Unemployment

The economic welfare of any country depends on the rate of the economic growth. There are
several determinants or the factors for the economic development of a country like industrialization,
agriculture, population, employment etc., one of the major indicator for the economic growth is
employment rate, as it has an adverse impact on the whole economy. Whenever there is high
degree of employment rate the production improves thereby increasing the standard of living
(Anderson, 2006).

High unemployment rate in a country leads to social and economic problems in the community as a
whole. Economic problems result in less production of goods and services, less distribution of
income, loss of tax revenues, fall in GDP rate etc. (www.economywatch.com). Social problems
cause’s social ills and shows effect on individuals financially and psychologically. Individuals cannot
meet their financial obligations on time and getting high stress which leads to problems like ill-
health, premature death, suicides etc. (Clark, 2003)

The economists describe unemployment as a condition of jobless within an economy.

Unemployment is lack of utilization of resources and it eats up the production of the economy. It can
be concluded that unemployment is inversely related to productivity of the economy. The history of
unemployment is directly related to history of industrialization. It leads to unwanted job losses and
willing workers without job. It is worthwhile to mention here that not everyone who is out of work is
seen as unemployed. A person with a large fortune not looking a job is not counted in the
unemployed population in that he is not willing to work in the first place, though he’s officially out of
work. As such unemployment refers to the inability for willing workers to find gainful employment.
One of the major indicators of the economic health of the country is the degree of unemployment.
The impact is of high unemployment is seen in the difficulty in finding mid level jobs. The fact is that
minimum wage level jobs are adequate but not considered as gainful employment of the majority of
the workforce (Anderson, 2006).

Moreover, the effects of unemployment are social, too, not just economic. Frequently, crime rates
rise as people are unable to meet their needs through work. Divorce rates often rise because people
cannot solve their financial problems. The rate of homelessness rises, as do the rates for mental and
physical illness. Homes are foreclosed upon or abandoned, and neighbourhoods deteriorate as a
result. When there is high unemployment, people pay less in income taxes and also pay less in sales
taxes because they purchase fewer goods and services. As such unemployment is not a good thing
for anyone in our society, and even the people who remain employed will suffer as a result
(www.economywatch.com). The study will enable the governments to take initiatives to increase the
productivity for overall development and reduction in unemployment. The study of unemployment
will provide a comparative data between public and private sector. It also gives indication of under
employment in private and public sectors. These factors become basis for the formulation of the
monetary policies of the country for the future years.

UNEMPLOYMENT
Unemployment generally defined as the number of persons (It is the percentage of labor force
depends on the population of the country) who are willing to work for the current wage rates in
society but not employed currently. Unemployment reduces the long run growth potential of the
economy. When the situation arises where there are more other resources for the production and
no man power leads to wastage of economic resources and lost output of goods and services and
this has a great impact on government expenditure directly (Clark, 2003).

High unemployment causes less consumption of goods and services and less tax payments results in
higher government borrowing requirements. The impact of the unemployment is seen with the
individuals and household curtailing the consumption drastically to meet financial obligation and
factors like this have adverse impact on the whole economy. It also reduces the output of goods and
services which could have produced by unemployed labor force. An economy is producing
substantially below its potential if unemployment rate is extremely high, thus everybody in the
society loses by consuming and enjoying less because less is produced for distribution

Many economists (Anderson, 2006) have done research studies to alleviate this problem and to find
solutions. In this study we will discuss about the causes for unemployment, challenges to
government and individuals to alleviate this problem. This report gives you the overview of the social
effects of unemployment and the challenges ahead for the situation.

CAUSES FOR UNEMPLOYMENT

There are several causes for unemployment and it depends on prevailing conditions of economy and
also on individual’s perception. The following are some of the causes for unemployment:

Change in technology is one of the serious cause for unemployment. As the technology changes
employers search for people with latest technical caliber. They look for better substitutes. Job cuts
due to change in the technology brings unemployment problem in the society.

Recession is prime factor for unemployment in most of the countries. Because of the financial crisis
in one country can affect the other countries economy due to globalization.

Changes in the global Markets are another important factor. Any country economy adversely affect
when its exports are down the line due to changes in global markets, and increase in price. With this
production suffers and companies unable to pay on time and this increases the rate of
unemployment

Job dissatisfaction by many employees is another cause, this happens when less attention given by
the employers on the performance of employee. This leads to lack of interest and desire to work and
unemployment becomes inevitable, as employees deliberately loose their jobs.

Employment discrimination based on the caste, religion, race etc., in the companies, an employee
looses the ease to work in the organization.
Negative attitude by the employees towards the employers creates unhealthy environment in the
organization. And this ultimately leads to unemployment (www.blacksacademy.net).

IMPACT OF UNEMPLOYMENT

Effect on Economy

Unemployment rate depends on the economy to economy. In developed countries like United Sates
and Europe the unemployment rate considered to be low because many people are self employed
people and working in agriculture. In countries where there are less self employed and more
population with less resources causes unemployment (Anderson, 2006).

Unemployment affects the economy adversely as the productivity falls below the normal level.
When there is high rate of unemployment in the country, government has to suffer extra borrowing
burden due to decrease in the production and less consumption of goods and services by the
people. Not only the unemployed people consume less its even employed has weak purchasing
power due to fear about their loss of their jobs. Unemployed not working and not contributing for
income generation of the economy, but also they claim benefits from the government and it is an
additional cost for the economy as a whole (Baker, 2009).

Social Effects

Not only unemployment problem suffers the economy, even there are many social affects too. The
following are some of the social affects of unemployment:

Loss of skills: when there is unemployment in the society, people loose their skills due to no usage
and it causes human capital loss.

Mental illness: There will be loss of self confidence, frustration, negative attitudes towards common
things when there is loss of income, and a person’s self-esteem gets hurt due to these mental
illnesses.

Financial obstacles: Unemployment brings financial obstacles in the family. People cannot meet their
financial obligations on time and it brings frustration among family members, brings tension at home
and may leads to suicides .

Increase crime rate: When there is unemployment in the society crime rate increases. When people
don’t have disposable income they can go to any extent like theft, robbery and also murders in order
to survive their livelihood.

Political instability: Due to unemployment people lose trust on government and their administration
and this may bring political instability.

Insecurity among existing employees: when the economy is facing unemployment problem it brings
insecurity among the existing employees and their purchasing power decreases due to fear or
insecurity on their jobs.
Poor standard of living: Unemployment causes poor standard of living as competition for jobs will
increase and people accept for less salaries and their standard of living will decrease due to their low
income.

Employment Gap: Unemployment brings employment gap in the companies for hiring a suitable
person and for an individual who is out of job has to find another one in difficult situations. This
brings the gap in income generation (www.enotes.com; www.economywatch.com).

CHALLENGES TO GOVERNMENT

Several policies have been made to reduce the unemployment problem in the economy.
Government just needs to focus on execution of these policies and work out hard in alleviating this
problem. Government can expand capital projects like new roads, constructions of new hospitals
and major infrastructural projects which can become a platform in creation for more jobs in the
economy. It increases income generation to the economy (Fritz, 2006).

Reduction in taxation can bring higher purchasing power to the consumers. It gives some relaxation
to consumers in spending their disposable income. Government should take proper steps in
investment decisions on huge projects like iron and steel, aviation etc., proper policies are to be
made to boost up these projects thereby creating employment opportunities. Proper recruitment,
training and development are to be needed by every company in order to increase the capabilities of
employees, and to enhance their skills and shows great performance in up bringing of the
organization. Government can take initiation in reducing the interest rates and it enhances the
demand for credit and improves savings by the individuals. Necessary steps are to be taken by the
government in increasing the productivity for the overall development of the country and reducing
the unemployment problem in the economy (Fritz, 2006).

CHALLENGES TO INDIVIDUALS

It is not only the responsibility of the government to take initiation in reducing the unemployment
problem, even individuals has to take step to overcome this problem. Lot of adjustments are to be
done by the individuals to come out of this situation. With out taking hasty decisions like suicide,
frustration they can plan and do proper adjustments like debt adjustments, expend their liquid
assets when it is required, cut down their expenditures and also encourage other family members to
find jobs so that they can compensate in income generation (Fritz, 2006).

An individual has to increase their capabilities and participate in proper counseling and training
sessions to improve their performance levels and enhance their skills. They have to think about self
employment apart their job with the help of their family members. This also improves their standard
of living (Fritz, 2006).

CONCLUSION
Unemployment is a serious issue for any economy. It creates negative affects to unemployed as they
are jobless and suffer from worse prospects to find new job and those who are employed feel less
secure to keep their jobs in future. However for overall development of economy, government and
individuals has to take initiative steps in increasing the productivity and improving the standard of
living.

Does economics growth bring increased living standards?

Increasing the rates of economic growth has long been the holy grail of conventional economics and
politics. To a large extent, most developed economies have been highly successful in increasing
economic output. But, has such an impressive increase in national output actually improved people’s
standard of living?

does-economic-growth-happiness

To decide whether economic growth has increased happiness is highly subjective, and it is difficult
for economists to make concrete arguments. However, it is worth noting the various side effects of
growth and consider there impact on general living standards.

Benefits of economic growth

1. Increased consumption

Consumers can benefit from consuming more goods and services. An assumption of economics is
that consumption is related to utility, so in theory, with higher consumption levels, there is greater
prosperity.

2. Improved public services

With increased tax revenues the government can spend more on important public services such as
health and education. Improved health care can improve quality of life through treating diseases and
increasing life expectancy. Increased educational standards can give the population a greater
diversity of skills and literacy. This enables greater opportunity and freedom. Education is seen as an
important determinant of welfare and happiness.

3. Reduced unemployment and poverty

Economic Growth helps to reduce unemployment by creating jobs. This is significant because
unemployment is a major source of social problems such as crime and alienation. However, despite
rapid increases in economic growth since the Second World War, areas of high unemployment in the
EU remain. For example, in France and Spain, there are currently high levels of structural
unemployment. This kind of unemployment may not be reduced by economic growth.

4. Reduction in poverty

poverty-real-absolute-uk

Even in past two decades, economic growth has led to reduction in ‘absolute’ low income

It is important to look at economic growth over a long period of time. At the turn of the Twentieth
Century, in US and Europe, there was widespread poverty amongst the working classes – with poor
people experiencing malnutrition. Even since 1945, absolute poverty levels have significantly fallen.
S.E. Asia has also seen significant decreases in absolute poverty – due to high rates of economic
growth in past few decades. Economic growth will be important for reducing absolute poverty and
increasing life expectancy in Africa.

Why economic growth may not bring increased happiness

1. Diminishing returns

If a section of the population is living in absolute poverty, economic growth enables people to have
higher incomes and therefore they will be able to afford the basic necessities of life such as; food,
and shelter. When economic growth can overcome this type of poverty there is a clear link with
improved living standards. However, when incomes increase from say $35,000 a year to $36,000 the
improvement in living standards is harder to justify. The diminishing marginal utility of income and
wealth is a basic economic concept, which suggests the tenth unit of a good will give much less
satisfaction than the first. If we already have 2 cars, do our living standards really improve if we now
have the capacity to own 3 cars? Often as economic growth increases incomes, people increasingly
save their money (higher marginal propensity to save) this is basically because they struggle to find
anything meaningful to spend their money on.

2. Externalities of growth.

Economic Growth with involves increased output causes external side effects, such, as increased
pollution. Global warming from pollution is becoming a real problem for society. The economic and
social costs could potentially be greater than all the perceived benefits of recent economic growth.
However, it is worth noting that economic growth doesn’t necessarily have to cause pollution. The
benefits of growth could be used to develop better technologies that create less pollution. It is just
at the moment this has been a low priority.
2. Economic growth can cause increased inequality.

It is perhaps a paradox that higher economic growth can cause an increase in relative poverty. This is
because those who benefit from growth are often the highly educated and those who own wealth.
In the 1980s and 1990s, higher growth in the UK and US has resulted in increased inequality. (1)
However, it depends on how growth is managed; economic growth can be used to reduce inequality,
for example, the economic growth which occurred in the 50s and 60s helped reduce inequality.

3. Increase in crime and social problems

It is another paradox that as incomes increase and people are better off the level of crime has
increased as well. (2) This suggests that crime is not motivated by poverty but perhaps envy. One
reason why crime rates increase is that quite simply there are more things to steal. Back in the 1930s
auto theft, mobile phone theft e.t.c were rare or non-existent. Economic Growth has created more
goods to steal. However, the link isn’t absolute for example in recent years crime rates in the US
have reduced from their peak. But there has been a general association between growth and crimes.

5. Higher economic growth has led to more hours worked

In the beginning of the industrial revolution, higher growth led to people working lower hours.(3)
However, in the past couple of decades, higher incomes have actually led to people working longer
hours. It seems people are unable to enjoy their higher incomes. Feeling the necessity or preferring
to work longer hours. This suggests people are valuing earning money more than leisure. However,
this trend may also be due to companies wanting people to work longer hours.

6. Diseases of affluence

Economic Growth has enabled improved healthcare treatments, but at the same time, there has
been an unexpected rise in the number of diseases and illnesses related to increased prosperity.(4)
One example is obesity. Modern lifestyles and modern diets have created an epidemic of obesity,
with significant proportions of the population expressing a desire to lose weight. It could be argued
that problems such as obesity and stress-related illnesses are not a direct consequence of growth.
This is true, but, it is symbolic of the fact increased prosperity has created as many new problems as
it has solved

Sustainable development may be defined as the development to meet the needs of the present
generation without compromising the needs of the future generations.

It is a process whereby the development can be sustained for generation. It affords the future
generation the same, if not more, capacity to prosper as the present generation.
Economic development is not a blessing for the human beings. No doubt, it brings higher material
welfare by increasing national output of goods and services on one hand and on the other hand it
pollutes the environment badly by overuse and misuse of natural resources.

In the course of economic development, the cost of environmental damage in the shape of
deforestation, land degradation, soil erosion and air and water pollution etc. may exceed the
benefits of having more output of goods and service.

The aftereffects of environmental damage have already been appearing in the form of green house
effects, inclement weather, Irregular monsoon, global warming and acid rain etc. Now the basic
question is how economic development and congenial environment can co-exist so that
development can be sustained for generations. That is why ‘sustainable development’ has come into
discussion.

Environment:

Literally speaking environment means external conditions and surroundings in which person,
animals and plants live. Simply speaking, environment means the surroundings and external
conditions affecting the life and development of an area.

Environment may be defined as the sum total of all natural factors that directly influence the chance
of organisms (plants, animals, human beings) to survive and reproduce. The environmental factors
that influence the life on earth may be broadly classified as abiotic and biotic components. Abiotic
component includes the climatic factors related to aerial environment. Soil conditions, topographic
factors. Biotic factors include living organisms like plants, animals and human beings.

Nature has maintained a fine balance among the various components of environment to enable the
plants, animals and human beings to survive and reproduce. But during the course of economic
development, this balance of nature got distributed which is termed as environmental crisis.

Meaning of Sustainable Development:

Simply speaking sustainable development means the development which should keep going.
Ordinarily speaking, it is a situation in which economic development does not decrease over time,
Sustainable development is the development that is everlasting. Sustainable development is a
process in which natural resource base is not allowed to deteriorate.

Sustainable development may be defined as the development to meet the needs of the present
generation without compromising the needs of the future generations. It is a process whereby the
development can be sustained for generation. It affords the future generation the same, if not more,
capacity to prosper as the present generation.
Relationship between Environment and Sustainable Development:

(a) Sustainable development minimizes environmental degradation. As development involves some

disturbances in our environment, sustainable development has to be understood as an endeavor to
minimize the rate of environmental degradation. It ensures that however small a degradation that
does occur is made up in the best acceptable form and as fast as possible.

(b) Environment is one of the dimension of sustainable development. Sustainable development is

one which raises national and per capita income by keeping the environmental damage within a
tolerable limit so that the future generation will get equal benefits in terms of output and congenial
environment.

Following are the main objectives:

(i) Sustainable improvements:

The sustainable development aims at creating sustainable improvements in the quality of life of all
people.

(ii) Increase in economic growth:The sustainable development aims at increasing the economic
growth through meeting basic needs i.e. raising the standard of living.

(iii) Public participation:

The sustainable development aims at public participation to keep the environment clean.

(iv) Maintenance of environment resources:

The sustainable development aims at maintenance of natural and environmental resources along
with economic development.

big issue in economics is the tradeoff between efficiency and equity.

EFFICIENCY

Efficiency is concerned with the optimal production and allocation of resources

given existing factors of production. For example, producing at the lowest cost.

Equity is concerned with how resources are distributed throughout society.

Vertical equity is concerned with the relative income and welfare of the whole population e.g.
Relative poverty when people have less than 50% of average income. Vertical equity is concerned
with how equitably resources are distributed and may imply higher tax rates for high-income
earners.

Horizontal equity is treating everyone in the same situation the same. e.g. everyone earning £15,000
should pay the same tax rates.

Concepts of efficiency may imply a lack of equity

For example, the Community Charge (Poll tax) was considered to be economically efficient because a
poll tax doesn’t distort economic behaviour. (A poll tax doesn’t reduce incentives to work). However,
by making a millionaire pay the same tax as a poor pensioner, it was considered to be unfair.

A tax on cigarettes can be said to increase social efficiency. Cigarettes have negative externalities
causing the social cost to be higher than personal cost. The cigarette tax makes people pay the full
social cost of smoking and increases social efficiency. However, a cigarette tax is also highly
regressive. It takes a bigger percentage of income from low-income earners.

Pareto efficiency is concerned with creating a situation where we cannot make one party better off
without making another party worse off. For example, a country may devote 60% of GDP to the
manufacture of armaments. In doing this, they may achieve technical and productive efficiency and
produce on their production possibility frontier. Therefore from this perspective, they are efficient.
But, such an economy may have a great deal of inequality, with large portions of the population
struggling to have enough to eat.

Bank bailouts and equityFrom one perspective we may say bailing out banks is an economic
necessity as it prevents a collapse in confidence in the banking system. By bailing out banks, we
enable a more productively efficient economy.

However, from another perspective, it seems unfair that the government enables bankers to retain
high paying jobs whilst they implement cuts for workers on lower income.

Increased inequality and increased growth

Sometimes, economic policies create a situation where everyone becomes better off (rising real
incomes across the population). However, those on high incomes gain a bigger percentage rise in
real incomes. The result is that everyone becomes better off, but there is also greater income
inequality. Therefore, some people may feel that relatively they appear worse off compared to
others in society.

This is a Pareto improvement in economic welfare but also an increase in inequality.

trickle-down-effect-criticism

It is like the ‘trickle down effect’ – where the poorest only gain a small increase in their income.
Whilst the rich gain a big percentage and bigger absolute increase in income. There is increased
economic efficiency but increased inequality.

Is it good to have increased efficiency but increased inequality?

Yes.

Reduction in absolute poverty.

Increase in real incomes – everyone is better off.

No.

People value happiness in terms of ‘fairness’ and relative perspectives. If the rich gain a bigger share
of national income, it may create resentment.

Diminishing marginal utility of income. Rich struggle to spend their increased income on goods which
increase utility.

The final point is that there doesn’t have to be a trade-off between equality and efficiency. An
improvement in efficiency should generally make the economy better off. There is no reason why
improved efficiency has to lead to inequality. It is compatible to improve both efficiency and equity
within society.

Can a Recession Really be a Good Thing?

It is argued by some people that a recession can benefit the economy, at least in the long run. The
reasoning is that falling revenues force firms to become more efficient, e.g. cutting unnecessary
costs e.t.c. In a recession, inefficient firms will go out of business and this shake up is necessary to
weed out the inefficient and provide incentives for firms to be as profitable as possible.

This belief was articulated by the Chairman of Ryanair, Michael O'Leary's recently, arguing that a
recession would be a good thing. see Guardian article

However, is this a good argument?

Problems of Recession - Why A Recession is Bad

A recession will make it difficult for new firms who have just entered the market. Most new firms
have high set up costs, therefore, a downturn in the economy could make them close down.
However, this does not mean that they are inefficient. It just means they are new and struggling to
get established..

Increased Monopoly Power. If a recession causes the smaller and newer firms to go out of business
then the larger dominant firms will gain more monopoly power. In the long run this will lead to less
choice and higher prices. This is a definite disadvantage of a recession. When the Chairman of
Ryanair argued recessions would be a good thing, maybe he meant - a good thing for Ryanair, as it
may involve new firms going out of business leaving him more market power.

Hysteresis. This is the argument that the past is a predictor for the future. Basically, if you have high
unemployment, then it is more likely to have high unemployment in the future. If people are made
unemployed in a recession, it may take a long time for them to find work again. When they are
unemployed they lose skills, become demotivated and become less attractive to employers. Note
after the recession of 1981, Unemployment remained stubbornly high in the UK, even into the boom
years of the late 1980s

Fall in Productive Capacity. A recession can damage the productive capacity of an economy. Firms
can go out of business and therefore shut down their resources. Furthermore in a recession, there
will be a significant fall in investment, this can harm the long term development of an economy.

You don't need a recession to weed out inefficient firms. If markets are reasonably competitive,
inefficient firms will be forced out of the market anyway.

Conclusion:

A recession is unnecessary to increase economic efficiency. The long term future of an economy can
be best helped through stable growth, which avoids the extremes of boom and bust economic
cycles.

The long run trend rate of growth is the average sustainable rate of economic growth over a period
of time. It could also be termed as the ‘underlying trend rate of economic growth’ The long run
trend rate is determined by growth in productive capacity (AS). It is the rate of growth which is
consistent with low inflation.

Actual growth can be quite volatile with booms and busts taking the growth rate away from this
underlying trend rate. In the UK, in the post war period, the long run trend rate is approximately
2.5% – but we had many periods of boom and bust.

This graph shows the actual growth rate is fluctuating above and below the long run trend rate.

If growth is above the long run trend rate we say there is a positive output gap (inflationary
pressures – boom)

If growth is below the long run trend rate, this creates a negative output gap (spare capacity or bust)

What determines the Long Run Trend Rate of Growth?

The long run trend rate of growth is essentially determined by the growth in productive capacity –
the growth in Long Run Aggregate Supply. The long run trend rate will be determined by factors such
as:

Technological improvements and technological sophistication. For example are firms investing in
new technology such as Artificial Intelligence and automation?

Labour productivity – output per worker – which depends on education, training and skill levels.

Availability of resources – easy access to power and natural resources can provide stimulus to
economic growth.

Investment levels and efficiency of investment

Scope for productivity gains from privatisation

Labour market flexibility.

Levels and quality of infrastructure – communication/transport.

Entrepreneurial spirit – Are people willing to set up and develop new business? This may depend on
confidence of people in long-run performance of economy

Some countries like China may have a high long-run trend rate because their productive capacity is
increasing at a faster rate than in UK.

Boom and Bust Cycles

If the actual growth is above the long run trend rate, then it implies that demand is exceeding the
growth of productive capacity. In this case, we tend to get inflation and a worsening of the current
account. This inflationary growth tends to be unsustainable and is often followed by an economic
downturn.
Should full employment be the primary macroeconomic objective?

Full employment involves zero or very low unemployment. In practice, there will always be some
frictional unemployment as people are looking for new jobs or leaving school. Economists suggest an
unemployment rate of 3% is close to full employment. However, it is difficult to determine precisely.
Full employment implies the macroeconomy is operating at its full capacity and there is no output
gap or demand deficient unemployment.

The main reason for targeting full employment is because high unemployment has various social and
economic costs. Firstly, the unemployed will have low income enabling low levels consumption. This
low income will lead to relative poverty. Also, the unemployed may become de-motivated and de-
skilled. On the job training, is considered important to employers. Being unemployed with no money
to spend on training and unable to work can create a negative cycle for the unemployed which
makes it difficult for them to find work in the future. People experiencing long-term unemployment
find it the most difficult to gain employment. (Hysteresis effect)

Also, during periods of high unemployment, the government will have to spend more on
unemployment benefits and also the government will receive lower tax revenues (less VAT, lower
income tax). Therefore, high unemployment will increase government borrowing. Finally,
unemployment may exacerbate social problems such as crime, vandalism and social alienation,
especially if unemployment is concentrated amongst young people who feel alienated by having no
jobs.
Therefore, given the costs of unemployment, there are many social benefits to achieving full
employment. Also, by achieving full employment, it will have the side-effect of improving other
objectives of the government. Lower unemployment will reduce government borrowing and help
economic growth. If the unemployed gain work, they will increase spending, and this will cause a
positive multiplier effect which helps to increase economic growth.

Achieving full employment

To achieve full employment, if there is a negative output gap, Keynesians will argue that it is
necessary to increase AD.

his can be achieved by loose fiscal or monetary policy e.g. lower interest rates. Increasing AD may
cause inflation to increase, but if there is spare capacity there should only be a limited increase in
inflation. Therefore, there is a strong case for aiming for full employment through demand
management (either fiscal or monetary policy)The Phillips curve suggests there is a trade-off
between inflation. Therefore, achieving full employment may cause a side effect of inflation.

Positive effects

Maximising potential output in an economy, achieving productive efficiency and economic growth

Reduces inequality and prevents relative poverty from those who are unemployed.

Full employment will improve business and consumer confidence which will encourage higher
growth in the long-term.

Unemployment is a big cause of poverty, stress and social problems.

Full employment reduces government welfare spending and enables more income taxes – improving
budget position

Negative effects

Full employment may cause labour shortages and wage inflation. This can lead to ordinary inflation.

Attempting to achieve full employment could lead to a boom and bust economic cycle. If growth is
above the long run trend rate, the growth will be unsustainable.

Britain’s period of full employment in the 1950s meant many companies struggled to fill vacancies in
unpopular jobs; this labour shortage was partly solved by encouraging immigration.
Evaluation

Full employment doesn’t necessarily have to be inflationary. If the growth is sustainable, we could
get close to full employment without inflationary pressures. It depends on the skills of the
workforce. If there are big labour shortages in skilled labour, full employment could lead to
shortages of labour.

Why Economic Growth does not always benefit developing countries

Factors that Can Prevent Developing countries experiencing Economic Growth

Specialisation in one Commodity

Developing countries may focus on production of one primary product. e.g. Cuba depends on Sugar.

Economic growth doesn't mean demand for all commodities increases. Sugar has a low income
elasticity of demand, rising incomes means a smaller % increase in demand. Therefore, economic
growth does not translate into higher demand for these goods.

Furthermore, the prices of commodities can easily fall due to excess global supply. Therefore,
countries who rely on this product see a fall in revenue.

This is important because demand is very inelastic for these goods. Increase in supply causes big fall
in price and incomes. It is important because a high % of revenue can come from one good. In recent
years, coffee has been a good example of a commodity with a falling price.

Structural weakness

Many developing economies doesn't have sufficient transport and infrastructure to make the most
from trade. Low levels of human capital mean the economy struggles to grow and diversify into
manufacturing industries. However, the cheap labour costs may encourage inward investment in
labour intensive industries. This has been one of the main reasons for China's success.

Agricultural based economy.

Countries who rely on agricultural output may suffer from adverse weather conditions. E.g. a
prolonged drought in sub Saharan Africa can lead to loss of farming income and therefore lower
growth.

Internal Conflict

Internal conflict or mismanagement can lead to declining living standards for many. E.g. war brings
about lower life expectancy and deters foreign investment.

Corruption and Mismanagement

Government in many of the poorest developing countries misuse Aid and the proceeds of growth.
oes AID increase economic and social development for developing countries?

Advantages of aid.

1. Provides foreign capital which can be used for investment and increasing productive capacity of
the economy.However, a large % of aid is tied aid. This means it is fixed for certain investment
projects which benefits the donor countries. In a sense this is not really aid, but it is classed as Aid.
(e.g. building of dams in Argentina)

2. Can be important for solving economic, environmental and food crises. Without aid the
developing country would struggle to rebuild. e.g. after tsunami disaster.

However, there is concern aid can lead to dependency. Developing countries come to rely on aid and
lose incentives to improve productivity. This depends on the type of aid given. E.g. some aid can be
just to improve infrastructure, this is more beneficial than handouts.

3. Food aid can harm local farmers. An increase in supply from the west can drive down market
prices. Because demand is inelastic for food, lower prices can lead to lower revenues. This was a real
problem when the EU "dumped" its surplus on world Markets.
However, if food aid is temporary, e.g. in a famine low prices are not concern. Food aid needs to be
short term and specifically targeted to avoid this potential problem.

4. Foreign aid has its limitations in increasing productive capacity. Arguably long term growth
requires building up trade and new industries.

However, aid could play a role in improving trade performance. For example, aid could be used for
education and training to increase labour productivity. This enables the country to become more
competitive in the long run.

5. Aid can be used to prevent environmental damage. E.g. securing the purchase of rainforest and
prevent exploitation of natural resources.

6. Aid and Corruption

A real problem with Aid is making sure it gets to the targeted people. This can actually be quite
difficult in countries with more infrastructure. The problem is exacerbated when countries
experience civil war. Unfortunately, aid often does not reach the intended recipients.

There is no guarantee that Aid will improve economic and social development; however, there is no
reason why it cannot increase economic and social development, if this it is targeted in the right
way.
 Marginal revenue product in the real world.

In the real world demand for labour is more complicated and there are more factors than MRP

 Difficulties of measuring. For many jobs, it is difficult to measure a worker’s productivity. If you
pick strawberries, it is relatively easy to measure. But, if you teach or work in the civil service, it
is very difficult as there is no physical output to count. Therefore, firms have to make best
guesses about productivity and value of a worker.
 Public sector wages. Many public sector jobs are not determined by market forces but
government policies and attitudes to employment. It depends on a normative judgement of
what we consider a job is worth.
 Efficiency wage theory. This theory states that paying a higher wage can contribute to
increasing worker’s productivity and morale. Cutting wages will depress productivity.
 Comparison. In the real world, workers pay much attention to relative pay gaps – do they get
more than a junior colleague? Are pay differentials maintained?
 Non-monetary benefits of jobs. A firm may feel that if a job is highly prestigious or desirable,
they can pay a lower wage and still get people to work. For example, jobs like nursing or
teaching may be filled by people looking for job satisfaction rather than maximising profit.
 Discrimination. Employers are not necessarily rational but may pay lower wages to particular
groups of workers.
 Wage contracts. Firms may offer wage contracts for a year or more. If there is seasonal demand
for their good, they don’t put up wages in response to this.
 Reciprocity and good will. Many labour markets depend on good-will and concepts of
reciprocity. For example, an employer may rely on a worker’s goodwill to do unpaid overtime, if
a cafe is exceptionally busy. Always paying bonuses or trying to figure out a workers MRP can
undermine this process of reciprocity. These ideas are more common in behavioural economics
than this neo-classical model.

In the real world, labour markets are rarely perfectly competitive. This is because workers or firms
usually have the power to set and influence wages and therefore wages may be set to levels
different than anticipated by Marginal Revenue Product (MRP) theory.

Imperfections in the labour market cause wages to differ from a competitive equilibrium.

Different Imperfections in the Labour Market

Monopsony

Trade unions

Discrimination

Difficult to measure productivity

Firms, not profit maximisers

Geographical immobiliities

Occupational immobilities

Poor information

1. Monopsony

Monopsony occurs when there is just one buyer of labour in a market. This gives the firm market
power in employing workers. The monopsony can set (lower) wages and limit the quantity of
workers.
The marginal cost of employing one more worker will be higher than the average cost because to
employ one extra worker the firm has to increase the wages of all workers.

To maximise the level of profit the firm employs Q2 of workers where MC = MRP

Therefore the firm only has to pay a wage of W2. This is less than the competitive wage.

Even if there is more than one employer, firms may still have the ability to set wages and have a
degree of monopsony power. For workers, there are significant costs and difficulties in moving
between employers. This means that if wages are low, it is costly to give up the job and work for a
firm with slightly higher wages.

2. Trades Unions

Under certain conditions, Trades unions can bargain for wages above the competitive equilibrium

This can be achieved by restricting the supply of labour (e.g. closed shops) or threatening to go on
strike

rades Unions can cause higher wages, however, in competitive markets, this can have the effect of
causing unemployment of Q1 – Q2

However, Trades Unions can be beneficial if:

They operate in an industry with a Monopsonistic employer

They help to increased productivity by bringing in new working practices

Demand for labour is inelastic

Efficiency wage theories – when higher wages lead to higher productivity.

3. Discrimination

Firms may not be rational but pay some workers different wages on the grounds of age, race, or
gender.

4. Difficult to measure productivity

The theory of MRP assumes firms can measure the MPP of a worker however in practice this is
difficult because in many jobs, especially in the service sector productivity cannot be measured
precisely

e.g. how do we measure the productivity of nurses and teachers?

Therefore wages may be set due to different reasons other than MRP

5. Firms may be non-profit maximisers

If demand for a product falls, MRP theory suggests wages are likely to fall. However, firms may be
reluctant to cut wages or make people redundant therefore they may keep paying high wages
despite this.

6. Wages will vary due to geographical differences

Geographical immobilities can include

Workers have attachments to their local communities – friends, children at local schools.

Difficult to find housing in the south.

Poor information about jobs elsewhere

7. Occupational immobilities

Even at periods of full employment (strong economic growth) workers can be unemployed due to
occupational immobilities. This involves having inadequate skills for the labour market. In a fast-
changing economy, some workers can be left behind when old industries close down and their
former skills are not transferable to new jobs. For example, manual workers from manufacturing
may struggle in a high tech service sector based economy. This can lead to structural unemployment.

8. Poor information

Workers or firms may suffer from poor information. E.g. workers may be unaware of better-paid
jobs elsewhere. Poor information is one factor that enables firms to have monopsony power.

Government Intervention in Markets

Governments intervene in markets to try and overcome market failure. The government may also
seek to improve the distribution of resources (greater equality). The aims of government
intervention in markets include
Stabilise prices

Provide producers/farmers with a minimum income

To avoid excessive prices for goods with important social welfare

Discourage demerit goods/encourage merit good

Forms of government intervention in markets

Minimum prices

Maximum prices

Minimum wages

Nudges/Behavioural unit

Advantages and Disadvantages of Flexible Labour Markets

Flexible labour markets involve a minimum of government regulations. Flexible labour markets imply
that wages and conditions are determined by market forces and not governments or trades unions.
Flexible labour markets have the following features:

Easier to hire and fire workers

Limited, if any, regulations

Downward pressure on wages

Greater variety of job contracts, e.g. temporary, part-time, several small jobs “The gig economy“

Disadvantages of flexible labour markets

Lack of training. Part-time and temporary staff may not get sufficient training from firms because
they only have short-term contracts. A firm has less incentive to develop their worker’s human
capital if they are only short-term. Therefore many low skilled workers will remain under-skilled
because they never gain job stability and the training this encourages

Lower productivity. Due to less investment in workers, it can adversely affect labour productivity – a
key determinant of long-term economic growth.

Flexible labour markets create greater job insecurity and stress. Job security is often as important to
workers as the level of wages. This insecurity could lead to lower morale and lower productivity for
the firm in the long-run

Rising inequality. Non-unionised part-time workers get smaller pay increases. Arguably flexible
labour markets have created a bigger gap between those ‘insiders’ with secure job contracts, and
those ‘outsiders’ without job contracts.
Higher search costs for workers needing to find new jobs. Also, firms may have higher replacement
costs for hiring more workers. Firms may end up paying a premium to employment agencies to help
fill gaps in their workforce.

Advantages of Flexible Labour Markets

Firms will be more efficient and competitive. Flexible labour markets help keep costs down for
firms. For example, firms can get rid of surplus workers. This may help prevent the firm go bankrupt
and protect jobs in the long term. Arguably with globalisation, it is increasingly important for firms to
remain competitive within the global economy.

Increased trade. With lower labour costs, there could be an increase in output and exports. There
could be a lower rate of natural unemployment and lower inflation.

Greater choice. Many workers will prefer flexible employment patterns because it suits their lifestyle
and offers a greater range of choice.

Increased labour market participation rates. Flexible labour markets have played a role in increasing
female participation rates.

May encourage inward investment. Multinational firms may be attracted to invest in countries with
more flexible labour markets, creating jobs in the first place.

Lower rates of structural unemployment. Arguably countries with restrictive labour market
practices, such as France and Spain have experienced higher rates of structural unemployment. The
UK and US with more flexible labour markets have experienced a lower natural rate of
unemployment.

Stabilises economic cycle. In boom times, a flexible labour market can be responsive to demand
labour (e.g. increased net migration). In bust periods, net migration falls, limiting the rise in
unemployment.

Supply-side policies encompass a range of different policies that seek to reduce tax rates and
government intervention in the economy. In the US, supply-side economics has become
synonymous with the Laffer Curve theory and the Reagan tax cuts of the 1980s. It is also referred to
as ‘trickle down economics‘.

Examples of free market supply side policies include:

Privatisation – selling state-owned assets to private sector

Deregulation – opening state-owned monopolies to competition.

Reducing power of trades unions

Reducing minimum wages

Reducing income/corporation taxes

Greater labour market flexibility – e.g. easier to hire and fire workers.

As an economist, it is daunting to try and give an overall assessment of supply-side policies because
it really depends on the policy and how it is implemented.

For example, privatisation and deregulation can have benefits for lower-income workers. Some
inefficient state-owned industries have benefitted from private ownership and increased
competition. This has been a factor in lower telecom prices and lower electricity prices. But, at the
same time, privatisation can create private monopolies which exploit the consumer even more than
inefficient state-owned monopolies. Rail privatisation in the UK has led to increased fragmentation
and higher prices for consumers (though also some benefits on some services).

Greater labour market flexibility can be a mixed blessing for workers. On the one hand, it can lead to
a more productive economy which creates more jobs. On the other hand, it can lead to greater wage
inequality and higher job insecurity.

In the late 1970s, British unions were very powerful, many days were lost due to strikes, Britain’s
competitiveness suffered as a result. To some extent, reforms to unions did help create a more
flexible economy in the UK.

However, the Conservative government grossly overestimated the impact of their ‘supply-side
miracle.’ In the Lawson boom, they allowed the economy to grow by 5% a year, thinking there had
been a supply side miracle. But, actually, there was no miracle. The UK’s long-run trend rate was
stuck at 2.5% and the Lawson boom led a bust and recession of 1991.

On the other hand, the US labour market has gone to the other extreme. Workers have very little
protection, minimum wages are low and there has been a widening of inequality, with little evidence
of a trickle-down effect to workers.

he strongest supporters of Supply-side economics argue that cutting income tax rates can boost
labour supply, increase economic growth and even increase government revenue. (though tax rates
fall, because more people work, overall tax revenue increases). Needless to say, it becomes a
popular policy.

Some argue the Reagan tax cuts for high earners showed that lower income tax rates could increase
labour supply and help increase tax revenue (supporters of supply-side economics)

Others dispute the extent to which tax cut actually increases labour supply. A study by Randall
Mariger, an economist at the Federal Reserve Board, found that tax rates cut increased the labour
 supply by less the 1% between 1985 and 1986. In other words, labour supply is quite inelastic. –
However, you could find studies which suggest labour supply is more elastic in the long term.

Empirical evidence suggests, the 1993 Clinton increase in the top marginal tax bracket to 39.6% had
no effect on the labour supply of the rich. The tax increase wasn’t a barrier to a strong period of
economic growth. Combined with fiscal restraint, it also led to one of the few US budget surpluses in
recent decades.

However, it depends on the marginal tax rate. For countries like Sweden with an 80% marginal tax
rate or the marginal tax rates which were a legacy of WWII in US and UK, there is a much stronger
case that these kinds of marginal tax rates do create disincentives to work.

Wage differential

Compensating wage differentials - higher pay can often be some reward for risk-taking in certain
jobs, working in poor conditions and having to work unsocial hours.

A reward for human capital - in a competitive labour market equilibrium, wage differentials
compensate workers for (opportunity and direct) costs of human capital acquisition. There is an
opportunity cost in acquiring qualifications - measured by the current earnings foregone by staying
in full or part-time education.

Different skill levels - the gap between poorly skilled and highly skilled workers gets wider each year.
One reason is that the market demand for skilled labour grows more quickly than the demand for
semi-skilled workers. This pushes up pay levels. Highly skilled workers are often in inelastic supply
and rising demand forces up the "going wage rate" in an industry.

Differences in labour productivity and revenue creation - workers whose efficiency is highest and
ability to generate revenue for a firm should be rewarded with higher pay. City economists and
analysts are often highly paid not least because they can claim annual bonuses based on
performance. Top sports stars can command top wages because of their potential to generate extra
revenue from ticket sales and merchandising.

Trade unions and their collective bargaining power - unions might exercise their bargaining power
to offset the power of an employer in a particular occupation and in doing so achieve a mark-up on
wages compared to those on offer to non-union members

Employer discrimination is a factor that cannot be ignored despite over twenty years of equal pay
legislation in place

Policies for Economic Development

Economic development implies an improvement in economic welfare through higher real GDP,
but also through an improvement in other economic indicators, such as improved literacy,
better infrastructure, reduced poverty and improved healthcare standards.

Policies for economic development could involve:

1. Improved macroeconomic conditions (create stable economic climate of low inflation and
positive economic growth)
2. Free market supply-side policies – privatisation, deregulation, lower taxes, less regulation to
stimulate private sector investment.
3. Government interventionist supply-side policies – increased spending on ‘public goods’ such as
education, public transport and healthcare.

For developing economies, other issues could involve:

1. Export Oriented Development – Reduction in tariff barriers and promoting free trade as a way
to improve economic development.
2. Diversification away from agriculture to manufacturing as a way to promote economic
development.

Policies for Economic Development

Macroeconomic Stability

Macroeconomic stability would involve a commitment to low inflation. Low inflation creates a
climate where foreign investors have more confidence to invest in that country. High inflation
can lead to devaluation of the currency and discourage foreign investment. To create a low
inflationary framework, it requires:

 Effective monetary policy. E.g. given a Central Bank independence to control inflation through
using monetary policy.
 Disciplined Fiscal Policy – i.e. avoid large budget deficits.
 For example, if you look at the current situation of China and India – they both have high rates
of economic growth, but the concern is that their economies could easily ‘overheat’ and cause
inflationary pressures. Therefore, to keep a lid on inflation is an important underlying factor in
sustainable economic development.

A potential problem of macroeconomic stability is that in the pursuit of low inflation, higher
interest rates can conflict with lower economic growth – at least in the short term. Sometimes,
countries have pursued low inflation with great vigour, but at a cost of recession and higher
unemployment. This creates a constraint to economic development. The ideal is to pursue a
combination of low inflation and sustainable economic growth.

It depends on the economic situation, some countries may be in a situation where there is a
fundamental lack of demand due to overvalued exchange rate and tight monetary policy.
Therefore, economic development may require demand-side policies which boost aggregate
demand.

Macroeconomic stabilisation may involve policies to reduce government budget deficits.

However, this may involve spending cuts on social welfare programs.

2. Less Restrictive Regulation and Tackle Corruption

Some developing countries are held back by over-restrictive regulation, corruption and high
costs of doing business. To attract both domestic and inward investment, it is necessary to
remove these costs and create a climate which is conducive to business. To tackle corruption
may not be easy, but it is often one of the biggest constraints to economic development.

Also, in the effort to reduce levels of regulation, it is important that useful regulations such as
protection of the environment aren’t discarded in efforts to attract inward investment.
Otherwise, economic growth may come at the expense of sustainable development.
3. Privatisation and De-regulation

An important aspect of China’s rapid economic development was the decision to move from a
Communist economy to a mixed economy. Several state-owned industries were privatised. This
gives firms a profit incentive to cut costs and aim for greater efficiency. De-regulation involves
making state-owned monopolies face competition. This greater competitive pressure can help
to create incentives to cut costs. Greater competitive pressures may also be gained through
liberalising trade and opening markets to international competition.

A potential problem of privatisation is that it can exacerbate inequality in society. In Russia,

privatisation enabled a small number of oligarchs to gain control of key industries at low cost.
Arguably, this does little for economic development because the nation’s resources become
owned by a small number of very rich individuals, and there is little ‘trickle down’ to poorer
members of society.

4. Effective Tax Structure and Tax Collection

One of the challenges developing economies often face is to effectively tax and collect what they
are supposed to. If the government is unable to collect sufficient tax from the richest aspect of
the economy (e.g. production of natural resources) there will be little funds to finance necessary
public sector investment in services with a high social benefit. For example, the average tax rate
in Sub-Saharan Africa is only 15% of GDP – compared to an average of 40% of GDP in the
developed world.

But average revenue collection rates in Sub-Saharan African countries stood at only 13.3
percent of GDP during 1990 to 1994. They increased very slightly to 15.6 percent during 2000
to 2006… And the researchers found that – and this is even more alarming – most of this slight
increase came from sources such as value added taxes, which tend to burden the poor more
heavily than the wealthy. Oxfam blog

5. Investment in Public Services

In areas such as education, healthcare and transport, there is often market failure – the free
market doesn’t provide sufficient levels of education. A key factor in improving economic
development is to increase levels of literacy and numeracy. Without basic levels of education
and training, it is very difficult for the economy to develop into higher value-added industries.

Evidence on returns from investing in education are mixed. Often investment takes a long time
to feed through into directly higher rates of economic growth. pdf World Bank But, on its
literacy is an aim of development.

6. Diversification away from agriculture

A constraint developing economies may face is that their current comparative advantage is in
the production of primary products. However, these limit economic development due to volatile
prices, a low-income elasticity of demand and finite nature. Therefore, economic development
may require government encouragement of new industries in different sectors, such as
manufacturing. This may require a temporary commitment to tariffs (see: infant industry
argument)

See also: Lewis’ model of a dual economy and arguments for shifting labour to manufacturing.

Attempts to diversify away from agriculture can have mixed results. Sometimes, countries with
a poor basic level of infrastructure struggle to make effective use of capital investment in
manufacturing. Some argue government attempts to encourage manufacturing industry is
 misplaced because they tend to have poor information about best kinds of industries to
promote. It is better to allow the free market to decide to which industries to invest in.

Role of IMF in Economic Development

The IMF can play a role in dealing with economic crisis. The IMF can give a country a loan to
meet a temporary fiscal or balance of payments problem. This loan can be vital for helping the
economy to deal with an unexpected crisis. Without the loan, the economy may have to
experience a bigger fall in living standards to meet the creditors.

However, the role of the IMF is often criticised. In return for a loan, the IMF has often insisted on
certain free-market reforms in return for the loan. This has included

 Privatisation
 Tax reform
 Cuts in government spending (often on welfare payments)

These free market supply-side policies have arguably often harmed economic development, e.g.
reducing access to basic necessities and lower government spending on the poor.

However, the IMF often point out that they are usually asked to help only in crisis so there is
often a difficult choice to make

Multinational companies like Nike, Sony, Apple, Toyota, Coca-Cola all have investments and
operations in developing economies. This can lead to both benefits and disadvantages for
developing economies.

Advantages of Multinational Corporations in developing countries.

Multinationals provide an inflow of capital into the developing country. E.g. the investment to
build the factory is counted as a capital flow on the financial account of the balance of payments.
This capital investment helps the economy develop and increase its productive capacity.

The Harrod-Domar model of growth suggests that this level of investment is important for
determining the level of economic growth. One of the best ways to increase the level of
economic growth is to provide an inflow of capital from abroad.

The inflows of capital help to finance a current account deficit. (Basically, this means that
foreign investment enables developing countries to buy imports)

Multinational corporations provide employment. Although wages seem very low by Western
standards, people in developing countries often see these new jobs as preferable to working as a
subsistence farmer with even lower income.

Even liberal economists like Paul Krugman and Jeffrey Sachs have defended ‘sweatshop labour’
arguing that although employers are paying too low wages. Often sweatshop labour is better
than the alternative of scavenging or no paid employment. Economies in south-east Asia have
seen rising wages in recent decades – showing that low wage economies can develop.
Multinational firms may help improve infrastructure in the economy. They may improve the
skills of their workforce. Foreign investment may stimulate spending in infrastructure such as
roads and transport.

Multinational firms help to diversify the economy away from relying on primary products and
agriculture – which are often subject to volatile prices and supply.

Disadvantages of Multinational Corporations in developing countries

Environmental costs. Multinational companies can outsource parts of the production process to
developing economies with weaker environmental legislation. For example, there is a trade in
rubbish, which gets sent to developing economies like India for disposal and recycling.

Profit repatriated. Although multinationals invest in developing economies, the profit is

repatriated to the location of the multinational, so the net capital inflows are less than they
seem.

Skilled labour. When undertaking new projects, the multinational may have to employ skilled
labour from other economies and not the developing economy. This means best jobs are not
received by local workers and the investment is diffused.

Raw materials. A large component of multinational investment in developing economies is

seeking out raw materials – oil, diamonds, rubber and precious metals. The extraction of raw
materials can cause environmental externalities – polluted rivers, loss of natural landscape.
Also, there is only a short-term inflow of money to pay for the materials. In many cases, the
payments have not effectively filtered through to the wider population – with money syphoned
off by corrupt officials and politicians. Therefore, local communities in developing economies
can face widespread disruption, but only limited compensation for the precious materials.

However, it is not all one way. Chinese companies have built new roads and railways in Africa to
gain better access to raw materials in Central Africa. This infrastructure investment will leave a
long-term legacy – even if firms leave Africa.

Sweat-shop labour. Not all economists are convinced sweat-shop labour is a good thing. Critics
argue that weak labour conditions allow multinationals to use their monopsony power and pay
lower wages to workers than they should get paid