Unemployment: a Challenge During Recession

By Shyam Paliwal

As the world faces the worst economic crisis in years, the most formidable problem is the one of rising unemployment. In this article I would like to look at the causes of unemployment.

In a free market system the employers compete for people who are free to work for anyone. However, the markets are generally imperfect. There are trade unions and owner associations that interfere with the employment of labor and create imperfections in the competition.

If a particular manufacturer or business association has a monopoly, then its profit margins are bound to be higher and the real wages of workers will be lower. These monopolists charge a higher price and produce less output and thus set a lower level of employment.

In order for unions to accept lower wages, unemployment has to be high. Therefore, a less competitive market leads to a lower rate of employment.

On the other hand if unions are powerful and have a monopoly, they can demand and get higher wages. This puts downward pressure on the profit margins of a company.

The reduced margins will lead them into hiring less workers and will again lead to a rise in unemployment. Thus in both cases when power resides completely on one side, there is a rise in the unemployment rate.

The best chance for maximum employment would be the possibility of free and fair competition between employers and between employees. Competition between the employed and the unemployed is also critical in maintaining a low rate of unemployment.

Strong trade unions, high benefits, skill mismatches and high taxes all reduce the competition between the employed and the unemployed and keep unemployment rates high.

Governments all over the world take various steps to reduce the unemployment rate. These include employee protection laws, which make it difficult and costly for firms to fire people and thus reduce the rate of unemployment.

But the most important question is whether these laws really work. Actually, these laws adversely affect the probability of the unemployed finding a job.

These laws make part-time workers less attractive to employers and the absence of such jobs usually reduces female participation in the labor force. Strong employee protection laws actually increase hiring costs and reduce demand for labor.

These laws therefore benefit people who are employed at the cost of those without jobs. Why would a government enact laws that benefit the employed at the cost of the unemployed?

The answer lies in political considerations. As the majority of people in any given country are employed, a democratically elected government is bound to take care of them.

Another government policy that is perceived to reduce unemployment rate but actually ends up increasing it is unemployment benefits. If unemployment benefits are high and last for a long time, they increase the monopoly power of those employed. These benefits reduce the motivation to look for new jobs.

Secondly, they also reduce the cost of being unemployed and make those employed more aggressive in their wage demands. This makes manufacturers reluctant to hire new workers and has a negative effect on the total number of jobs actually available.

As the demand for goods falls during an economic downturn, profit margins are squeezed and manufacturers are left with overcapacity of labor and machines. This leads them to take cost cutting measures such as reducing their workforce.

The employees respond by taking shelter with stronger unions. This can lead to a complete halt to production as a result of strikes and the resultant bankruptcies, which benefit neither the manufacturers nor the laborers.

Therefore, there is a greater need to enact labor market reforms, reduce the power of unions and increase the role of market forces. This will stimulate labor market turnover and reduce unemployment.

The only system that has effectively raised the living standards of a society is the free market system with minimum restrictions on trade and commerce. In such a system the unemployed compete effectively with the employed for jobs.

This competition is critical in maintaining a low rate of unemployment. Another approach used to lower the unemployment rate is the active labor market spending by the government.

This includes expenditure by the government on assisting the unemployed in job searching, improving the flow of information about jobs, subsidizing the creation of jobs for the unemployed, offering loans to individuals willing to start their own business, retraining people and assisting to acquire new skill set.

The unemployment rate is a key economic indicator. As the number of the unemployed grows, people start to spend less. This in turn affects the manufacture of consumer goods. A recent rise in consumer spending in the United States is a positive sign.

This shows that people have started to spend and many people believe that recovery is around the corner. However, for any real recovery to occur the unemployment rate has to be controlled and taxes reduced. This will put money in people's hands.

Shyam Paliwal is an international investor and an economic advisor. He now resides in Haeundae, Busan. He can be reached at shyampali@gmail.com.