Theory of employment or theory of Unemployment

Higher employment (or lower unemployment) rate is good indicator of the macro economic health of any country and that is desirable to any government, economic analyst, even to a commoner. But ’employment’ is not an economic problem, rather the problem is ‘scarcity of employment opportunity’ that is unemployment. So unemployment covers more economic discussion than employment. To reach the optimum level of employment economic theorists always quest for reasons, types, and others notion of unemployment.
Many economists point out many views about increase the level of employment as well as decrease the level of unemployment and causes behind and ways out to do so. All these theory can be accommodated under the title of ‘theory of employment’ or even ‘theory of unemployment’.
Types of Unemployment
There is considerable debate amongst economists as to what the main causes of unemployment are. Keynesian economics emphasizes unemployment resulting from insufficient effective demand for goods and service in the economy (cyclical unemployment). Others point to structural problems (inefficiencies) inherent in labor markets (structural unemployment). Classical or neoclassical economics tends to reject these explanations, and focuses more on rigidities imposed on the labor market from the outside, such as minimum wage laws, taxes, and other regulations that may discourage the hiring of workers (classical unemployment). Yet others see unemployment as largely due to voluntary choices by the unemployed (frictional unemployment). On the other extreme, Marxists see unemployment as a structural fact helping to preserve business profitability and capitalism (Marxian unemployment). The different perspectives may be right in different ways, contributing to our understanding of different types of unemployment.
Economists distinguish between five major kinds of unemployment, i.e., cyclical, frictional, structural, classical, and Marxian. (There is another distinction between voluntary and involuntary unemployment.) Real-world unemployment may combine different types, while all five might exist at one time. The magnitude of each of these is difficult to measure, partly because they overlap and are thus hard to separate from each other.
Frictional Unemployment
This unemployment involves people being temporarily between jobs, searching for new ones or searching for first job by just entering in the labour force. It is sometimes called search unemployment and is seen as largely voluntary. It arises because either employers fire workers or workers quit, usually because the individual characteristics of the workers do not fit the individual characteristics of the job (including matters of the employer’s personal taste or the employee’s inadequate work effort) or newly redundant workers or workers entering the labour market (such as university graduates) may take time to find appropriate jobs at wage rates they are prepared to accept. Some employers – such as restaurants and other providers of secondary labor markets – use human management strategies that rely on rapid turnover of employees, so that frictional unemployment is normal in these sectors.
This type of unemployment coincides with an equal number of vacancies and the best way to lower this kind of unemployment is to provide more and better information to job seekers and employers, perhaps through job-banks in centralized computers (as in some countries in Europe). In theory, an economy could also be shifted away from emphasizing jobs that have high turnover, perhaps by using tax incentives or worker-training programs. Technological change, for example, the internet made job searches cheaper and more comprehensive and improvement in labour market mediation, for example, activities of recruitment and Hiring agencies (like labour contractor or Monowar Associates) often reduces frictional unemployment.
One kind of frictional unemployment is called wait unemployment; it refers to the effects of the existence of some sectors where employed workers are paid more than the market-clearing equilibrium wage. Not only does this restrict the amount of employment in the high-wage sector, but also it attracts workers from other sectors who wait to try to get jobs there. The main problem with this theory is that such workers will likely “wait” while having jobs, so that they are not counted as unemployed. In showbiz, for example, those who are waiting for acting jobs also do some work (private tuition) in the secondary labour market (while acting in some plays of any theater group at night for no pay). However, these workers might be seen as underemployed.
Another type of frictional unemployment is seasonal unemployment, where specific industries or occupations are characterised by seasonal work, which may lead to unemployment. Examples include workers employed during farm harvest times or those working rain time jobs in the water bodies (ferrying boatman). Because the jobs that are lost are those that rely on the season, it is difficult to employ these workers.
Structural Unemployment
This reflects a mismatch between the skills and other attributes of the labor force and those demanded by employers. Even though the number of vacancies may be equal to the number of the unemployed, the unemployed workers lack the skills needed for the jobs – or are in the wrong part of the country or world to take the jobs offered. It is a mismatch of skills and opportunities due to the structure of the economy changing. That is, it is very expensive to unite the workers with jobs. One possible example in the rich countries is the present combination of the shortage of nurses with an excess labor supply in Information Technology. Unemployed programmers cannot easily become nurses, because of the need for new specialized training, the willingness to switch into the available jobs, and the legal requirements of such professions.
Structural unemployment is a result of the dynamic changes of a capitalist economy (such as technological change) – and the fact that labor markets can never be as flexible as (say) financial markets. Workers are “left behind” due to costs of training and moving (e.g., the cost of selling one’s house in a depressed local economy), plus inefficiencies in the labor markets, such as discrimination.
Structural unemployment is hard to separate empirically from frictional unemployment, except to say that it lasts longer. It is also more painful. As with frictional unemployment, simple demand-side stimulus will not work to easily abolish this type of unemployment. Some sort of direct attack on the problems of the labor market – such as training programs, mobility subsidies, anti-discrimination policies, a Basic Income Guarantee, and/or a Citizen’s Dividend – seems required. These policies may be reinforced by the maintenance of high aggregate demand, so that the two types of policy are complementary.
Much technological unemployment (e.g. due to the replacement of workers by machines or robots) might be counted as structural unemployment. Alternatively, technological unemployment might refer to the way in which steady increases in labor productivity mean that fewer workers are needed to produce the same level of output every year. The fact that aggregate demand can be raised to deal with this problem suggests that this problem is one of cyclical unemployment. As indicated by Okun’s Law, the demand side must grow sufficiently quickly to absorb not only the growing labor force but also the workers made redundant by increased labor productivity.
Cyclical or Demand Deficient Unemployment
Cyclical unemployment is involuntary unemployment due to a lack of aggregate demand for goods and services. This is also known as Keynesian “demand deficient” unemployment and is associated with the transition of the economy through the business cycle. When there is an economic recession we expect to see a rising level of unemployment because of plant closures and worker lay-offs. This is due to a fall in demand leading to a contraction in output across many industries.
In Keynesian economics, any level of unemployment beyond the natural rate is most likely due to insufficient demand in the overall economy. During a recession, aggregate expenditure is deficient causing the underutilization of inputs (including labour). Aggregate expenditure can be increased, according to Keynes, by increasing consumption spending, increasing investment spending, increasing government spending, or increasing the net of exports and an expansion in Aggregate expenditure lessen the unemployment rate i.e., cyclical unemployment.




Classical or Real Wage Unemployment
Real wage unemployment is a form of dis-equilibrium unemployment that occurs when real wages for jobs are forced above the market clearing level.
Traditionally, trade unions and wages councils are seen as the institutions causing this type of unemployment.
Classical unemployment is thought to be the result of real wages being above their market clearing level leading to an excess supply of labour. Some economists believe that the introduction of the national minimum wage (NMW) may create some classical unemployment in industries where average wage rates are closer to the NMW level and where international competition from low-labour cost producers is severe.
Marxian unemployment
As Karl Marx claimed some unemployment – the reserve army of the unemployed – is normally needed in order to maintain work discipline in jobs, keep wages down, and protect business profitability. If profitability suffers a sustained depression, capitalists[1] can and will punish people by imposing a recession via their control over investment decisions (a capital strike). To the Marxian school, these strikes are rare, since in normal times the government, responding to pressure from their most important constituencies, will encourage recessions before profits are hurt.
To Marxists, this kind of unemployment cannot be abolished without overthrowing capitalism as an economic system and replacing it with democratic socialism – or else by running capitalism using a fascist state, under which profitability is protected by the systematic use of direct force.
Voluntary and involuntary Unemployment
Though there have been several definitions of voluntary (and involuntary) unemployment in the economics literature, a simple distinction is often applied. Voluntary unemployment is blamed on the individual unemployed workers (and their decisions), whereas involuntary unemployment exists because of the socio-economic environment (including the market structure, government intervention, and the level of aggregate demand) in which individuals operate. In these terms, much or most of frictional unemployment is voluntary, since it reflects individual search behavior. On the other hand, cyclical unemployment, structural unemployment, classical unemployment, and Marxian unemployment are largely involuntary in nature. However, the existence of structural unemployment may reflect choices made by the unemployed in the past, while classical unemployment may result from the legislative and economic choices made by labor unions and/or political parties. So in practice, the distinction between voluntary and involuntary unemployment is hard to draw. The clearest cases of involuntary unemployment are those where there are fewer job vacancies than unemployed workers even when wages are allowed to adjust, so that even if all vacancies were to be filled, there would be unemployed workers. This is the case of cyclical unemployment and Marxian unemployment, for which macroeconomic forces lead to microeconomic unemployment.

Hidden unemployment
Hidden, or covered, unemployment is the unemployment of potential workers that is not reflected in official unemployment statistics, due to the way the statistics are collected. In many countries only those who have no work but are actively looking for work (and/or qualifying for social security benefits) are counted as unemployed. Those who have given up looking for work (and sometimes those who are on Government retraining programmes) are not officially counted among the unemployed, even though they are not employed. The same applies to those who have taken early retirement to avoid being laid off, but would prefer to be working. Because of hidden unemployment, official statistics often underestimate unemployment rates.
Determinants of Employment
Many economists call attention to many points that determine the level of employment. Some of those are institutional and some are exterior variables. The following list includes some of the determinants of employment/unemployment
(i)                  Ratio of Population Growth and Economic growth,
(ii)                Real interest rate (Monetary Policy),
(iii)               Tax rate and government expenditure (Fiscal Policy),
(iv)              Income, labour, wage policy and their implementation,
(ii)        Union density,
(v)                Wage coordination,
(vi)              Business cycle,
(vii)             Rate of technological advancement.
Major Economics Schools’ views on labour and employment

Mercantilist (about 1500 – 1800 or 1776)
In the history of economics, the mercantilists are considered as the first school of economic thought, though they are often criticized as “Pamphleteers” rather than a school of thought. They had no systematic, comprehensive, consistent treatise, no leader, common method, or theory. Each “mercantilist” sought advantage for a specific, trade, merchant, joint-stock company or social group. “Protectionism” is often seen as a primary characteristic of Mercantilism.
The primary objective of Mercantilism was to increase the power of the nation state. One of the important aspects of national power or strength was wealth that was equated with specie i.e., hard currency. The states that followed a policy of mercantilism tended to see trade, colonialism and conquest as the primary ways of increasing wealth.
The mercantilism has given more concentration on political economics than  economic behavioral aspects and had a little discussion on issues like labour market or unemployment. One of the mercantilists, Sir William Petty (1623-1687), described “Land and Labour” as the basic element of the value creation and said, “labour is the father and active principle of wealth as lands are the mother.”
Physiocrats (18th century)
Physiocrats, a group of French philosophers, developed the idea of the economy as a circular flow of income and output – the first complete system of economics. They opposed the Mercantilist policy of promoting trade at the expense of agriculture because they believed that agriculture was the sole source of wealth in an economy. As a reaction against the Mercantilists’ copious trade regulations, the Physiocrats advocated a policy of laissez-faire, which called for minimal government interference in the economy.
The most significant contribution of the physiocrats was their emphasis on productive work as the source of national wealth. This is in contrast to earlier mercantilist schools, which often focused on the ruler’s wealth, accumulation of gold or the balance of trade. A chief weakness of the physiocrats, from the viewpoint of modern economics, is that they only considered agricultural labor to be valuable. Physiocrats viewed the production of goods and services as consumption of the agricultural surplus, while modern economists consider these to be productive activities, which add to national income.
Classical School
The Classical School of economic theory began with the publication in 1776 of Adam Smith’s (1723-1790) monumental work, The Wealth of Nations. The book identified land, labor, and capital as the three factors of production and the major contributors to a nation’s wealth. Smith incorporated some of the Physiocrats’ ideas, including laissez-faire, into his own economic theories, but rejected the idea that only agriculture was productive.
While Adam Smith emphasized the production of income, David Ricardo (1772-1823) focused on the distribution of income among landowners, workers, and capitalists. Ricardo saw a conflict between landowners on the one hand and labor and capital on the other. He posited that the growth of population and capital, pressing against a fixed supply of land, pushes up rents and holds down wages and profits.
Thomas Robert Malthus (1766-1834) used the idea of diminishing returns to explain low living standards. Population, he argued, tended to increase geometrically, outstripping the production of food, which increased arithmetically. The force of a rapidly growing population against a limited amount of land meant diminishing returns to labor. The result, he claimed, was chronically low wages, which prevented the standard of living for most of the population from rising above the subsistence level.
Malthus also questioned the automatic tendency of a market economy to produce full employment. He blamed unemployment upon the economy’s tendency to limit its spending by saving too much, a theme that lay forgotten until John Maynard Keynes revived it in the 1930s.
Coming at the end of the Classical tradition, John Stuart Mill (1806-1873) parted company with the earlier classical economists on the inevitability of the distribution of income produced by the market system. Mill pointed to a distinct difference between the market’s two roles: allocation of resources and distribution of income. The market might be efficient in allocating resources but not in distributing income, he wrote, making it necessary for society to intervene.

Neo classical or Marginalist School
Classical economists theorized that prices are determined by the costs of production. Marginalist economists emphasized that prices also depend upon the level of demand, which in turn depends upon the amount of consumer satisfaction provided by individual goods and services.
Marginalists provided modern microeconomics with the basic analytic tools of demand and supply, consumer utility, and a mathematical framework for using those tools. Marginalists also showed that in a free market economy, the factors of production — land, labor, and capital — receive returns equal to their contributions to production. This principle was sometimes used to justify the existing distribution of income: that people earned exactly what they or their property contributed to production.
Neoclassical or marginalist analysis model and tools are very important contribution to the modern labour economics rather any of its employment or labour market related theory.

Marxist School
The Marxist School challenged the foundations of Classical theory. Writing during the mid-19th century, Karl Marx (1818-1883) saw capitalism as an evolutionary phase in economic development. He believed that capitalism would ultimately destroy itself and be succeeded by a world without private property.
An advocate of a labor theory of value, Marx believed that all production belongs to labor because workers produce all value within society. He believed that the market system allows capitalists, the owners of machinery and factories, to exploit workers by denying them a fair share of what they produce, as well as their income. Marx predicted that capitalism would produce growing misery for workers as competition for profit led capitalists to adopt labor-saving machinery, creating a “reserve army of the unemployed” who would eventually rise up and seize the means of production.
Keynesian School
Reacting to the severity of the worldwide depression, John Maynard Keynes (1883-1946) in 1936 broke from the Classical tradition with the publication of the General Theory of Employment, Interest, and Money. The Classical view assumed that in a recession, wages and prices would decline to restore full employment. Keynes held that the opposite was true. Falling prices and wages, by depressing people’s incomes, would prevent a revival of spending. He insisted that direct government intervention was necessary to increase total spending.
Keynes’ arguments proved the modern rationale for the use of government spending and taxing to stabilize the economy. Government would spend and decrease taxes when private spending was insufficient and threatened a recession; it would reduce spending and increase taxes when private spending was too great and threatened inflation. His analytic framework, focusing on the factors that determine total spending, remains the core of modern macroeconomic analysis. Keynes establishes a set of functional relationships that shows interactions between commodity market and labour market. Demand for goods in monetary terms must be the same as money income because payments and receipts for the total of economic transactions must be the same. In other words national income equals national expenditure. Employment thus depends on the size of the national income.
Since the level of employment depends upon the level of income, we can say that level of employment depends upon level of consumption plus investment. If investment reduces, income will fall. If income falls, consumption will fall by an amount determined by the marginal propensity to consume. Thus income will again fall to a new equilibrium point. There is a whole series of levels of income at which this equilibrium may occur, thus a whole series of equilibrium employment levels. The level of investment will determine the equilibrium level of employment. (Over employment is not possible because such will lead to inflation thus reducing real value of income. But Keynes does not elaborate here.) Also money wages are inflexible downwards, thus classical equilibrium models are held to be inaccurate.


[1] Here, the term “capitalism” is used to refer to a person who owns economic capital, whether or not s/he holds “capitalist” political views.