What’s it: Employment refers to the condition of having paid work, as in the Cambridge Dictionary. We also use it to refer to the number of people who have a job (Cambridge Dictionary) or the extent to which a labor force is used (Merriam-Webster dictionary).
Workers perform tasks in exchange for monetary wages or salaries. They use the money, after paying taxes, to save or spend on goods and services.
Wages can take many forms. That may be per hour, per job, or annual salary. Apart from salary, some companies also offer benefits such as bonuses, share ownership, insurance benefits, housing, or gym membership.
Not everyone in the population is available for work. From the total population, we can classify it into the working age and non-working age categories.
The definition of working-age varies from country to country. Usually, it refers to individuals aged 15-64 years. Outside the range, they are a non-working age population, including infants, school-age children, retirees.
From the working-age population, we can divide it into the following two categories:
- Labor force
- Non-working population
The labor force represents all the labor input available for use in the production of goods and services. They consist of two groups. First are those who are at work. They may be full-time workers, part-time workers, or casual workers. They can be hired temporarily for a specific project only or permanently.
Second is unemployment. This consists of people who are unemployed but are actively looking for work. They may be recent graduates or have switched jobs. Those who were fired and who are actively looking for a job also fall into this category. Economists usually classify unemployment into several categories: frictional unemployment, structural unemployment, and cyclical unemployment.
Furthermore, the non-working population consists of people who are not working and are not actively looking for work. They are in the working-age range. But, they do not want to work and not actively look for jobs for reasons such as continuing their education or taking care of family members.
Three indicators for analyzing labor conditions are:
- Labor force participation rate equals the ratio between the labor force to the total working-age population.
- Employment rate refers to the ratio between the number of employed people and the working-age population. It measures the extent to which labor resources are being used.
- Unemployment rate is the ratio between total unemployed workers and the total labor force. This indicator usually moves along the business cycle.
Apart from the three above, several most-often observed indicators are wages, working hours, and labor productivity.
Labor force participation rate
Increasing the participation rate indicates more labor is available for the production of goods and services. Thus, its increase has a positive contribution to potential output (potential GDP) in an economy.
Several factors influence the level of labor force participation. It decreases as much of the population enters retirement age. Likewise, during a recession or depression, many unemployed give up and stop looking for work, reducing participation rates.
Other factors contributing to reduced labor force participation are inadequate public health levels, low spending on retraining programs, and less generous pregnancy and child care policies.
The level of education and industrialization also affects labor force participation. Higher education levels make workers more flexible and mobile to change jobs. It increases the participation rate.
Meanwhile, industrialization creates more jobs. Many people then move from the informal sector and household production to the manufacturing sector.
Finally, the high cost of living also affects the level of participation. It encourages more women to work and leave their roles as housewives.
Unemployment rate is never zero for structural or frictional reasons. We call the lowest point the natural rate of unemployment. When this is reached, the economy is full employment, and unemployment consists only of structural and frictional unemployment.
Structural unemployment occurs because workers do not have skills that match the demand. It usually happens because of a shift in the economic structure. For example, agricultural mechanization leaves some farmworkers unemployed. They cannot switch to other jobs, for example, in the manufacturing sector, because of inadequate skills.
Possible solutions to address structural unemployment is through retraining programs and improving the education system. As people are more educated, they become more flexible, making it easier to learn new skills.
Meanwhile, frictional unemployment occurs because of the time lag to get a job. People entering the workforce for the first time (recent graduates) or changing jobs need time to find suitable jobs. So, as long as they are not yet found a job, they are categorized as unemployed.
Frictional unemployment occurs because the labor market operates in imperfect competition. Workers are immobile when changing jobs. You need time to find a job that matches your skills. Once you find it, the employer may offer you unsuitable wages, hours of work, and benefits, and so you turn it down.
Why employment matters for the economy
Labor is one of the production factors besides land, capital, and entrepreneurship. Companies use them as input in producing goods and providing services. They may be manual workers, white-collar workers. Although automation and robots emerged, they did not wholly replace labor input for some types of jobs.
Employment conditions are important because they indicate the health level of the economy. We often associate it with other economic indicators such as potential GDP, economic growth, prospects for household income and business profits, and demand for goods and services.
Workers supply productive inputs to firms and, in aggregate, to the economy. In macroeconomics, the labor force (labor supply) and its productivity determine the country’s potential output (potential GDP).
Workers also act as consumers of goods and services produced by the business. Typically, consumption represents a large proportion of gross domestic product (GDP). Hence, changes in consumption can affect economic growth.
During a prosperous economy (economic expansion), workers are optimistic about their income and job security and are likely to spend more money. Higher consumer spending raises aggregate demand and boosts real GDP growth.
Higher real GDP indicates an increase in economic activity. Businesses absorb more labor to increase production and meet demand. As a result, the unemployment rate decreases.
Conversely, when the economy worsens (contraction or recession), the employment outlook worsens as the number of jobs shrinks. Unemployment rate is high. Workers see their income and employment prospects as deteriorating. They prefer to save money and reduce some demand for goods and services.
Weak demand forces businesses to cut their output. That led to a further decline in economic growth. At the same time, they also reduce some of their labor to streamline operations. As a result, the unemployment rate rises, worsening household income, and demand prospects.
Full employment occurs when all labor resources are fully utilized. The unemployment rate reaches its natural level and leaves only structural and frictional unemployment. The economy is operating at full capacity, and real GDP equals potential GDP.
Full employment is another macroeconomic goals besides low and stable inflation, sustainable economic growth rates, and balance of payments equilibrium.
Achieving full employment is important for several reasons. Full employment means the economy is prosperous. When lots of people work, it improves household income prospects. They have a lot of money to buy goods and services.
Increased household demand leads to improved business profit prospects. They increase production and create a lot of jobs.
For the government, the improving prospects for household income and business profits contribute positively to tax revenues. Expenditures on social programs such as unemployment benefits also decrease. Poverty and social costs, such as crime and vandalism, decrease when the economy is prosperous.
Policies to achieve full employment
To achieve full employment, the government can adopt two economic policy approaches:
- Demand-side policy
- Supply-side policy
Demand-side policies aim to reduce the cyclical unemployment inherent in economic cycles. The two main policy options are monetary policy and fiscal policy. Both affect aggregate demand, which in turn affects business activities.
Monetary policy is under the central bank. In this case, the central bank affects the money supply through the policy rate, open market operations, and the reserve requirement ratio.
Changes in the money supply affect aggregate demand through several channels. One of them is through lending rates.
For example, when interest rates fall, it increases the demand for new loans by households and businesses. They can use it to purchase several items such as housing, cars, and capital goods.
Meanwhile, fiscal policy works through changes to the government budget. To influence the economy, the government changes its taxes and spending.
Say, the government lowers income taxes. A reduction in taxes stimulates household demand because they have more money to spend on goods and services. Increasing demand will encourage businesses to increase production.
Finally, supply-side policies aim to reduce structural and frictional unemployment in the economy. In other words, it’s to try and reduce the natural rate of unemployment.
Some examples of supply-side policies are:
- Investing in human capital. For example, the government increases the budget to improve the education system and training programs.
- Reducing labor union power. When they are strong, unions demand higher wages. It increases production costs and reduces business profits. Thus, companies demand fewer workers.
- Eliminating the minimum wage. Minimum wages put the labor market in disequilibrium and raise excess supply. Wages are too high for some businesses, prompting them to ask for less labor.
- Deregulation of the labor market. One example is making it easier to hire and fire workers.
- Improve infrastructure and transportation. That way, it is easy for people to find work in different areas, thereby increasing geographic mobility.