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Policies to Reduce Unemployment


A range of government policies are available for Governments wanting to reduce the scale of unemployment in the economy. These policies need to focus on the underlying causes of unemployment for them to be successful.

        Real Wage






Real Wage Unemployment

Prescriptions for reducing real wage unemployment normally focus around the strategy of making each labour market more flexible so that pay conditions become more adaptable to changing demand and supply conditions. Real wages should rise when demand, output and employment and rising, but they may need to fall if an industry experiences recession which puts jobs at threat. The UK economy has developed a flexible labour market model similar to that of the United States during the last fifteen years.


Trade Union reforms were a centre-piece of the Conservative Government's strategy to improve the performance of the labour market. The Labour Party under Tony Blair has not reversed these reforms since coming to office, although some new legislation has been introduced to give workers the right to achieve union recognition. A National Minimum Wage has also been introduced.


Keynesian Unemployment

Policies to reduce Keynesian demand-deficient unemployment need to raise the level of aggregate demand for goods and services in the economy. A number of options are available.


Increased Government Expenditure

The Government can raise the level of its own spending. This "fiscal pump-priming" directly increases aggregate demand and can have a multiplier effect on equilibrium national income. The government could raise current expenditure (for example raising pay levels in education and the health service) or expand spending on capital projects which add to the stock of capital (for example spending on new roads, new hospitals or other major infrastructural projects).  Sustained economic growth provides a platform for more jobs to be created in the economy.


Lower Taxation

A reduction in direct taxation increases consumers' disposable income and should boost household spending. The effect may be greater if taxes are cut for people on lower than average incomes. These tax-payers are likely to spend a greater percentage of their disposable income.



Lower interest rates

A relaxation of monetary policy through lower interest rates encourages the demand for credit, reduces saving and increases consumers' real 'effective' disposable incomes; all of which will boost consumption and demand. It may also encourage firms to invest, as the marginal cost of investment will fall.   Remember that interest rates are not set by the government. The Bank of England now sets interest rates each month at the meetings of the Monetary Policy Committee.


Depreciation of the exchange rate

A lower value for the pound should lead to a rise in the orders of exports from UK firms and to a reduction of import penetration by making exports cheaper and imports more expensive.


Remember the importance of time lags!

Government policies to stimulate increased aggregate demand for domestic output take time to have their effect. There are variable time lags between the government reflating the economy using fiscal and or monetary policy and the final effect on output and employment in specific industries.


Structural Unemployment



There are a number of different approaches that can be adopted to help alleviate structural unemployment. These are sometimes known as active labour market policies. The first involves direct government action to match jobs to the unemployed.


Regional policy incentives

Gives grants and subsidies to firms to locate in areas of high unemployment. However, this does not solve the problem of occupational immobility. Often regional policy requires extra retraining schemes to give workers the relevant skills to allow them to take up new jobs.


Investment in worker training

Spending on training schemes to re-skill the unemployed through investment in vocational education or guaranteed work experience for unemployed "outsiders" in the labour market.



Improving geographical mobility of labour

The government could provide grants or low cost housing to encourage workers to move to other regions where there are jobs. The problem with this policy is that people are inherently immobile as they are often bound by family and social ties.


Market solution - no need for government to get involved!

One approach is to simply leave the problem of structural unemployment to the market. Some economists argue that intervention slows the natural reallocation of resources to high growth areas and only makes the problem worse. In areas of above average unemployment it may make some sense to allow wage levels to fall to attract new capital into an area.


Frictional Unemployment

Lower real values of unemployment benefit and improved job information

The implementation of the Job Seeker's Allowance in 1996 ensures that workers are actively seeking work as the payment of benefit is dependent on them proving this at fortnightly interviews.


However, if the government reduced the real value of unemployment benefits, or limited the duration of a claim, search times between jobs could be reduced even further as workers would have to quickly take on new positions before their financial situations deteriorated.


Better information on job vacancies in the labour market can help to reduce job search.


Cuts in direct taxes

The government could reduce direct taxes for the low paid to increase the post tax wage and, therefore, encourage them to find work more quickly. The Labour Government is introducing a 10% starting rate of tax to encourage more low income groups back into work.


Most analysts believe that tax cuts on their own are insufficient to reduce frictional unemployment. Complementary reforms to the benefits system to reduce the problem of the poverty trap may also be needed.




E-mail Steve Margetts