unemployed); some economists consider these workers voluntarily unemployed and thus not part of the involuntary jobless.8 It might be defined also to exclude those whose inappropriate skill levels make them de facto not “able” to work at jobs that are available—the so-called structurally unemployed. So defined, a full-employment (no-unemployment) level occurs where the quantity of labor demanded equals the quantity of labor supplied.
Less than full employment, or what economists generally call “cyclical unemployment,” exists when wages exceed the market-clearing equilibrium wage. It is possible also to have, temporarily, a below-equilibrium wage where there are, in the context of figure 2.1, labor shortages, or, to use conventional contemporary terminology, negative cyclical unemployment—people are working who would not normally work at the prevailing wage. They work because they are temporarily misinformed as to their true wage since they suffer from “money illusion,” or perhaps because labor contracts require them to do so even though they would not choose to do so if the legal obligation were not present.
Normally, however, the theory suggests that wages will tend to move toward equilibrium. Using our restricted labor-force definition, unemployment is zero at that equilibrium. Using the official unemployment definition, there is frictional and structural unemployment. Officially defined unemployment at the equilibrium wage equals what is now often called the natural rate of unemployment.
While most of the remainder of this book attempts to use the simple wages model discussed above to explain variations in cyclical unemployment in the United States in the twentieth century, in chapters 13 and 14 historical dimensions of frictional and structural unemployment are discussed, both in general and with respect to demographic (race, gender, and age) and geographic variations in the natural rate of unemployment.
AUSTRIAN PERSPECTIVES ON UNEMPLOYMENT
No school of economic thought has placed a greater emphasis on the importance of markets in coordinating economic activity than the Austrian school. With respect to unemployment, Austrians accept the view that unemployment reflects discoordination and disequilibrium in the labor market, or, more simply, excessive wage levels.9 As the late Friedrich von Hayek put it, “The cause of unemployment … is a deviation from the equilibrium prices and wages which would establish themselves with a free market and stable money.”10 Recently, scholars have supported this view empirically.11
Recognizing that, however, the Austrians generally believe that the disequilibrium in the labor market often may be a by-product or consequence of human-caused disturbances in other markets. In particular, increases in the stock of money induced by monetary policies of the central bank (Federal Reserve Bank in the United States) change the purchasing power of the circulating medium. Such a move tends to push interest rates in a downward direction not justified by true human time preferences. The price of capital resources falls relative to the price of labor services. This, in turn, leads to a distortion in resource allocation toward capital-intensive ventures and away from labor-intensive ones.
A Digression on Unemployment Statistics
In the discussion above, we suggested that the labor force could be defined to exclude workers who are conventionally classified as frictionally or structurally unemployed. That may seem artificial and arbitrary. It is important to realize, however, that the official unemployment definition is inherently arbitrary in several ways. For example, at the present time no one under the age of sixteen is included in the labor force, even though there are some child entertainers whose work earns them seven-digit annual incomes. There are millions of housewives and househusbands who “work around the house” doing economically productive activity. Yet they are excluded from the labor force since they do not sell their services in a market. A person working in a child-care facility is “employed”, while a mother who takes care of her own four children at home is “not employed” (as distinct from “unemployed”) even though she probably provides as many (and as high-quality) child care services as the person selling her services in the labor market.
Another problem comes from the fact that many of those persons classified as unemployed in fact have opportunities to work and have chosen not to exercise them. They choose to be unemployed. Suppose an aerospace engineer with graduate degrees is dismissed from his $60,000-a-year job with a defense contractor because of defense cutbacks. Suppose he stops into a local fast-food restaurant after his last day of work and starts talking with his friend, the owner of the restaurant. Suppose further that the friend offers the engineer a job as restaurant manager at a salary of $500 a week ($26,000 a year.) Suppose also that the engineer turns him down. Is the engineer unemployed? Yes, as far as the Bureau of Labor Statistics is concerned, as long as he continues to search for a job similar to his previous one. Clearly, such a definition of “unemployed” fails adequately to convey voluntarily foregone job prospects. Consider figure 2.2. Unemployed individuals have a reservation wage—a minimum wage that they will take as a condition for accepting a new job. A freshly unemployed person may have high aspirations with respect to a new job, expecting a relatively high wage. The longer he or she is unemployed, however, the more likely the worker is to lower the reservation wage, as the reality of job opportunities and the financial pressure of unemployment impact on decisions. Similarly, the longer one searches for a job, the better the job that the unemployed individual is likely to find (although there is an obvious limit to the gains in wages obtainable from more thorough searching.)
FIGURE 2.2 THE DURATION OF UNEMPLOYMENT
In figure 2.2, the individual chooses to take a new job when the best offered position equals (or exceeds) the reservation wage. It is optimal for the individual to remain unemployed for a duration of OX weeks. Government policies might change the reservation wage. For example, if the unemployed receives generous unemployment benefits, he or she may be more choosy about taking a new job. In the context of figure 2.2, unemployment compensation raises the reservation wage to the dotted line, leading to the optimal employment occurring after a longer duration of unemployment. This raises the reported unemployment rate, as well as the natural rate of unemployment.12
There are still other difficulties with the unemployment definition. Some persons become discouraged after long unemployment spells and stop looking for jobs, even though they certainly would like one. They are dropped from the labor force and no longer classified as unemployed, even though in a meaningful sense they are in fact unemployed. Still other problems deal with part-time work, workers in the “underground economy” not included in the government statistics, and with some welfare recipients in workfare programs.13
Some economists believe that the employment-population ratio is a better measure of job opportunities. Over time, that ratio has tended to rise with increased female labor-force participation. For example, in both 1960 and 1988, the civilian unemployment rate was 5.5 percent. Yet 62.6 percent of the noninstutionalized population over sixteen worked in 1988, compared with but 56.8 percent in 1960. By the unemployment measure, job opportunities were similar in both years, but the employment-population ratio tells a different story.
While the imperfections of the unemployment statistics are numerous, to some extent they cancel each other out. While the fact that some people temporarily choose to be unemployed leads to some inflation in the unemployment
