Unemployment and Supply-Side Policy in the UK

1. Introduction:

Unemployment increased substantially across the world after the sharp oil price rises in 1970s and the collapse of the fixed exchange rates system. But unlike many other parts of the world, unemployment in many European countries never returned to its low levels seen during the golden age after the Second World War. Unemployment has generally been shown to have long-term negative consequences on the individual level, even after reemployment. These include considerable and sustained income losses among reemployed workers. In the US, for example, the estimated loss in income of those re-entering employment after a period of unemployment – relative to those without unemployment experience – is between 10% and 25% (Fallick, 1996). The figures for the UK are estimated to be somewhat lower, at between 6% and 10% (Arulampalam, 2001; Gregory and Jukes, 2001).

As a result, since 1970s one of the major issues in macroeconomics has been the extent to which low output and high unemployment are caused by deficient demand and how far they are the result of supply-side factors such as: high real wages, unemployment benefits and so on. Many of these supply-side factors involve arguments about the nature of the labour market.

The question underlying most discussions of these problems is why did European unemployment remain persistently high? The standard explanation is that industrialised economies became more unstable and more frequently subject to shocks. Other questions rises also are, what cause that unemployment, how much unemployment is due to supply-side factors and why countries have different growth level of unemployment?

This essay will start by outlining in brief both the causes for unemployment in general and the supply-side policies especially for labour market. Then illustrate what cause the European unemployment crisis in general during the last two decades and how UK government and policy makers’ responses to it. Finally, set up the conclusion.

2. The causes for unemployment:

In a modern economy unemployment has a variety of causes. Some of them relate to the general level of economic activity, others are the result of a failure of the labour market in an economy to work optimally.

Among the main types of unemployment we can consider:

•Real wage unemployment

•Demand deficient unemployment (cyclical)

•Frictional unemployment

•Structural unemployment

-Real wage (classical) unemployment: is a form of disequilibrium unemployment that occurs when real wages for jobs are forced above the market clearing level. Classical unemployment is thought to be the result of real wages being above their market clearing level leading to an excess supply of labour.

As demonstrated in some research, that a large part of the rise in unemployment after the first oil shock have been classical unemployment, caused by high real wage rates. In the late 1970s Europe was experiencing this type of unemployment (classical unemployment), which explain why European policy-makers were concerned with keeping wages down as one solution.

-Demand deficient (or cyclical) unemployment: is involuntary unemployment due to a lack of aggregate demand for goods and services. This is also known as Keynesian “demand deficient” unemployment and is associated with the transition of the economy through the business cycle.

As the economy recovers from a downturn, the expectation to see a decline of cyclical unemployment will raise. This has certainly been the case in the UK over recent years as the recovery of output from the early 1990s.

-Frictional unemployment: is transitional unemployment due to people moving between jobs: For example, newly redundant workers or workers entering the labour market (such as university graduates) may take time to find appropriate jobs at wage rates they are prepared to accept.

Fractional unemployment is the major forms of unemployment exist in UK, but not in extremely high amounts. Some of the frictionally unemployed may choose not to accept jobs if they believe the tax and benefit system will reduce significantly the net increase in income from taking paid work. The Government try to minimise the amount of search unemployment affecting the economy.

-Structural unemployment: occurs when people are made unemployed because of capital-labour substitution (which reduces the demand for labour) or when there is a long run decline in demand in their particular industry.

Structural unemployment exists where there is a mismatch between the labours skills and the requirements of the new job opportunities. Many of the unemployed from heavy manufacturing industry have found it difficult to gain re-employment without an investment in re-training. This problem is one of occupational immobility, that lead most governments to focus in reduce long-term unemployment by increasing the human capital of the unemployed and improving their employability.

3.Supply-side policy:

Supply-side economic policies are mainly microeconomic policies designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster rate of growth of real national output. It often helps to explain why it is that some countries grow faster than others.

Supply side policies for the Labour Market:

These policies are designed to improve the quality and quantity of the supply of labour available to the economy. They seek to make the labour market more flexible so that it is better able to match the labour force to the demands placed upon it by employers in expanding sectors thereby reducing the risk of structural unemployment.

An expansion in the UK’s total labour supply increases the productive potential of an economy. That expansion in the supply of people willing and able to work can come from several sources for example: encouraging older people to stay in the workforce; a relaxed approach to labour migration and measures to get non-working parents to actively look for work.

Income Tax Reforms and the Incentive to Work:

This policy is one of the most important policies designed to improve the quality of the supply of labour available to the economy. Economists who support supply-side policies believe that lower rates of income tax provide a short-term boost to demand, and they improve incentives for people to work longer hours or take a new job, because they get to keep a higher percentage of the money they earn. In UK, attention has focused on lower income households. In the mid 1990s, a lower starting rate of tax (of 10%) was introduced.

Evaluation of the UK’s Supply side performance:

In general the supply-side of the British economy has improved over the last two decades years. Its product and labour markets are more flexible than where was a decade ago.

Although, other countries signs that the underlying rate of economic growth has improved above 2.5% per year (have a faster rate of growth of potential output), UK’s unemployment falling and continued low inflation, that suggesting an improvement in the trade-off between these two important macroeconomic objectives. Moreover, The UK labour market is seen as one of the most flexible among leading economies, with a rising level of occupational flexibility of labour.

After understanding the different causes for unemployment and the role of supply-side policies in general, let’s interpret the European unemployment experience and how UK considered as one of the four success countries in Europe next to Denmark, Netherlands and Ireland.

4. What is different about the European Unemployment Experience?

Two factors differentiate unemployment in large European countries from unemployment elsewhere: its persistence and the behaviour of unemployment flows. Unemployment in major European countries increased in two dramatic steps following the first and second oil shocks. However, high unemployment has persisted despite a reversal of many of the factors that have been linked to its rise.

Although, unemployment in the US, UK, Germany and France rose rapidly after the 1979 oil price shock, there has been a dramatic difference between the US and European unemployment experience since the end of 1982, when US unemployment began to fall. By 1987 it had returned to approximately its 1980 level, and it has since come down significantly more.

The level of unemployment in the UK rose steeply in 1981-2, then somewhat more slowly from 1983-6, and has declined since mid-1986.

In Germany, however, the post-1979 rise continued sharply to 1983, and has since remained at this level.

French unemployment has risen rather steadily throughout the period. The question here is, Why?

Changes in unemployment policies and social protection in each country play a key role in these differences. In UK, the supply-side approach in the 1980s emphasized deregulation of the labour market, cut backs in benefits for unemployed, weakening the influence of trade unions people and greater pressure on unemployed people to move into paid work, have a positive impact on labour market participation.

– Trade Union:

The trade union effect will be small in the total economy if there are many labour markets. If the total labour supply coming from the individual union members exceeds the total labour demand of the firms at the wage rate chosen by the union, then there will be unemployment. In other word, there will be individual workers who would like to work at the going wage rate but cannot find a job. The presence of these unemployed workers should be expected to exert a downward pressure on the wage rate.

The aims of the British Employment Department are ‘to support economic growth by promoting a competitive, efficient and flexible labour market’. The main reforms in support of these policies have been the weakening of trade unions and the relaxation of laws regulating employment and wages. As a result, UK trade union membership declined from 52% to 27% of the labour force between 1979 and 1995.

– Unemployment Benefit:

Many labour market researchers tend to attribute the consistently high rates of unemployment in almost all European states to their overgenerous systems of unemployment insurance. The economic literature identifies several ways in which generous benefit payments inhibit the reduction of unemployment. One central mechanism is that receipt of unemployment benefits increases the reservation wage of unemployed individuals, which in turn lengthens individual periods of unemployment and hence raises the unemployment. (As illustrated in Figure1).

Figure1: Wage offer distribution

Pop

Reservation wage Productivity

= (W/P)

Increase in average wage

The new permanent unemployment level

In that case UK policy’s makers decide to have low employment insurance compared to other countries to avoid unemployment benefit. By 1994 UK scored lowest legal protection among EU countries and alongside the US (in a composite index of labour market standards, covering regulation of working time, minimum wages, employment protection, employee representation and fixed-term contracts).

– Welfare to Work:

UK set a number of regime for unemployed people to encourage them to work such as:

Youth Training.

Emphasis on individual counselling, designed to improve motivation by making clear that benefits will not be available indefinitely and to build self-esteem and also to attempt to ensure that placements and training are appropriate to individual needs.

Opportunities to participate in employment are also to be enhanced through an expansion of child-care provision. UK government encourage schools to provide pre-school classes for 3 and 4 year olds (the compulsory entry age is 5). By 1998 the figure had risen to 60% of 3 and 4 year-olds were in school instead of 20% in 1970. etc

5. Conclusion:

This essay cover three main topic: the four types for unemployment and what causes each. Then the important of supply-side policy in represent the economy improvement in any country. Finally, the European unemployment crisis and how UK policy makers response to it and be one of the four success countries in Europe.

To sum up, understanding the causes of unemployment is the first stage to eliminate its impact, since it will help to identify the needed supply-side policy. The main thrust of British labour market policy is clear and well identified the unemployment problem which leads the country to fast recovery than others.