Unemployment and Fiscal Policies

Unemployment is an important macroeconomic variable which can be devastating not only to an individual but to his/her family and the economy as well. As unemployment turns out to be all the more long haul, its effect turns out to be progressively sweeping, frequently affecting expectations for everyday comforts. At a personal level, it can damage the chances and opportunities for future generations while at an economical level, unemployment is considered as a loss of valuable skills and resources. It is important to note that unemployed are the ones who are of legal age and is willing and able to work and are constantly looking for jobs and opportunities but are not able to find such an opportunity because of various reasons and all those who are of legal age and does not wish to work, that is, all those who chose to be voluntarily unemployed cannot be termed as categorized under the unemployed.

Causes of Unemployment

Unemployment can be caused mainly due to four reasons:

1.      A high rate of population: More the number of people searching for job opportunities lesser will be the availability for the same. This will lead to an excess demand-supply gap resulting in unemployment. This kind of a situation where demand for employment opportunities exceed the supply can be noted in overpopulated countries like China and India.

2.      Rapid technological change: Jobs which were earlier handled by manpower are replaced with different machines and technologies nowadays. Even though the replacement of low skilled and unskilled workers with advanced technology increased efficient and accurate production, it also resulted in a higher unemployment rate.

3. Lack of education or skills: This occurs when the capabilities or qualifications of an individual are not adequate to meet his/her job obligations or responsibilities. In addition to this, new technological advances require higher levels of skills which will cause a problem to a large section of the population with no access to any of these. Therefore, the lack of employment opportunities for those without higher education will lead to higher unemployment rates.

4.      Due to the rising cost: A rise in the cost of production for a firm makes it difficult for them to pay the optimum salary for the workers or even the minimum wage permitted by the law. Consequently, the workers will quit low-income jobs and leave the firms.

Types of unemployment

Due to the reasons stated above, unemployment can be of four types:

1.      Frictional Unemployment: It is that type of unemployment which exists due to the process of job searching or due to the process of moving from one job to another. Therefore, this type of unemployment is faced by the ones entering the workforce or by the ones decided to leave the present jobs in search of a new one or in other words, a mismatch between the available opportunities and preferences.

2. Structural Unemployment: It is a more extending and enduring type of unemployment caused by the technological changes, wage rigidity and job rationing. Workers come up short on the imperative employment skills required or might face geographical problems which restrict travelling to the place where jobs are available, etc.
3. Cyclical Unemployment: It is that type of unemployment caused by cyclical trends and therefore, there will be an increase in the unemployment rate during recession and decrease during an expansion of the economy. For example, during a recession, the number of people buying a car would be very less and hence, the manufacturer might cut off the excess labour due to low demand for cars and during an expansion, the vice versa. 

4.      Seasonal Unemployment: It is that type of unemployment which occurs at a particular time or season of a year as the demand for labour is lower than usual. For example, the farmers will remain unemployed till their crops are harvested or people employed in snow skiing resort maybe unemployed during summer-time.

Consequences of unemployment

The problem of unemployment can affect both an individual as well as the economy as whole. At an individual level, unemployment causes poverty especially if the individual has financial commitments like loans, rent, etc. Without a constant income, an independent individual will naturally go below the poverty line, hence adding as a burden to the economy. Being unemployed for a long time can cause excessive stress and misguide these people to earn money in the wrong ways, hence adding to domestic violence, drug abuse, illegal activities, etc.

Both mental and physical health of the unemployed can be greatly disturbed due to poor standards of living, malnourishment, lack of confidence self-esteem, etc., which might lead to depression and even suicides. Therefore, unemployment can affect a person at financial, social and psychological levels.

For the economy, unemployment indicates the wastage of valuable skills and resources and reduction in the tax revenues and receipts as well. And moreover, economic growth will be lowered due to unemployed resources.

Fiscal policies adopted to compact with the problem.

To resolve the problem of unemployment caused by recession, demand-side policies should be adopted and supply-side policies should be adopted to reduce the natural rate of unemployment. During a recession, there will be a decrease in the consumer spending and investment which results in a negative multiplier effect with unemployed resources.

An increase in the aggregate demand (AD) through fiscal policy measures will boost the economic growth with an increase in real GDP. Therefore, the government need to adopt expansionary fiscal policies which include a reduction in taxes or increasing government spending through higher investment.

In the above figure, an expansionary fiscal policy through reducing the tax rates will shift the aggregate demand from AD₁ to AD₂. This led to an increase in the price level from P₁ to P₂ and output/employment to increase from Y₁ to Y₂ which will ultimately boost the economy. This boost in economic growth will facilitate more employment opportunities, thus reducing unemployment.

Fiscal Policies & IS-LM Framework.

As a part of fiscal policy measures, when the government introduces tax cuts in the economy, the consumers will spend more, therefore increasing the planned expenditure. This will lead to an increase in the level of income at any given interest rate due to the tax multiplier. Thus, the IS curve will shift rightwards resulting in an increase in both income and interest rate. 

In the above diagram, a decrease in the tax rates will increase the consumer spending which will further increase the planned expenditure causing the IS curve to shift from IS₁ to IS₂. Hence, the equilibrium point is shifted from point A to point B with a rise in income from Y₁ to Y₂ and interest rate from r₁ to r₂. 

Case Study on US The recession from 2001.

As the unemployment rate rose from 3.9% to 4.9% from the second half of 2000 till the first half of 2001 and to 6.3% by June 2003, the US economy faced a tremendous decline in economic activity steered by a fall in aggregate demand. A series of events including a steep decline in the stock market, terrorists attack on New York City and Washington DC and scandals by some well-known co-operations, etc shifted the IS curve leftwards causing a decline in the employment opportunities as well. As fiscal and monetary policy measures were quickly taken as a response to this by major tax cuts both in 2001 and 2003, the IS was shifted to the right and the unemployment rate was below 5% by July 2005 and for the next few years, this rate remained almost the same but by the end of 2008, the unemployment rate started rising again tremendously causing another recession.

To tackle the recession of 2009, President Barack Obama approved a package of increased spending and tax cuts worth $787 billion which took a few months to be implemented properly so as to spread higher spending throughout the economy.

  Pettinger, Tejvan (2017)                                                                                                                              From the above images, it is evident that the Fiscal Stimulus Act in 2009 was able to limit the scope of unemployment resulting in an economic recovery. Even though the initiative was anything but a far-reaching intend to revitalize performance measurement in the national government, it is a positive initial move toward making genuine improvement in government execution.

But this fall in unemployment was not just a result of expansionary fiscal policy but in addition monetary policy measures were also included for the speedy recovery of the economy. However, when compared to the countries that did not adopt fiscal policy measures to boost the economy, the US did have a stronger recovery than any other country.

Limitations of Fiscal Policy Measures in Solving Unemployment.

1.      When unemployment is caused by supply-side factors like that of lack of skills or mismatch of opportunities, i.e., structural or frictional unemployment, a fiscal policy increasing the aggregate demand and economic growth is likely to be ineffective in tackling unemployment.

2.      Also, adopting an expansionary fiscal policy, when the economy is at full employment, will lead to higher inflation than reducing the unemployment rate.

3.      A tax cut may not always lead to increased spending but can also lead to increased saving which will not increase the planned expenditure, hence pushing the economy into further recession.

Conclusion

Unemployment has become a significant issue which influences our life, wellbeing, economy and network. Hence, nations should fabricate more organizations and production lines to give more chances and positions to react to the need for the expanded populace along with both fiscal and monetary policy measures.