progress has shifted labor demand 10 from unskilled to skilled workers in recent 9 decades. 8 bor force Effect in United States a 7 6 An increase in the “skill premium” – the wage gap 5 between skilled and unskilled workers.

4 France

Percent of l Effect in Europe 3 Germany Higher unemployment, due to generous govt 2 Italy benefits for unemployed workers and strong union 1 U.K. presence. 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 CHAPTER 6 Unemployment 35

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Percent of workers covered by collective bargaining, selected countries Chapter Summary

1. The natural rate of unemployment United States 18% . definition: the long-run average or “steady United Kingdom 47 state” rate of unemployment Switzerland 53 . depends on the rates of job separation and job finding SiSpain 68 Sweden 83 2. Frictional unemployment . due to the time it takes to match workers with Germany 90 jobs France 92 . may be increased by unemployment insurance Austria 98

Chapter Summary Chapter Summary

3. Structural unemployment 5. Behavior of the natural rate in the U.S. . results from wage rigidity: the real wage . rose from 1960 to early 1980s, then fell remains above the equilibrium level . possible explanations: . caused by: minimum wage, unions, efficiency trends in real minimum wage, wages union membership, p revalence of sectoral shifts, and aging of the Baby Boomers 4. Duration of unemployment . most spells are short term . but most weeks of unemployment are attributable to a small number of long-term unemployed persons

Chapter Summary

6. European unemployment . has risen sharply since 1970 . probably due to generous , strong union presence, and a technology-driven shift in demand away from unskilled workers

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