What Causes Changes in Unemployment over the Long Run

A Preview of Policies to Fight Unemployment

The Government Budgets and Fiscal Policy and Macroeconomic Policy Around the World chapters provide a detailed discussion of how to fight unemployment, when we can discuss these policies in the context of the full array of macroeconomic goals and frameworks for analysis. However, even at this preliminary stage, it is useful to preview the main issues concerning policies to fight unemployment.

The remedy for unemployment will depend on the diagnosis. Cyclical unemployment is a short-term problem, caused because the economy is in a recession. Thus, the preferred solution will be to avoid or minimize recessions. As Government Budgets and Fiscal Policy discusses, governments can enact this policy by stimulating the overall buying power in the economy, so that firms perceive that sales and profits are possible, which makes them eager to hire.

Dealing with the natural rate of unemployment is trickier. In a market-oriented economy, firms will hire and fire workers. Governments cannot control this. Furthermore, the evolving age structure of the economy's population, or unexpected shifts in productivity are beyond a government's control and, will affect the natural rate of unemployment for a time. However, as the example of high ongoing unemployment rates for many European countries illustrates, government policy clearly can affect the natural rate of unemployment that will persist even when GDP is growing.

When a government enacts policies that will affect workers or employers, it must examine how these policies will affect the information and incentives employees and employers have to find one another. For example, the government may have a role to play in helping some of the unemployed with job searches. Governments may need to rethink the design of their programs that offer assistance to unemployed workers and protections to employed workers so that they will not unduly discourage the supply of labor. Similarly, governments may need to reassess rules that make it difficult for businesses to begin or to expand so that they will not unduly discourage the demand for labor. The message is not that governments should repeal all laws affecting labor markets, but only that when they enact such laws, a society that cares about unemployment will need to consider the tradeoffs involved.

Unemployment and the Great Recession

In the review of unemployment during and after the Great Recession at the outset of this chapter, we noted that unemployment tends to be a lagging indicator of business activity. This has historically been the case, and it is evident for all recessions that have taken place since the end of World War II. In brief, this results from the costs to employers of recruitment, hiring, and training workers. Those costs represent investments by firms in their work forces.

At the outset of a recession, when a firm realizes that demand for its product or service is not as strong as anticipated, it has an incentive to lay off workers. However, doing so runs the risk of losing those workers, and if the weak demand proves to be only temporary, the firm will be obliged to recruit, hire, and train new workers. Thus, firms tend to retain workers initially in a downturn. Similarly, as business begins to pick up when a recession is over, firms are not sure if the improvement will last. Rather than incur the costs of hiring and training new workers, they will wait, and perhaps resort to overtime work for existing workers, until they are confident that the recession is over.

Another point that we noted at the outset is that the duration of recoveries in employment following recessions has been longer following the last three recessions (going back to the early 1990s) than previously. Nir Jaimovich and Henry Siu have argued that these “jobless recoveries” are a consequence of job polarization – the disappearance of employment opportunities focused on “routine” tasks. Job polarization refers to the increasing concentration of employment in the highest- and lowest-wage occupations, as jobs in middle-skill occupations disappear. Job polarization is an outcome of technological progress in robotics, computing, and information and communication technology. The result of this progress is a decline in demand for labor in occupations that perform “routine” tasks – tasks that are limited in scope and can be performed by following a well-defined set of procedures – and hence a decline in the share of total employment that is composed of routine occupations. Jaimovich and Siu have shown that job polarization characterizes the aftermath of the last three recessions, and this appears to be responsible for the jobless recoveries.