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Economics of unemployment

Unemployment figures often make headlines. Indeed this is an economic indicator frequently quoted in the financial and political press. Quite often the same figures are seen as exceptionally positive or particularly negative, depending on the points of view.

While commenting on economic indicators is in itself beneficial, as it helps people focus their analysis on facts rather than perceptions, it is equally important that any analysis is based on a sound understanding of the concepts used and related issues.

Unemployment occurs when the demand for labour – the number of jobs available – falls short of labour supply – the number of persons who are willing to work. This is a situation of disequilibrium, which occurs when the price of labour (wage rate) is ‘too high’ when compared to the equilibrium wage. Viewed along these lines, unemployment is thus the result of a situation where the wage rate is not sufficiently flexible in the downward direction because of some form of market rigidity.

A common bone of contention is whether one should focus on the level of unemployment (headcount) or the unemployment rate (the number of people unemployed compared to the labour force). While from a social perspective the number of people unemployed is important, because these people could be at risk of falling into poverty, from a narrow economic perspective the unemployment rate is more important since this indicator is not influenced by the size of the population and thus ensures comparability across countries.

Another area where confusion reigns relates to the different measures of unemployment that are published. The Employment and Training Corporation (ETC) compiles the number of registered unemployed, which basically captures the amount of people who actually go to register as unemployed. In parallel, the National Statistics Office (NSO) estimates the unemployment rate based on the Labour Force Survey (LFS) methodology, which simply put, is based on responses provided by a sample of people.

While this measure is by its very nature imprecise, because it is based on a survey, it is only the LFS results which are comparable to those published by other countries because these are based on an internationally agreed methodology.

What few commentators (if any) bother to highlight is that the estimate of the unemployment based on the LFS, carries with it an important proviso: that figures have to be treated with caution because of the ‘margin of error’. In simple English, this means that small differences from one period to the next can be attributable to sampling factors rather than genuine changes. All analysis carried out on changes which fall within the margin of error would thus be spurious.

Nonetheless, a clear message which emerges from Malta’s LFS survey results is that the unemployment rate is higher than that based on the ETC register, the reason being that there are people who are technically unemployed, in the sense that they are actively seeking a job, but who do not bother to register with the ETC, particularly if they are not eligible for any financial assistance.

Another issue which is not fully appreciated is that unemployment is generally thought to be influenced by seasonal factors, primarily because labour demand and labour supply change along the year. For example, in summer there are more jobs created in the tourism sector while, on the other hand, school leavers join the labour market at particular intervals.

Hence, it is more useful to evaluate annual developments (to remove seasonality), or if one wants to be more scientific, comment on the seasonally-adjusted unemployment rate, which is basically a rate which adjusts the headline unemployment to even out known seasonal fluctuations.

Unemployment rate is higher than that based on ETC register

Another clear message emerging from the LFS statistics is that the unemployment rate in Malta compares very favourably with the situation in the other EU member states. Indeed Malta’s low unemployment rate is often quoted as a sign of positive economic conditions.

However, this figure has to be treated with caution since labour supply in Malta is still rather low because of a low female activity rate. The latter limits the production potential of an economy and is therefore not positive from an economic perspective.

Another phenomenon whose magnitude is unknown relates to ‘the discouraged worker effect’ which happens when people lose hope of looking for a job, and as a result they actually drop out of the labour supply.

Looking ahead, government’s policies aiming to increase the female participation rate could in the short term lead to a higher headline unemployment rate if the rate of job creation does not match the accelerated influx of people willing to work.

However, it is more important to focus on a more crucial economic indicator which at present hardly finds itself on the local press. This is the ‘natural rate of unemployment’ which refers to the lowest rate of unemployment that an economy can sustain over the long run.

This economic concept captures the idea that some element of unemployment is inevitable. Economic theories suggest that the natural rate could be influenced by factors such as the relative generosity of the unemployment benefits, the mismatch between job seekers and potential employers, and possible deteriorating skills because of long periods of absence from work.

If the quality of the economic debate is to increase in Malta, institutions which publish economic commentaries should start popularising this measure.

Unemployment is a very serious economic and social problem, and this phenomenon deserves to be analysed correctly.

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