Causes of unemployment and solutions

                                   Causes of unemployment and solutions  
 
The UK has to face high unemployment rates many times in its history. In a time of recession, it is important to find a global solution for unemployment. First, this essay will present the causes of unemployment. The second issue it considers is some economic theories that can be used to tackle unemployment using the UK in the twentieth century as an example. Finally, their effects on the economy will be shown in order to illustrate whether they favour the economy or not. 
According to Sloman and Wride (2009), unemployment can be classified into two broad categories: disequilibrium unemployment and equilibrium (natural) unemployment. Disequilibrium unemployment is due to inflexibility of wages when real wages are higher than the equilibrium wage of the labour market. There are three main reasons for this disequilibrium. The first one is the trade unions demanding higher level of wage than the market or the government’s minimum wage being too high. The second reason relates to a fall of aggregate demand in a recession period. If an economic is in recession, aggregate demand will fall. As a consequence, business will shrink to reduce costs. In this situation, a possible solution is that firms can choose to pay the employee less and reduce work capacity. However, with minimum wage and trade union’s pressure, this solution is not practical. Moreover, making people redundant can save money in terms of administration costs. Therefore, it is a rational decision to lay off employees. In this case, there will be demand-deficient or cyclical unemployment. The third reason which leads to disequilibrium unemployment is growth in the labour supply. As labour supply increases, wages will tend to decrease. However, the fact that wages stay at the same level will result in a labour force surplus. 
The second category is equilibrium unemployment. It is sometimes called natural unemployment. In fact, there are always some people looking for a job. Perhaps they do not want to stick to one job for life and look for a more attractive wage or working environment. There are many students who have just left education and may not find a job immediately. Shifts in the economy’s structure may result in unemployment. For example, a change from an industrial to a service economy leads to a significant number of redundancies in factories. New technology or regional issues may cause such structural unemployment. Another sub-category of natural unemployment is seasonal unemployment, which refers to the fact that agricultural or holiday-related jobs are only available seasonally.  
Natural unemployment may either be planned or have positive effects on society, which means that government policies to combat unemployment mostly deals with disequilibrium unemployment. Although it is impossible to achieve zero unemployment, governments consider full employment (there is only natural unemployment) is an important aim of their policies. (Routh, 1986) Why cannot unemployment rate be zero? Gordon (1988) showed the reason; the economy always changes, old industries vanish and new ones appear, requiring new labour skills. As a consequence, there is always structural unemployment. Moreover, when people change jobs, it takes time for them to find a new one. Therefore, frictional unemployment cannot be avoided without any negative consequences on society.    
Many theories have been proposed to explain the causes and solutions of unemployment but all of them were either in classical view or Keynesian view. Sloman and Wride (2009) analysed the classical theory. Economics that follow this school of thought believed that if the labour market is free to make its way to the equilibrium wage, there will be full employment. In order to do that, the government should adjust their budget to a state where leakages and injections in the economy are equal. This mean savings equal to investment, imports equal exports and net taxes equal government expenditure. A flexible interest rate will create a balance between savings and investments. If imports and exports are not equal, the government will intervene by adjusting its own reserves. The only work left for the government is to balance its budget. (Sloman and Wride, 2009) 
The British economy after the First World War faced many difficulties. Price levels doubled due to war-time inflation; unemployment rose significantly from 4% in 1920 to 17% in 1921 and during the 20s to 30s period, the average is 14%. (Benjamin and Matthews, 1992) This situation can be considered as a consequence of the classical treasury view of economists and politicians in that time. According to Sloman and Wride (2009), the Treasury adopted the classical view, that encouraging people to accept lower wages and increase savings. The government should avoid deficit by any means, in the attempt to balance their budget. After the Great Depression in 1929 as a result of gold standard adopted by UK government in 1925, this point of view does not seem to be practical and could not come up with a possible solution for the problems in that time. In his book ‘General Theory of Employment, Interest and Money’, Keynes has explained the reason and proposed a new theory. 
Criticising classical theory, Keynes argued that unemployment will not be reduced by reducing wages and the only way to prevent mass unemployment is demand management. Sloman and Wride (2009) has analysed this theory. The classical theory indicated that when the real wage is above the market equilibrium, it will fall to meet it. However, real wage fall means that people will spend less due to lower income. In this situation, demand for goods will decrease leading to a fall in demand in labour. As a result, a recession will happen. Keynes’ conclusion is: in order to avoid high unemployment rate, sustain stable growth and control inflation, the government has to stimulate demand by adopting fiscal policies. This is a change of government in tax and public spending in order to achieve certain macroeconomic goals. In a recession period, the government will either increase their spending or reduce tax to increase aggregate demand (expansionary policy). On the contrary, when demand reaches a high level and inflation becomes a problem, the government will decrease public spending and increase tax (contraction policy). Additionally, Keynesian theory also adopts monetary policy as a temporary solution in the time of recession. After the Second World War, many governments were successful in adopting Keynesian theory. During the 1950s and 1960s, UK government followed Keynes’ theory in making economic policy. Unemployment rate in this period was significantly lower than it had been before the war and even after that. (Sloman and Wride, 2009; Gordon, 1988) 
However, the economic growth was relatively low compared with other countries at that time and a stable growth was not yet to be achieved. Keynesians explain that fluctuation of the economy is due to fluctuation in aggregate demand. In the 1970s, stagflation rose and become a new serious problem which put the theory into doubt. Stagflation is described as a combination of inflation, slow growth and high unemployment which is impossible in the Keynesian view. The crisis following rising oil prices and strikes in 1973 showed that fiscal policy was not the perfect solution. The classical approach returned as monetarist policy under Thatcher in the 1980s. This theory argue that when demand increases, people’s expectation of wages will rise and cause unemployment. A further stimulation of demand to cure unemployment will result in more unemployment and high inflation. The monetarists propose a policy to control money supply, free the market. (Sloman and Wride, 2009) 
The fiscal policy in the UK seemed to be working in the 50s and 60s but the crisis of stagnation in the 70s revealed some problems. As discussed by Sloman and Wride (2009), pure fiscal policy (without money supply control) can cause a crowding out effect. Increasing public spending requires money but governments cannot print more because that will lead to inflation. They will borrow money by issuing bond which reduces investment in the private sector. As a consequence, firms have less money to invest in infrastructure and productivity and quality of goods are reduced. Another weakness of fiscal policy is the delay in responding. The policy does not directly target the labour market so that it takes time to work. In the meantime, the situation changes and the policy will have negative effects: high inflation and over-growth. 
In conclusion, there are two main reasons for unemployment: lack of flexibility in real wages in response to the market and natural causes. Two different theories are used to create policy to combat unemployment: classical and Keynesian theory. While classical economists recommend supply-side solution, Keynesians propose demand side policy. Both solutions have advantages and disadvantages. In current recession, the government should be careful to select their policy to achieve best economic and social impact, which should involve in a combination of the two approaches. 
(1457 words) 
References: 
Benjamin, D. and Matthews, K. (1992) US and UK unemployment between the wars: A doleful story London: the Institute of Economic Affairs  
Gordon, A. (1988) The Crisis of Unemployment London: Christopher Helm 
Leach, R., Coxall, B. and Robin, L. (2006) British Politics Basingstoke: Palgrave Macmillan 
Routh, G. (1986) Unemployment: Economic Perspectives Hampshire: Macmillan Sloman, J. and Wride, A. (2009) Economics (7th edition) Harlow: Prentice Hal