Structure of State Economy and Unemployment

Chapter One

Unemployment is one of the most essential indicators of economic development in any financial system as it provides insights of the labor market operations as well as the percentage of the human capital, unutilized in the productive process. Economic structure and unemployment in most countries are interrelated since unemployment affects the GDP and productivity of the country. When the rate of unemployment is high in a country, the purchasing power of the citizens will be low (Tansel, Dogan, & Hakan, 2008). This will lower the living standards of the citizens, which is a major determinant of economic growth and development of a country. Decrease in the purchasing power of the citizens will reduce the production of the industries, which in turn will cut on the cost of production. Labor is one of the core factors of production and the cost of labor in the production process is high for the organization. Therefore, when the organization decides to cut cost of production they cut cost of the employed labor by reducing the workforce. Therefore, unemployment and economic productivity in a country represents a vicious cycle, which the economic structure should avoid. There are various types of unemployment in the economy. These include cyclical unemployment, voluntary and involuntary unemployment, and structural unemployment. There are many causes of unemployment in the economy, such as imperfect information of the labor market. Imperfect information may cause frictional unemployment as people remain jobless when there are available jobs in the job market. Voluntary unemployment is the case where people are unemployed due to the low wages offered by the available occupations in the job market as they search for better opportunities. Structural unemployment is caused by structural changes of the organization, which causes a layoff of some employees from the organization. Unemployment is not only disastrous to an individual and society, rather the whole economy is affected by unemployment. High unemployment rates weaken the economy due to decreased productivity and manufacture of the country, which in turn affects the GDP. Flexible economic system facilitates occupational mobility as employment structures keep changing from time to time.

Purpose of the Study. Employment is an important indicator of finincial development in any economy. Understanding the vicious cycle of unemployment in the economy will provide insight of its main causes as well as realizing the effects of unemployment on such economy. This study will be essential since it is also aimed to make important conclusions that can be used for decision making in a country. As an important indicator, the growth of a country’s unemployment is one of the most variable aggregates in the economy. Most of the aggregate variables in the economy are interrelated, thus exploring unemployment will assist in evaluating its effects on other variable of the economy. In most capitalist economies, majority of the individuals earn their income through employment; however, not all individuals will be able to secure employment at a given time. In capitalist economies, resources are held by a few individuals, and a large number of people depend on employment as a source of income. Therefore, in most of these capitalist economies they have fluctuating unemployment rates of 3% to 15%, which have been used as normal rates of unemployment (Hammer, 2003). Various economists from different schools of thought have explained the possible causes of unemployment. For example, Keynesian economists argue that unemployment is a vicious cycle resulting from insufficient demand of products and services in the economy. Some economists have used the structural changes as a major source of unemployment. However, most of the neoclassical economists argue that unemployment is caused by labor market rigidities such as minimum wage requirements, taxes and other regulations. In addition, other economists argue that the majority of the unemployment cases occur due to voluntary choices, while others blame globalization and disruptive technologies.

Objectives of this Study

  1. Establish effects of unemployment on economy
  2. Determine the prevalent causes of unemployment in the economy
  3. Establish measures that can be taken to reduce unemployment in the economy
  4. Establish effects of unemployment on the GDP economy

Research Questions

  1. What are the causes of unemployment in the economy?
  2. What are the effects of unemployment in the economy?
  3. How can unemployment in the economy be reduced?
  4. How is GDP affected by high unemployment levels?

Significance of the Study. Continuous progress is an important aspect of the economy. Unemployment acts as a significant indicator of the economic development. The more people are unemployed, the lower is the purchasing power, as well as the living standards of the nation. Establishing the causes of unemployment will be essential in the policy formulation of measures that can be taken in a country to reduce the rates of joblessness. Understanding the effects of it in various sectors of the economy is also essential as it will establish the impacts of unemployment on the general economic development.

Hypothesis

  • Persistent unemployment affects the potential output of an economy i.e the GDP.
  • Unemployment affects the general price level of products due to reduced purchasing power.

Chapter Two

Literature Review

This chapter will review literature of the interrelationship between the economy and the unemployment rates. Since redundancy is an important indicator of economic development, this literature review is aimed to define the causes and effects of unemployment, and remedial actions that can be taken against it.

Causes of Unemployment in an Economy. Labor force in a country consists of all individuals who have reached employment age, and are working or searching for a job. When there is a full employment, the economy experiences natural rate of unemployment and its economic output. However, natural rate of unemployment varies from one country to another since the employment laws and labor market conditions are different. For example, the natural rate of unemployment is high in Europe as compared to the United States. In Europe, there are higher minimum wage laws as compared to the United States. In addition, most of the labor unions in Europe are stronger than in the USA, hence they have high bargaining power in terms of higher wages as compared to the USA (OECD, 2006). In most European countries, the governments also support the unemployed workforce through welfare payments longer as compared to the United States. Therefore, unemployment conditions vary from one country to another depending on the policies and laws in regard to employment in such countries. There are various factors that may cause unemployment in a country. These include frictional unemployment where people are switching from one job to the other, or become new entrants into the job market. Frictionally unemployed people are short-term unemployed while they are searching for jobs. Other job seekers may get imperfect information about availability of jobs in the labor market. Although opportunities of employment are available, such people lack information of the availability of such opportunities. This can be caused by geographical immobility of labor; the unemployed may be seeking for a place of work only in their local area (Galgóczi & Watt, 2009). The problem of employment trap has also been a major cause of joblessness in a country. This is a situation where the unemployed workforce refuses to work at prevailing wage rates if the income tax and benefit system will reduce their net changes of income. Structural changes are other major causes of unemployment as technology improves and firms adopt capital intensive methods of production. Human capital is substituted with capital labor, leading to reduction of the employed workforce due to layoffs carried out by organization (Breullard, 2007). The demand for labor also decreases while making the mismatch of the required skills and the new job opportunities available. In the market-oriented economies, structural changes are a constant phenomenon as organizations increase their profitability and competitiveness. Increased globalization and technological changes has enhanced the demand of highly skilled workers in order to adapt new changing technologies. The cyclical economic changes significantly affect the rates of unemployment. Deficiency of demand in the economy reduces firms’ productivity, which in turn reduce their production and cut the cost of it. It is also referred to as Keynesian argument of unemployment. The economy undergoes various phases of boom and recession. During recession, there is demand deficiency and firms reduce their production as well as the cost for every product. Since labor is a major factor of production and a major cost driver, firms reduce their demand for labor and even dismiss some labor force. This action is closely connected with the reduction of the output cost. The economy operates below full capacity causing a fall in the real national product, which results in the total employment. Some individuals are also unemployed due to their free will when a worker refuses an employment offer at the existing wage rate. The economist, Arthur Okun, explained the relationship between the rate of unemployment and the level of GDP. According to Okun’s law, GDP grows at the rate of 3% when the levels of unemployment are natural (Tansel, Dogan, & Hakan, 2008).

Effects of Unemployment in the Economy. Persistent unemployment is an indication of market failure since it denotes the resource wastage. Resources in the country are not efficiently utilized, and the output gap deviation may be too large. The output gap is the difference between the real production in the economy and the potential production. For example, during a recession when the economy is contracting, real output will be reducing and economy will operate below the potential output. In addition, employees’ redundancies cause wastage of resources used for the sake of training and educating progress of the workers. The longer an employee stays out of work, the higher is the loss of acquired skills and the lower is the motivation. Therefore, long-term unemployment has negative effects on the economic growth (Mankiw, 2011). In addition, it affects government spending since the government spends more on welfare programs to cater for the unemployed workforce. Lack of employment also affects the government revenues because the increment of unemployed people causes a reduction of income tax collected by the government. However, zero unemployment is unachievable in a free market economy, consequently there is always a natural rate of employment. When the unemployment rate falls below the natural rate, there is an upward pressure on the wages to be increased, which places the economy at the risk of inflation. The natural rate of unemployment has been referred as the non-accelerating rate of unemployment (NAIRU) (OECD, 2006). Persistent unemployment also affects the society in general as the sources of income are curtailed; there are high chances of rising social crimes in the economy. Economic hardships cause financial and psychological problems to the unemployed individuals. The economy is also affected by high unemployment since the production is below potential productivity, and the GDP of the country falls below the potential GDP. In addition, persistent unemployment causes a fall of necessary income and creates wealth inequalities in the world of economy. Income and wealth distribution have been major social and political problems for most of the economies (Breullard, 2007).

Remedies of Unemployment. The issue of unemployment has been a common phenomenon in for the majority of global economies, which took various remedial actions against the deficiency of jobsites. Factors affecting unemployment levels vary from one country to another depending on policies adopted to deal with the unemployment rate in such economies. Therefore, remedial actions taken by different countries also have diverse peculiarities. In addition, governmental remedial actions are limited since policies adopted against inflation can be costly and result in high opportunity cost. However, the adopted policies affect either the demand or the supply side of the economy. The supply side policies applied to reduce rates of unemployment include reduction of occupational mobility. This can be achieved by improving education and training to ensure that the unemployed people have special skills to take the available job opportunities in the global market. Tax and benefit reforms, which facilitate reduction of welfare benefits increase the incentives of the unemployed people to take the available job opportunities at the prevailing wages. The government should facilitate reduction of marginal income tax rates for people earning low incomes. These include various other fiscal and monetary policies, which can influence and control the frictional unemployment. Fiscal policies are used by the government to increase the economic output lowering unemployment through reduction of taxes and increasing output. On the other hand, monetary policies increase the money supply, hence boosting output and lowering the levels of unemployment. There are different sectors of the economy such as banking and finance, manufacturing, insurance, education, health, transportation, distribution, hotels & restaurants, transport and communication, construction, agriculture, mining electricity, gas and water. Unemployment can result in the transfer of employee from one sector to another, causing changes in the job pattern.

Chapter Three

Methodology

Research Design. This chapter evaluates all the methods involved in the research process. An evaluation will be done on the UK economy and the relationship with the rates of unemployment in the country. The data to be used in this study will be secondary. It was sought from the government databases, Internet and journals. These will include information and data from labor unions on unemployment levels in the country. Methodology of evaluating the effects of unemployment on the economy GDP will be evaluated on a theoretical and empirical framework.

Theoretical framework. Unemployment rate is one of the economic indicators of economic development. Other indicators include the consumer’s price index, which measures the rates of inflation in a country, ratio of government expenditure as well as the physical capital. Therefore, a theoretical framework will express the GDP as a part of the following factors affecting the GDP of the country.

This model has been found establishing the relationship of various factors affecting the GDP of an economy. This will assist in establishing the relation of unemployment with the economic production and the GDP in general. The theoretical model will also facilitate the development of the empirical model. In the theoretical model, GDP is a factor of the error in approximation of variables, previous levels of GDP, unemployment rates, physical capital, government expenditures and consumer price index. GDP is an increasing function of the rates of employment, physical capital and government expenditure. However, increase in the consumer price index may affect the GDP relatively depending on the existing economic conditions. For example, there are normal levels of increase in the consumer price index. They do not affect the growth of GDP negatively. In addition, unemployment is related to the consumer price index. Thus, if the unemployment levels fall below the natural rate, there will be an increasing pressure on the prices of products.

Empirical Framework. The empirical framework will employ regression model in explaining the relationship between different variables. Supplementary model will be employed in developing the regression model in this framework.

GDPt = E + GDPt-1 + Lt + CPIt + Kt + Gt

GDPt – GDP in the current period

E – Error in measurement of variables

GDPt-1 – GDP in the previous period

Lt – rate of unemployment in the current period

CPIt – consumer price index in the current period

Kt – physical capital in the current period

Gt – ratio of government expenditure

Measurement of the Variable. The model has been developed to evaluate the relationship affecting the GDP of an economy. The major objective of developing the model is to establish the relationship between unemployment and the GDP growth and development. GDPt in the current period will be measured as a factor of the previous levels of GDPt-1, rate of unemployment, consumer price index, physical capital and government expenditure. The major objective will evaluate the relationship between unemployment rates with GDP and other factors in the economy.

Data labor force surveys (LFS) database of the UK.

The following data was collected from the unemployment rates in the UK from 1996 to 2005 showing the trends of the employment of the UK labor market.

Year unemployment rate in %

Employment changes in the UK economy

1990

000s

2005

000s

1990 – 2005

% change

Financial industry

4442

6097

27.1

Health and education

6470

7790

16.9

Hotel industry

6463

7078

8.7

Transport & communication

1680

1839

8.6

Construction

2357

2099

-12.3

Agriculture

641

446

-43.7

Manufacturing

5203

3383

-53.8

Mining gas & water

398

171

-132.7

1996                                                                    8.3

1997                                                                    7.2

1998                                                                    6.3

1999                                                                    6.1

2000                                                                    5.6

2001                                                                    4.9

2002                                                                    5.2

2003                                                                    5.0

2004                                                                    4.8

2005                                                                    4.7

Source: UK Labor Market Statistics

The table above represents changing patterns of UK job market. This shows that UK has developed policies that have been adopted to reduce the overtime rate of unemployment in the country. The levels of unemployment have been reducing overtime following a special tendency the country has adopted.

The structural changes in the UK can be attributed to the technological improvement and increased globalization. There has been a great shift of the traditional methods of production in the economy such as industrialization, which was reduced through the development of technology. Adoption of technology in the service industries such as banks and insurance companies has led to increased employment in the industry. The agricultural sector employment has been also reduced in the current global economies as well as the mining industry due to introduction of modern technology. The global labor market has increased demand for skilled and competent labor. This has led to the increased demand of the education and the improved employment in the education sector.

Chapter Four

Findings and data analysis

The main objectives of this inquiry were aimed to establish the most apparent causes of unemployment as well as to take remedial actions against the joblessness. In addition, central objective of the research was to establish the relationship between the rate of unemployment and economic growth and development in terms of GDP. Unemployment is an important determinant in the rate of economic growth as well as an imperative indicator of economic recovery. Persistent high levels of unemployment reduce the economic development of a certain country. It is termed as a market failure since the economy is not employing all the resources in the production process. The model explained the theoretical framework and the empirical framework used to expose the relationship between the GDP and the various factors affecting it. Unemployment is among the major determinants of economic development. High levels of unemployment affect the total number of production, since the economy is not operating to the fullest and not all resources are utilized effectively. Moreover, high number of unemployed individuals increases government expenditures on welfare programs. The insurance schemes adopted to cater for the unemployed people have also been increased. Therefore, as unemployment increases in an economy, the GDP in such an economy also shifts into low gear. Consumer price index play an integral part in it as it measures the rates of inflation and unemployment. The problems of successful employment only worsen when the lack of workplaces falls below the natural rates of unemployment. There is an increased pressure on the general price level of products. Therefore, there are natural rates of unemployment in an economy, which are maintained if the joblessness levels fall below such natural rates and provoke an increase of the consumer price index. The pattern of employment in the UK labor market indicates a shift from the traditional dependency of agriculture, manufacturing and mining to a modern approach of technology adoption in the production process. For example, the finance industry composing of the financial institution, banks and insurance industry has adopted modern technology, hence absorbing most of the skilled workers in the job market. The demand of skilled has increased the demand of the tutors as an education institution tends to provide the development of skills and knowledge in the global market. This has led to demand of more labor in education and health sector in the UK. Hotel industry has also experienced development and a shift of the statistics collected from 1996 to 2005. The traditional industry has experienced a reduction of the total labor employed in the sector. This can be attributed to the structural changes in the economy and adoption of capital intensive methods of production. This has led to the increased dismissal among the non-skilled employees from these sectors of the economy. They include agricultural farming, construction industry, and manufacturing industry, which have taken the lion share employment opportunities throughout its history in the UK.

Chapter Five

Discussion and Policy Implications

The information and data reported above show that unemployment and GDP are highly interrelated along with the consumer price index. Persistent unemployment in the economy affects both productivity of the country and economy of GDP. Various monetary and fiscal measures have been taken in dealing with high rates of unemployment in the economy. Monetary measures increase the money supply, thereby advancing the purchasing power of the people. The demand of products increases, hence firms expand their production capacity to meet the growing demand of products. Finally, we can observe the increase of the demand for labor and the decrease of unemployment rate. The fiscal measures include incentives through reduction of tax as well as benefits levied from certain low income in order to encourage the participation of individuals in the job market at the prevailing wages. The development of technology and increased globalization has led to a shift of the global labor market. This has caused increased demand for a skilled workforce because of adoption of modern technology and capital intensive methods of production. Enhanced productivity urgency of the organization has also induced better rates of unemployment in the global market since more capital intensive methods of production were provided in order to reduce human capital. Sectors such as industrialization, construction and farming were labor-intensive and had the lion share of job opportunities in the market. However, this has changed in the global market as the majority of organizations are market-oriented, always employing capital intensive methods of production rather than human capital.

Conclusion

In conclusion, unemployment is an important aggregate economic indicator of the level of economic development. There are various types of unemployment such as frictional unemployment, structural unemployment and seasonal unemployment among others. These are caused by various economic and social factors. For example, people are unemployed when they leave one employment and start searching for other job opportunities or voluntary unemployment when the individual refuses to work at the prevailing wage rate. In the UK, the employment trend for the last ten years has been consistently improving with the reduced rate of unemployment. This has been fulfilled owing to various policies developed by the government to reduce the rates of unemployment. The global labor market has also experienced tremendous changes with increased globalization and use of information and technology.

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