Government Policies For Reducing Equilibrium Unemployment Economics Essay

In practice, there always exists some level of unemployment even when the labor supply and labor demand are in equilibrium and is known as equilibrium unemployment. Equilibrium unemployment is always positive and may be structural or frictional in nature. The level of equilibrium unemployment is affected by all those factors that affect the ease with which the unemployed workers can be matched with the available positions and the factors that tend to increase wage rates even though labor is in excess supply in the market.

These factors may include unemployment benefit system, employment protection laws, barriers and restrictions on movement of labor, high bargaining power of unions, high interest rates, and high labor taxes. Reducing equilibrium unemployment requires a macro level effort from the governmental level in terms of policies that try to reduce structural and frictional unemployment.

Introduction

The Keynesian theory assumes that there is a maximum GDP level that can be achieved at a given time and at that GDP level, there will be no unemployment but in practice, there always exists some level of unemployment even at the equilibrium and is known as equilibrium unemployment (Sloman & Sutcliffe, 2006).

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Equilibrium unemployment is always positive and exists because of the time take by new workers to find their first job, current workers to switch from one job to another (frictional unemployment) and because of a mismatch between structure of the labor force in terms of their skills and the demand for labor (structural unemployment) (Lipsey & Chrystal, 2007).

The structural and frictional unemployment both contribute to equilibrium unemployment which requires government action for its reduction. The unemployed agents in the economy have the option to pick between accepting employment and continuing their search until they find a suitable employment (Gomesa, Greenwood & Rebelo, 2001). Also known as the natural rate of unemployment, the phenomenon can be explained with the help of the following graph:

http://www.economicshelp.org/images/macro/Natural-rate-unemployment.jpg

Figure : Equilibrium Unemployment [1] 

ASL is the labor supply; ADL is the demand for labor while N is the total labor force. The difference between the labor force and labor supply, represented by the red line is the rate of unemployment or the equilibrium unemployment.

Determinants of Equilibrium Unemployment

The level of equilibrium unemployment is affected by all those factors that affect the ease with which the unemployed workers can be matched with the available positions and the factors that tend to increase wage rates even though labor is in excess supply in the market (Layard, Nickell & Jackman, 2005).

According to this criterion, the factors that will directly affect the equilibrium unemployment rate include the unemployment benefit system, In case the benefit system provides coverage for a long time and is distributed fairly, employees may lose their willingness to search for employment.

Another factor is employment protection laws, in case these laws are strict, the firms may be very cautious and slow in filling vacancies and hence the process of finding employment becomes longer. However these laws also have a positive impact in reducing equilibrium unemployment because they help reduce voluntary separations from jobs.

At times, there are barriers and restrictions on movement of labor from one region or occupation to another. As these restrictions make it more difficult to match unemployed with vacancies, they add to the increase in equilibrium unemployment.

High bargaining power of unions in negotiating wage rates can drive the wage rates upwards and create a mismatch between skill level and the compensation. As a result of this, firms may hire fewer workers and increase equilibrium unemployment. High interest rates may also inhibit firms to expand while also restricting future investment therefore reducing job prospects and increasing equilibrium unemployment.

Some other factors that may contribute to equilibrium unemployment are the labor market policies of the government, real wage resistance and high labour taxes.

Government Policies

As evident from the above discussion, reducing equilibrium unemployment requires a macro level effort from the governmental level in terms of policies that try to reduce structural and frictional unemployment. One policy that helps reduce equilibrium unemployment is to encourage the workers and labor force to adapt to change.

In this way workers continuously upgrade their skill set and there is a movement of workers across industries, regions and occupations depending on the demand for labor. Similarly, subsidies can be offered to firms setting up their operations in areas where unemployment is high. This approach directly targets the structural unemployment and aims to reduce the mismatch between the structure and demand for labor, this policy was quite successful in Sweden (Lipsey & Chrystal, 2007).

In addition to this, in order to keep the unemployed from becoming complacent and becoming reliant on unemployment benefits, these benefits for the unemployed can be reduced while giving more benefits for those who have a low paying job or have just recently gotten a job. In order to target frictional unemployment, the government has to reduce the time taken to search for a job.

The government can set up placement facilities that maintain a database of workers and their skill sets and the vacancies available and helps people find jobs according to their skills and qualifications and help the unemployed in finding temporary jobs till they find a suitable position (Miller, 1994).

Similarly, artificially high wage rates need to be cured as well, the government needs to arbitrate the rights of the firm versus the rights of the workers and one party should not be able to exploit the other through stricter legislation for unions.

The government can also offer lower interest rates in areas stricken with high level of unemployment so that investment thrives in that area and new businesses are set up, increasing employment opportunities for the unemployed. The government can also define wage rates for various skill level and categories, making negotiations by unions to artificially increase wages by the unions meaningless.