Unit 5 - Labor Markets and Unemployment

Labor Markets

In this section we will take a look at household consumption and saving decisions. Individuals can use their disposable income for either consumption or savings.

Household Consumption and Saving

We now examine the individual's decision to save and the market for funds. The decision to save can also be considered a tradeoff between present and future consumption. By not spending a portion of our disposable income today, we have money available for future consumption. Assume you decide to take $100 of your income today and save it. If the return on savings, r (the interest rate), is 10%, then you will have $110 available for consumption in a year from now.




Figure 5-1 shows the supply of savings curve. The curve has a positive slope due to the substitution effect of higher interest rates. As the interest rate r increases, the return from saving also rises. People reduce their present consumption and substitute in favor of savings, thus allowing for greater future consumption.

Savings is undertaken by individuals, businesses, the government and foreign savers may also supply savings to the domestic market. Savings is provided in the loanable funds (capital market) and refers to savings with financial institutions such as banks, in the form of a bond or stock purchase or with some other type of financial intermediary.

Total Domestic Savings  = Private Savings + Public Savings + Net Foreign Savings.

Equilibrium in the Capital Market




The demand for loanable funds is generated by businesses that wish to borrow money to undertake investment in capital. Investment is undertaken by firms to add to their capital stock. Capital is considered to be the machinery, tools, buildings, computers, and other equipment used in the production of goods and services. The capital market is where firms and other institutions borrow money. Firms use this borrowed money to purchase (invest in) capital. Figure 5-2 shows equilibrium in the capital market where borrowers (the Demand for Loanable Funds curve) and savers (the Savings curve) determine the market interest rate, r*, and the quantity of capital.

The Labor Market - Household Supply and Employer Demand

The labor market looks at the decisions of individuals to work and the demand by employers for workers. The household labor supply decision will have a positive correlation to the wage rate. The higher the wage we can obtain, the greater our desire to work (especially when all households in the economy are included in this decision process). The demand for labor by businesses, governments, and other employers will have a negative relationship to the wage rate. As the wage rate increases, the cost of hiring workers rises. With higher wage rates, employers increasingly seek lower-cost alternatives to labor, such as capital.




In Figure 5-3 we show the labor market. This is where households supply labor and employers demand workers. In the graph we have the equilibrium wage, w*, and the level of employment QL* determined.

Bringing the Markets Together

In the above two graphs we showed how the capital market determined the equilibrium interest rate, r*, and the labor market set the wage rate, w*. We also include the product market on the left, where the market price, p*, is determined by the equilibrium of supply and demand for a good.

We conclude this section by recognizing that markets are interrelated: changes in one market have an impact on other markets. Consider the three markets discussed here (capital, labor, and product). Assume that economic growth is increasing the demand for goods and services, including the item produced in the product market graphed above. The demand curve for the good shifts to the right, raising the market price. As producers increase their quantity supplied they increase their demand for inputs of labor and capital. An increase in the demand for labor increases the wage rate, and greater demands for capital bid up the interest rate.

Is the story over? Hardly. Prices, wages, and interest rates have all increased due to economic growth. What happens next requires good analytical skills, as there are several options. For example, higher wages allow for the consumer to buy more, although the increase in interest rates encourages savings. If few substitutes in consumption are available for the consumer, higher prices in the product market for this good illustrated here may erode the wage gains enjoyed by workers.

Fortunately, cataloging the possible permutations is not the essence of this course. We need to understand the relationships that markets have to each other and have a working knowledge of the fundamentals of markets. You should be able to verbally and graphically describe what happens in each market if the demand or supply of either the product, labor, or capital changes. If you are uncertain, review the basics of market equilibrium in Unit 4.


Unemployment is a measure of those people who are actively seeking work but cannot find a job which matches their qualifications. As Figure 1-2 shows, unemployment represents an underutilization of resources. An economy with excessive unemployment produces at point F, below the potential output along its production possibilities frontier at point G. By reducing unemployment (moving from point F to G), more goods are produced with the same amount of resources and the current state of technology.

Before giving the details of unemployment we should note that macroeconomic policies do not desire to provide all individuals with jobs. Some people choose to be unemployed voluntarily. Individuals may choose to be unemployed as they switch jobs, move from on region of the country to another, or for various other reasons. The goal of macroeconomic policy is to achieve full employment. Full employment is described as the absence of involuntary unemployment. Involuntary unemployment is that characterized by individuals who would like a job that matches their skills, but none are available. This may sound clear, but the study of economics is often the examination of shades of gray. The thorn in the side of economic policy-makers is the difficulty of determining what is an appropriate level for full employment.

Measuring Unemployment

To measure unemployment we must first consider those people who are considered eligible to work. The definition of the labor force is all employed or unemployed civilians (16+ years of age) plus armed forces stationed in the US. Excluded from the labor force are students, housekeepers for a working spouse, those who have given up looking for work, and others who are considered non-labor force participants. The unemployment rates is defined as the ratio of the number of unemployed to the labor force:

unemployment rate = number unemployed

labor force

Unemployed individuals are those who are actively looking for work or are waiting to return to a job from which they have been laid off. As the following table shows, unemployment rates differ substantially throughout the world.

Global Rates of Unemployment – May 2002


% Unemployment















United States


Euro area


It is important to note that actual number of unemployed is higher than reported due to discouraged workers who have given up actively seeking work and have dropped out of the labor force. Individuals may be unable to work for such reasons as disabilities, personal hardship, bad luck, a lack of skills, and other reasons. Sometimes an economy is too weak to provide jobs for its citizens. It is estimated that 75% of the adult population in Haiti does not work. During the depression of the 1930s, over 24% of the United States workforce lacked employment. Although the exact number is uncertain,the estimated impact of including discouraged and underemployed (or involuntary) part-time workers would add approximately 2%-3% to the overall unemployment rate of the United States.

Currently, among American men aged 25 to 55, the non-employment rate is about 11 percent. This group includes all the unemployed plus those who don't bother looking for work and thus aren't counted among the jobless. These people may choose not to work, or may be physically or mentally incapable of holding jobs. Or they may be discouraged from seeking work because employers constantly reject their applications or because they are offered inadequate wages. It is uncertain whether an rapidly growing economy will help the non-employed. A recent study by Richard B. Freeman of Harvard University and William M. Rodgers 3d of the College of William and Mary found that even in areas of the country with very tight labor markets, overall non-employment rates barely budged throughout the 1990's. That might suggest that relatively few non-working Americans would be drawn to work by an expanding economy.

Types of Unemployment

We begin by categorizing the common definitions of unemployment. Those individuals who find themselves unemployed most often are considered one of the following:

  1. Frictionally unemployed
  2. Seasonally unemployed
  3. Structurally unemployed
  4. Cyclically unemployed

Frictional unemployment represents job turnover as people change jobs, move to different areas, and for other reasons that are generally temporary, and voluntary.

Seasonal unemployment refers to changes in employment that follow recurring patterns through the years. Construction workers, people who fish for a living, and lifeguards all face layoffs during the winter months. Consequently, the number of unemployed rises and statistics need to be adjusted accordingly to deal with temporary changes in the number of unemployed. This will prevent needless volatility in the unemployment rate that does not accurately reflect the status of the economy.

Structural unemployment represents a mismatch between supply of labor and demand for workers. Of all the unemployment categories listed here, structural unemployment represents the most significant long-term problem for economic policymakers. Individuals who fall into this category have trouble finding jobs because of a lack of adequate skills or regional employment problems. These people have the greatest potential to eventually become discouraged workers.

Within the category of structural unemployment, there are three subgroups:

Occupational unemployment results from a mismatch between the demand and supply of labor in specific industries. The demand for workers in growing fields such as health care may exceed the supply of available workers, while the supply of labor in declining areas may be in surplus. As a result, there is high unemployment in stagnant or declining job areas, while demand is strong for alternative occupations. An important recent trend in the United States and some other developed countries is the transition from manufacturing to service employment

An imbalance between the supply and demand for labor also occurs geographically, and is known as regional unemployment. For many countries, growth is not uniform across the landscape. Some areas may enjoy rapid growth and thus have a strong demand for labor, while other locations are stagnant and the surplus labor leads to high local unemployment rates. In the recession of 1981-82, the middle part of the United States was called the 'rust belt' due to its large manufacturing economy having fallen on hard times in competing with more efficient foreign producers. In contrast, the recession had a minimal impact on the southwestern region of the United States, which supported many jobs in the fast-growing energy, technology, and defense sectors.

International competition is an additional source of long-term structural unemployment. The argument is that less-skilled workers in developed countries are increasingly being displaced by foreign workers in less-developed countries (LDCs) who are paid significantly lower wages. In developed countries the average wage for less-skilled workers is relatively high compared to that in LDCs due to greater living costs, union and worker power, and tradition. As the world economy has evolved, businesses and corporations have increasingly sold their goods in a global marketplace. In order to compete internationally, firms need to produce at the lowest possible costs. With wages comprising 2/3 of the cost of production of the average good, one way for producers in developed countries to compete is to transfer production abroad, where labor costs are lower. While this argument does have merit, it is often twisted to support the goals of politicians who wish to play on the fears of the electorate. This is a complex issue; if you would like to read further, link here

Structural unemployment is the most difficult for economic policymakers to deal with, and solutions evolve slowly. Individuals stuck in occupations that allow for little future growth need to be retrained and educated to gain the skills necessary to work productively in areas where they are needed. Time, information, and money are required to deal with structural unemployment. The government can take an active role in providing vital information about jobs and help in financing education and training for displaced workers. In the long run, governments will find it more cost-effective to help people gain skills than to deal with the consequences of individuals with no future. Link here for further information about recent changes to the welfare system in the United States.

Cyclical Unemployment is the type of unemployment that we focus on in a macroeconomics course. Resulting from fluctuations in the business cycle, cyclical unemployment rises significantly during economic downturns (recessions) and falls during growth phases, both having dramatic impacts on the national rate of unemployment. In this course we will discuss in detail how economic policymakers use fiscal policy and monetary policy to deal with the macroeconomic issues of unemployment, inflation, and economic growth.


Unit 5 - Future Employment: Are We Going Nowhere Fast?

A Look Back

The American economy has undergone two major transitions since its independence in 1776. Early America, like the rest of the world, was an agricultural-based economy. This was followed by the transition to an industrial economy during the nineteenth century. The industrial revolution transferred jobs from the rural agricultural sector to factory-based urban production. The ultimate clash of the two economic systems came during the American Civil War where a Southern economy that was still dominated by agriculture (King Cotton) unsuccessfully tried to succeed from the growing industrial strength of the North.

Even though the South dominated militarily, with many of the best-trained West Point graduates (Lee, Longstreet) coming from the South, the North eventually wore down the South simply by the production of basic war materials which the South had trouble providing its soldiers. Shoes, uniforms, and guns became increasingly abundant in the North, while Southern soldiers were generally ill-equipped in comparison. The famous Southern general Stonewall Jackson would lead his men on one-day marches of over 20 miles with many of his men going barefoot or in severely tattered footwear. A key to the North's success was the effective blockade of Southern shipping that prevented the importation of these items from sympathetic European traders.

The American (and world) economy is now moving well into the next stage: a transition from an industrial to a global, information-based economic system. This world economy increasingly emphasizes technology and skills rather the mass production of consumer goods, especially for the developed economies such as the United States.

Give them some rope

Since the beginning of the industrial revolution people have been predicting that machines would destroy jobs. After the end of the Napoleonic Wars the economic slump saw the widespread displacement of handweavers by the power loom. In the early 19th century the Luddites responded by destroying the looms and jennies that threatened their traditional livelihood. Karl Marx wrote that by investing in machinery, factory owners would create a vast army of unemployed and underemployed. These workers would be increasingly exploited, earning a subsistence wage as the value of the goods produced was taken by the owners of resources. Marx philosophized that the number of despondent workers would swell until a revolution occurred. The factory owners would produce the rope with which the workers would hang them.

When unemployment rates in the United States soared above 25% during the Great Depression of the 1930s, some observers tied the lack of jobs to the spread of assembly line production techniques during the 1920s. In the late 1940s, Norbert Weiner, a pioneer of computing, forecast that this new technology would destroy enough jobs to make depression era unemployment rates of 25% a picnic. Today, unemployment rates in many Western European countries easily exceed 10%. Some European politicians and union leaders worry that there is not enough work to go around, and there are proposals to cut the number of hours in the average workweek and for job-sharing programs.

And now Jeremy Rifkin has written another in a series of end-of-the-world books, predicting along with many others that in the coming years the world will have no need for workers as machines displace almost all labor. Rifkin and others claim that the current wave of technological change is different in pace and nature than its predecessors. This time the consequences matter because:

         Previous changes in technology have only impacted certain sectors. When farm labor was displaced by tractors and ploughs, factories were there to absorb the excess supply of workers. When automated production displaced factory workers in the manufacturing sector, such as the textile workers who were displaced by automated looms, the booming service sector was there to take up the slack. But now that telephone operators, bank tellers, even doctors, stockbrokers, and other skilled professional employed in the service sector are being rapidly displaced by technology, where do they go? Some argue that at the present time, there is no defined direction to create new opportunities for the displaced workers.

         Not just the unskilled, but skilled workers are at risk for the following reasons:

a.       Global competition is transferring both high-paying and low-paying jobs overseas. U.S. firms are relocating not only assembly line work abroad to take advantage of lower wages but also some highly skilled jobs to take advantage of lower wages for engineers, software programmers, accountants, lawyers, and other professionals.

For example, Intel has plenty of engineers to choose from in California who have been displaced by military cutbacks. Instead, Intel has chosen to expand to Ireland where engineers are paid only about 1/3 the level of their American counterparts. And Boeing, in the design of the new 777, is contracting out hundreds of engineering jobs to Taiwan and Russia. Many U.S. software companies are contracting out programming overseas to workers in places like Bulgaria, Russia, and India where wages are roughly 1/5 of what U.S. programmers receive.

b.      For the last decades, automation has steadily displaced workers in the manufacturing sector as jobs have been displaced by machines, increasing productivity along the way. Now this is occurring with white-collar jobs as well, as producers seek improvements in productivity. We are at the beginning of a computer revolution that will greatly increase worker productivity but displace many workers in the service sector.

q       For example, using automated computer systems, inventory managers are displaced by direct ordering from the retailer to the plant. The retailer ties directly into the producer's computer and places an order, which is automatically transferred to production, where the desired output is generated. This allows faster turnaround for retail business and less need for their in-store inventories as orders are processed rapidly.

q       Presently there are computer programs being developed and implemented that can diagnose illnesses as well as doctors can do. A robot that can perform hip replacement surgery is under development in California.

q       IBM is introducing an Internet-based automobile financing service for member banks and auto dealerships to approve car loans for customers. The service, uses touch-screen computers that a dealer or customer can use to apply for and obtain loan credit within 30 minutes. To apply for credit, the dealer or consumer uses the touch-screen to enter an "intelligent application." Once completed, the application is transmitted via the Internet to a server at a participating bank. There it is fed into the bank's loan systems. Once the consumer has agreed to the financing, IBM electronically transmits a completed contract to the bank. Funds are wired to the dealer the same day. The system captures electronic signatures to complete the applications and contracts quickly.

         The contingent work force creates a large number of temporary jobs that offer no long-run guarantees of employment. In 1992, 2/3 of new private sector jobs created in the United States were temporary. The trend is likely to continue as hiring temporary workers often allows businesses to cut costs by avoiding worker benefit programs and paid leave.

         Information Technology (IT) is being introduced much faster than previous technological developments, implying there is less time to create new opportunities for displaced workers.

         Adherents of the idea of a future global glut argue that growth in the capacity to produce goods and services will zoom ahead of the demand for the same goods and services leading to a global glut of output that will result in another economic crisis like that of the Great Depression. The basic propositions that are critical to the Global Glut doctrine are:

o        Global productive capacity is growing at an exceptional and unprecedented rate.

o        Demand in developed countries can not keep up with the growth in potential supply.

o        The policies in rapidly developing countries emphasize high savings rates and development of export industries. The result is that these countries will contribute much more to supply than to demand.

According to Rifkin in a Mother Jones article, "the hard reality is that the global economy is in the midst of a transformation as significant as the Industrial Revolution. We are in the early stages of a shift from "mass labor" to highly skilled "elite labor," accompanied by increasing automation in the production of goods and the delivery of services. Sophisticated computers, robots, telecommunications, and other Information Age technologies are replacing human beings in nearly every sector. Factory workers, secretaries, receptionists, clerical workers, salesclerks, bank tellers, telephone operators, librarians, wholesalers, and middle managers are just a few of the many occupations destined for virtual extinction. In the United States alone, as many as 90 million jobs in a labor force of 124 million are potentially vulnerable to displacement by automation."

Rifkin continues, "Even if thousands of new products come along, they are likely to be manufactured in near-workerless factories and marketed by near-virtual companies requiring ever-smaller, more highly skilled workforces." Rifkin continues, "by replacing more and more workers with machines ... who's going to buy the flood of products and services being churned out?"

The reasons for living (if you really do want to work)

Although it is argued that things will be different this time, similar arguments have been made in the past. If we use the past as a guide to the future, the outlook is very good for some of the following reasons:

1.      In the past 200 years, millions of manual workers have been displaced by machines. Over the same period the number of jobs has grown almost continuously as have the real incomes of people in the industrial world. Technological change is the catalyst for this growth and enrichment.

2.      Despite huge investments in computing and other technology since the 1960s, the U.S. unemployment rate is no higher today than it was in the early '60s. The two countries that have been most successful in creating jobs over the past decades are the U.S. and Japan, both of which have also had the most rapid shift in their industrial structure towards a high-technology knowledge-based economy.

3.      In Western Europe, where investment in new technologies has lagged behind, the unemployment rate averages over 8%, significantly higher than in the U.S. and Japan. Those European industries that have made the transition are also the ones creating the majority of jobs.

From an economic point of view, technological change is part of the economic growth process. We should consider several key points:

1.      It is wrong to think that output and thus labor inputs are fixed. Advances in technology increase worker productivity, raising real incomes and consumption. With the added demand for goods and services comes increased output and new jobs.

2.      As technology advances and displaces workers, production costs fall. What is known as compensating demand-generating effects implies that falling costs lead to some combination of decreasing prices, increasing real wages, and profits (and thus return on savings for equity holders). These changes lead to increases in consumer purchasing power and thus demand.

For example, although the United States has the world's largest productive capacity to produce goods and services, it continuously runs a trade deficit indicating that consumer demand exceeds domestic production. Consumers have continuously increased their demands for goods and services as incomes rise and have kept pace with the growth in productive capacity.

3.      Regarding the Global Glut hypothesis, while there is evidence that there is overcapacity in some industries where expected future supply is expected to exceed future demand - autos for example - there is no evidence that global productive capacity is increasing at an unprecedented pace. Global supply side growth rates remain below the levels present in the 1950s and 1960s.

4.      It is important to note, that production produces capital as well as consumer goods. Not all that is produced is destined to end up on the market, some will be used to build up the capital stock of a country and besides machinery and computers, may include physical capital such as schools, roads and parks.

Furthermore, one of the fastest growing segments of the global economy is in the production of knowledge. Many of the goods we consume are knowledge-based such as entertainment, computer software, books and other goods where the value of the output is not a tangible good that contains physical value such as a car, but a goods such as software that are the summation of the skills of programmers. While our consumption of many physical goods is finite, our potential consumption of many services and knowledge-goods is essentially unlimited.

Optimist, pessimist, we do need to consider some consequences of change

For example, although ATM's and telephone banking have displaced many traditional banking jobs, opportunities in the financial services industry have grown rapidly over the past decade due to the introduction of new products and services.

In 1999 the average wage for a US worker with a college education was $43,782 per year. For the typical high school graduate who never obtained a college degree, the average annual salary was $24,594.


Unit 5 - What is the Full Employment Rate of Unemployment?

Full employment, or the natural rate of unemployment, is considered to be consistent with a level of unemployment that predominantly comprises voluntarily unemployed workers. In other words, those members of the labor force who really want a job have one. Leaving the nuances of who is part of the labor force for the main text, the rate of unemployment consistent with full employment is a major issue for economic policymakers. Small differences in the perceived rate of full employment lead to significant variations in the policy response to economic growth.

The definition of full employment is critical, because as unemployment rates reach and fall below this level, inflationary pressures start to build. The further that the unemployment rate falls below the natural rate, the greater the pressure on inflation. This is a result of modern production methods. Even in a capital-favoring production country like the United States, worker wages represent over 70% of all production costs. Rising wages increase costs, which are usually passed on to consumers as price increases, leading to climbing inflation.

To understand the relationship between full employment and wage increases, let us assume that the agreed upon natural unemployment rate is 4%. If the unemployment rate is 6%, then there are workers who desire jobs but cannot obtain one (known as involuntary unemployment). With high unemployment rates, the existing labor surplus implies that employers have little trouble finding people to work at the prevailing wage. But as economic growth accelerates, the labor surplus diminishes as more workers are hired, and the unemployment rate falls. Finally, due to strong economic growth, the unemployment rate falls to a level consistent with full employment.

As the story unfolds, economic growth remains persistently bullish, but now everyone (give or take) who wants a job has one. Yet increases in the demand for labor continue to grow and employers must pay existing workers overtime and entice non-labor force participants into the labor force by offering them higher wages. As wages increase, more people are willing to work (reaching their reservation wage), but production costs rise. If strong economic growth persists, wages pressures continue to build, leading to increasing inflation (also known as cost-push inflation).

OK you say; no big deal. When the unemployment rate reaches full employment, use restrictive economic policies to slow economic growth to a level consistent with labor force growth (and labor productivity). That way the unemployment rate will stay constant at the full employment rate, and wage pressures will remain muted. That's a great idea. However, what is the full employment rate of unemployment?

Certainly, full employment in the United States has changed over the years. During the 1950s and 1960s it remained low, consistent with 3-5% unemployment rates. In the 1970s two main changes swept through the American labor force:

  1. The post-World War II baby boomers began to enter the labor force.
  2. Females increased their participation rate to 50% of the total women of working age.

Since both boomers and the wave of new females entering the labor force tended to be younger and less experienced job turnover, increased. By the late 1970s the natural unemployment rate had risen to the 7% range.

During the 1980s the increasing participation rates of women stabilized and the boomers were followed by the baby bust. The natural unemployment rate fell into the 6% range. The consensus among policymakers today is that the full employment rate of unemployment is roughly 4.5%. Once unemployment rates reach that level, economic growth needs to be slowed (we will see how later in this course), in order to level out the changes in the unemployment rate.

The problem with this analysis is what if economic policymakers are wrong? Many argue that the natural unemployment rate has fallen to about 4%. If during an expansion, economic growth is slowed to maintain a 5% rate of unemployment, while 4% is consistent with non-inflationary growth, then there are still plenty of people (over 1.4 million in the US) who want to work at prevailing wages but cannot find a job. By putting on the growth brakes too soon, many involuntarily unemployed workers will still be denied meaningful work.

Evidence indicates that the natural unemployment rate is equal to about 4% and that businesses are increasingly effective in keeping labor costs low. Higher worker productivity helps maintain the nation's standard of living by keeping inflation under control and boosting the competitiveness of U.S. products overseas. Regardless, policy makers are content with a non-accelerating inflationary growth rate consistent with an unemployment rate of around 4%

Low Unemployment Rates Help Reduce Structural Unemployment

Individuals seeking work are often placed in broad categories. People who have been laid off from their jobs due to poor macroeconomic conditions are part of cyclical unemployment that corresponds to fluctuations in economic growth rates. The solution to a rise in the rate of unemployment due to a recession or economic slowdown is simply to increase the growth rate of the economy. As economic activity picks up, firms will increase hiring and the number of unemployed will decrease.

Even as renewed economic vigor allows many unemployed people to return to work, unemployment rates do not fall to zero. Some individuals choose to be unemployed during a brief transition, usually lasting less than five weeks. Perhaps they are taking some time off in-between jobs or moving to another part of the country. Students and spouses leave school and home to find their first jobs. In contrast to those who are voluntarily unemployed are those who remain unemployed regardless if the economy is booming or sinking.. The long term unemployed are considered to be structurally unemployed. Members of this group may lack the education and skills to find work or they may simply be in the wrong place. Many younger African-Americans find themselves in the city when the majority of available jobs are located in the suburbs. The same holds true for Native-Americans who may find few jobs on their home reservations.

The prolonged U.S. economic boom that began in 1992 has helped to reduce unemployment rates to levels not seen in 30 years. Finally, by the late 1990s, the growing economy and record rate of job growth reached many of those previously considered to be permanent fixtures on welfare. For many residents of poorer rural America, and a significant number of blacks and other minorities who have had little opportunity for sustained employment in the past, jobs have become available. As a   group, the unemployment rates among blacks and Hispanics, though still high compared with that for whites, have fallen to record lows. By 1999, joblessness among high school dropouts has fallen to about half the rate in 1992. And wages for the lowest paid are rising faster than inflation for the first time in decades.

The key point made here is that when full employment is reached, the remaining unemployed are considered to be structurally unemployed. There individuals lack the skills and education that are in demand.  For years the blame for structural unemployment was primarily placed on the lack of opportunity or the individuals themselves. Favorite solutions included government intervention to create jobs, provide training and to give the structurally unemployed incentives to work. It now appears that many of the structurally unemployed have wanted to work all along when given the opportunity and they really should have been considered cyclically unemployed.

Unit 5 - The Shift of Employment from Manufacturing

One of the most dramatic changes that have occurred in the workplace of many developed countries during the last half of the twentieth century is the decline in the rate of job growth in the manufacturing sector. Manufacturing jobs that typically produce durable goods such as autos, home appliances and many others have been considered the foundation of a country's economic base. Yet today, manufacturing firms only employ 1/6 of all workers in the United States, 1/5 in Britain, and 1/3 in Germany and Japan. In all four of these countries, manufacturing jobs as a percentage of total workforce employment has been declining steadily. In the United States, manufacturing employment comprised almost 25% of the workforce in 1970 but had fallen by almost 33% by the early 1990s. The declines in the other industrialized countries have been equally dramatic.

Within the manufacturing sector, there have been major shifts in employment. For developing countries, jobs in relatively low-skilled metal-producing industries, such as steel and aluminum, along with employment in textiles, leather, and footwear have all decreased by 25% or more. Picking up some of the slack is job growth in high-technology areas of manufacturing such as computers and aerospace. Consistent with this trend of the movement of jobs into medium (chemical) and high-technology manufacturing has been the transition from labor-intensive to capital-intensive production methods.

For workers in low-technology manufacturing production in developed countries, wages have been falling along with the departure of jobs. For those workers without the skills and education to make the move to high-technology areas, the combination of reduced employment and falling wages has been severe. The low-skilled manufacturing jobs have left the developed economies for the less-developed countries where wages are substantially lower. Over the past decades, the developing countries have increased their share of world manufacturing output, especially in low-skilled production.

For the developed countries, the loss of manufacturing jobs has not been a disaster in the aggregate due to the growth of the service industry. During the same time period that employment (as a percentage of total employment) has fallen in manufacturing, it has grown steadily in the service sector by more than enough to offset the declines in manufacturing employment. In developed countries (OECD), the service sector accounts for more than half of all jobs and also over 50% of all GDP (output). For the United States, the following table shows the rapid shift between the service and manufacturing sectors:

% of employment













Projections for the year 2005 are made by the U.S. Bureau of Labor Statistics.
Services are the new engine of job growth

Wages in the manufacturing sector have historically been relatively high in the United States and other developed countries. Part of the reason was the higher level of unionization of manufacturing employees. As employment in the manufacturing sector has given way to the service industry, there is concern that overall wage rates will fall. In reality, the service sector is very broad, including occupations from fast food worker to investment banker. Many workers in the service industry will find jobs that pay on the same level or higher than employees in the manufacturing sector. Overall, there should be no decline in wages due to the transition of employment from manufacturing to services.

There is also concern that as services dominate domestic production there will be less demand for a nation's exports. In contrast, trade in services is booming worldwide. Services' share of total world trade increased from 17% in 1980 to 22% in 1992. Services such as banking, consulting, computer software, and tourism are growing in demand throughout the world.

Some analysts have pointed to a decline in productivity growth during the 1980s and early 1990s in the United States as a consequence of the transfer of jobs from manufacturing to low-productivity services. In reality, growth rates of productivity slowed down in the 1980s as the industrial era began to fade. Much of the innovative changes in production due to better machinery had been incorporated into the production process, leaving a slower pace of improvement. In contrast, the growth in services associated with computers and telecommunications will lead to a new revolution in the way work is conducted. As a result, starting in 1993 U.S. productivity growth has sprung back. The next decades should see a resurgence of 2% and over annual increases in worker productivity as business adapts to the knowledge revolution.

Part of the decline in manufacturing employment is due to an increase in service-related production. An increasing part of the value added in the production of a final product is due to services. Many manufacturing firms are contracting out accounting, advertising, design, and other business services that were formally done in-house. Statistics show a transfer of jobs from manufacturing to services, where, in reality, production is becoming increasingly specialized.

Unit 5 - Are American blue-collar jobs being displaced by foreign workers?

The facts are troubling. During the past twenty years, imports of foreign goods into America have doubled as a share of GDP. Meanwhile, the wages for many blue-collar workers have stagnated, leading to declining standards of living for many workers. For the lowest 10% of wage earners in America, real wages fell by 13% between 1979 and 1989. Meanwhile, the wage gap between skilled and unskilled workers has widened significantly. The blame is being passed to foreign workers, who are taking away American jobs with their low-cost exports to America. When production does remain in the United States, domestic workers are forced to accept pay cuts to keep production costs competitive with low-priced foreign labor.

The Stolper-Samuelson Theorem

An economic theory, known as the Stolper-Samuelson theorem, predicts that international trade will lower the real income of factors of production that are relatively scarce in a country. In the United States, unskilled labor would be considered to be the relatively scarce factor of production, especially in comparison to most of the less-developed countries (LDCs) where the majority of the population has not attained the same level of education. With falling incomes of less-skilled labor in developed countries and rising wages of abundant low-skilled workers in the LDCs, in theory, international trade will lead to a convergence of wages between countries that trade.

Consider the example of the United States and Mexico, which along with Canada compromise the countries of NAFTA (the North American Free Trade Agreement), which practically eliminates trade restrictions between the countries. In comparison to Mexico, less-skilled workers are scarce in the United States, while skilled workers are abundant. The U.S. has a comparative advantage in the production of goods and services that require skilled labor, Mexico has the advantage in output produced by unskilled workers. According to the Stolper-Samuelson theorem, production in the U.S. will shift toward skill-intensive sectors and the wages of skilled workers will increase. In contrast, unskilled jobs will be transferred to Mexico, where the wages of unskilled workers will rise, eventually converging with the falling wages of unskilled labor in the United States.

As the wages of unskilled workers in the U.S. fall, the cost of producing goods by them should also decline, leading to falling prices in the market. If the Stolper-Samuelson theorem is extended, we should see a fall in the price of goods produced in the United States by unskilled workers relative to those goods produced in Mexico. However, the evidence is contrary to the theory, as the relative prices of goods produced by less-skilled workers in the U.S. have risen (correcting for exchange rates).

Take a look within

Perhaps international trade is not wreaking the lives of unskilled workers in the United States after all. With the fall in the wages of unskilled workers, the cost of hiring unskilled labor also declines. Over time, we would expect businesses to employ more unskilled labor as their cost decreases relative to other inputs such as skilled workers and capital. Yet the opposite has happened over time, as the ratio of skilled to unskilled workers employed in the production of goods and services in the U.S. has increased.

The evidence suggests that a major factor in decreasing the demand for unskilled workers is due to changes within industries, not foreign trade. The demand for unskilled labor has declined primarily as a result of changes in technology.

Consider the case of the timber industry and the protection of the spotted owl habitat in the Pacific Northwest region of the United States. Opponents of the Endangered Species Act blame the reduction in logging required to protect the habitat of the spotted owl as a critical culprit in the loss of jobs in the logging industry. However, statistics show that the displacement of timber industry jobs by technology is much greater than job loss due to reduced logging acreage. The impact on timber jobs caused by more capital-intensive production, such as the use of tractors to harvest trees and automated sawmills, has displaced many more workers than the spotted owl.

Structural Unemployment

It is likely that both domestic (technology) and external (international trade) forces play a role in the fall in the wages of unskilled workers. Presently, U.S. imports from low-wage developing countries only equals 2.8% of America's GDP. As international trade expands, so will this percentage and the Stolper-Samuelson theorem may become increasingly relevant. Combining the growing global economy with the rapid changes in technology that are occurring, it is likely that unskilled workers in developed countries will come under increasing wage pressures.

As less-skilled workers are increasingly displaced in America, the problem with structural unemployment is likely to balloon into a major social and political problem. How the United States deals with the redistribution of income from those gaining from these trends to those who are willing to work but are not needed, will be a test of the nation's future. Rather than relying on opportunistic cries for trade protection, the U.S. and other developed countries should ensure that its citizens have the education and skills required in our global economy.

Unit 5 - Welfare Reform - August 1996

In August 1996, President Clinton signed legislation to reform the current U.S. system of welfare benefits. The legislation is considered to be the most sweeping changes in the welfare system since the New Deal of the early 1930s. Here are some highlights and related issues.

State Management

Work and Time Limits

While largely abdicating the task of reforming welfare to the states, the federal government would require states to abide by a couple of new rules or risk losing federal funds:

         At least half of all adult welfare recipients in a state would have to be working -- not just enrolled in job-training programs -- or providing community service within two years of going on welfare.

         Requires states to cut off federal funds to people who had been on welfare for five years, although states could provide benefits or vouchers for items, such as diapers, out of other funds.

         Requires at least half of all single mothers on welfare to be working or in "working activities" by 2002 or a state will loose some federal funds; requires states to reduce benefits to individuals who refuse to work.

         In addition, the bill offers bonus payments to states that reduce their rates of out-of-wedlock births among welfare mothers. States would be allowed to deny benefits to unmarried teen-age mothers under 18.

         In all, states would get less money -- about $55 billion over the next six years -- than it is estimated they otherwise would have gotten from the federal government.

         Federal money available for the basic welfare program, Aid to Families with Dependent Children, would remain roughly the same, though AFDC would be replaced by a lump-sum grant to the states.

Target: Illegitimacy

Experts agree that young mothers who have children out of wedlock tend to stay on welfare longest. And their children are more likely to be have troubles in school and, later on, in achieving economic self-sufficiency. Thus, experts say, reduce illegitimacy rates and you have gone a long way toward a long-term fix of welfare.

But many conservatives say welfare encourages poor young single women to have children. Others reject this reasoning-- and remedy -- as simplistic, arguing that high out-of-wedlock birth rates are rooted in a host of much deeper social maladies, from unemployment to urban decay.

Other Changes

Loopholes Exist

Questions that come up include:

Small and medium-size businesses, which created 11.8m new jobs in 1992-96 while bigger companies were losing a net 645,000 jobs, are the key.

Copyright 2002, Jay Kaplan
All rights reserved
Last updated August 2002