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Structural unemployment
High levels of unemployment indicate that the labour market isn’t working properly and that structural problems are stopping it from reaching equilibrium. The labour market is in equilibrium when the quantity of labour that firms want to hire is equal to the quantity of labour workers want to supply.
We illustrate this situation in Figure 3-2:
Demand curve (D): How much labour firms are willing to hire at different wage rates; the lower the wage rate, the more labour firms want to hire.
Supply curve (S): How much labour workers are willing to supply at different wage rates; the higher the wage, the more people want to work.
© John Wiley & Sons
Figure 3-2: Labour market equilibrium.
Where supply and demand meet represents equilibrium in the labour market. Here, the amount of labour supplied (q*) is exactly equal to the amount of labour demanded (also q*). Notice also that the wage rate needs to equal w* in equilibrium.
Several reasons can prevent the labour market from reaching equilibrium:
Minimum wage: Sets a legal minimum that workers must be paid. For most workers it’s not binding – they’d earn more than the minimum wage in any case – and so the minimum wage has no impact on them. But for some workers the minimum wage is binding – their equilibrium wage is lower than the minimum. For these workers the minimum wage has an impact, both positive and negative:
The positive impact is that low-paid workers who find work are paid better.
The negative impact is that unemployment increases (see Figure 3-3).
Figure 3-3 shows that the minimum wage has been set at wm, which is higher than the equilibrium wage rate. Now, more people want to work (qs) than firms want to hire (qd) leading to an increase in unemployment for this group of workers of (qs – qd).
Instead of having a minimum wage – which is likely to increase unemployment, especially for those with the lowest wages – many economists think that a better idea is to directly give poor people money. This is because trying to redistribute by having a minimum wage increases firms’ labour costs and reduces the number of workers hired, increasing unemployment. Ideally, you want firms to pay the correct equilibrium wage (which reduces unemployment). If the government is worried that this figure is too low, it can directly redistribute to those people using the tax system.
Powerful unions: Trade unions are important organisations that help to protect workers from unfair treatment at work. What worries economists is when a union is so powerful that – through industrial action (striking or threatening to strike) – it’s able to raise significantly the wages paid to workers above the equilibrium level. Much like the binding minimum wage shown in Figure 3-3, this action increases unemployment.
Economists point out that unions that successfully increase wages above the equilibrium level benefit insiders (union members) to the detriment of outsiders (people who’d like to work in the industry but can’t). Ideally, in a market economy, union industrial action isn’t necessary to maintain workers’ wages. Instead, firms competing with each other to hire workers ensures that workers are fairly paid (and unemployment is kept low). Any firm not paying the market rate soon finds itself in trouble because a large fraction of its workforce leaves.
Too much regulation: Some regulation of the labour market is a good thing – for example, making sure that firms provide a safe working environment. Too much regulation, however, can significantly add to the cost of hiring workers. Some regulation can even hurt the people it intends to help. For example, making it very difficult to fire workers may
be intended to keep unemployment low by making firings rare, but doing so is likely to make firms think twice before offering someone a job and may instead make hiring rare! Ironically, having less regulation and making it easier for firms to ‘hire and fire’ could reduce unemployment.
© John Wiley & Sons
Figure 3-3: Minimum wage and unemployment.
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