Question

Please only answer the first question!

The OECD is a club of the most advanced economic nations in the world – based on living standards and per capita income more than absolute size. Newer members include Turkey, Mexico and Hungary. China and India are not yet members despite their vast populations. Currently the OECD has 32 members.

The 2009 OECD Employment Outlook discusses prospects for unemployment and possible policy responses. The evolution of unemployment depends on (a) the size of the shock, (b) the flexibility of the economy to respond and (c) the extent of support by government. In the worst previous postwar recession of 1973-76, OECD unemployment increased by half. By 2009, the OECD reckoned that unemployment would rise by 80 per cent - from 5.5 per cent to 10 per cent of the labour force - during 2007-10.

This analysis reflected the magnitude of the initial shock. Clearly, this would affect different countries differently. One way in which to assess which economies were most vulnerable is to estimate their capacity to absorb shocks through flexible labour markets that match potential workers and job opportunities more quickly. This is likely to depend on wage flexibility, labour market mobility, attitudes of trade unions and the extent of labour market regulation.

The figure below shows a measure of labour market flexibility based on labour market history during 2000-05. It plots the annual fraction of workers hired to new jobs or leaving existing jobs (by choice or dismissal) during the year. It shows that in Turkey, Denmark and the United States, half of all workers are changing jobs annually. In contrast, the countries with the lowest labour market mobility are Greece, Italy and Austria.

Annual fraction of workers hired or fired, 2000-05 (%)


Source : OECD Employment Outlook, 2009  
Econ 1110 Section D Case # 1 Winter 2018 3

Countries with greater job stability are probably slower to experience initial unemployment but, when unemployment does increase, they are also less successful at helping people out of unemployment back into work. Since there is considerable cross-country evidence that those in longer-term unemployment find it ever more difficult to reconnect with the labour market, in the medium run this fiscal burden of unemployment benefits is likely to be greater in countries with less flexible labour markets.

Governments provide two kinds of support. The first is measurable by the generosity of unemployment benefit, which has two dimensions – the replacement rate (the ratio of benefit to previous wages in work) and the number of years for which benefit is available. The table below documents considerable differences across countries.

In Norway and Belgium, with strong traditions of social democracy, unemployment benefit is generous both because it is high relative to wages in work and because it continues for at least 5 years after a spell of unemployment begins. French unemployment benefit is initially as generous but less so after year 2. The UK is considerably less generous in replacement rate, but entitlement continues undiminished over the 5 year period. In countries such as Japan, Greece and the USA, unemployment benefit is almost worthless after the first year in unemployment.

Duration of unemployment Year 1 Year 2 Year 5   Replacement rate (%) Norway 72 72 72 Belgium 65 63 63 France 67 64 31 UK 28 28 28 Japan 45 3 3 Greece 33 5 1 USA 28 0 0 Source: OECD Employment Outlook, 2009

The second aspect of state support for the unemployed are active labour market policies that enhance incentives, confidence and the ability of the unemployed to look for jobs. Even if the post-crash recession reflected a sharp fall in demand – for output and then for labour – it is important not to neglect supply-side policies that maintain the maximum labour market flexibility.

With the benefit of hindsight, the most puzzling features of the labour market since the financial crash have been (a) the relatively small increase in unemployment and (b) the disappointing performance of labour productivity. For example, UK unemployment was still only 8 per cent in late 2012. The US has also avoided double-digit unemployment and appeared to have resumed steady if modest output growth. Two explanations consistent with facts (a) and (b) are that (i) firms engaged in more labour hoarding in recession than in previous cyclical recessions, and (ii) that many workers who would otherwise have become unemployed took up part-time working or self-employment. The rise of the Internet allowed many people to embark on small businesses in the service sector.

Econ 1110 Section D Case # 1 Winter 2018 4

With long-term demographic trends also implying that pension schemes would face greater and greater financial strains, and with governments removing subsidies to pension contributions in an effort to retain fiscal solvency, it is also possible that some older workers simply retired while the going was good, rather than face a period of unemployment when rehiring of older workers was likely to be a tough prospect.


Questions on case study 23.2

1. The case study highlights the difference between two types of unemployment, namely frictional and structural unemployment. Explain these two types with examples from the case study.

2. With reference to the case study, explain how higher labour market flexibility can be less costly to both the unemployed and the economy.

3. Unemployment tends to fall during economic booms and rise in periods of economic recession. This type of unemployment is known as cyclical or demand-deficient unemployment. Explain what supply–side policies are and how they can be implemented to reduce unemployment.

Answer 1

" ... there is considerable cross-country evidence that those in longer-term unemployment find it ever more difficult to reconnect with the labor market, ..." - Frictional Unemployment.

Frictional Unemployment is nothing but the time lag between the transition of a person from one job or work to another. It is generally labor market turnover. In a standard way, it is the time between a person leaves one job and searches for the other.

" In the worst previous postwar recession of 1973-76, OECD unemployment increased by half. " - Structural Unemployment

Structural Unemployment occurs when some external factors affect the labor force in the economy. External factors can be anything like a change in technology or competition or maybe some government policy.