University of Illinois

Economics 103
Term Paper: US Unemployment
Behruz Mistry
Discussion section:
AQO
3.00pm to 3.50pm
Yue Wu
Article Name:
US Unemployment: A Long-Term Trap
Article Source:
http://www.ft.com/cms/s/0/b2a7549e-cf8a11e3-9b2b00144feabdc0.html#axzz30QyJTK2a
Published: 04-30-2014
Written: 04-30-2014

Introduction
The considered article discusses the slowing of economic growth in the United States
of America since the recession of 2008, mainly due to a static high unemployment
rate. Speculation of the near future indicates further stagnant unemployment rates in
the USA for the next few years, greatly affecting the economic progress. The article
specifies that the main problem in the USA is long-term unemployment. Although
short-term unemployment has remained at a considerably low 4 percent, long-term
unemployment soars high above the anticipated 5.5 to 6 percent.

The government is worried that due to the stagnant nature of long-term

unemployment, this will soon become a structural economic problem. The worry
persists that the long-term unemployment cannot be cured by the slow economic
growth. Economists fear that America is heading in a threatening direction of
hysteresis. In the unfortunate event of such an economic crisis, the USA would be
faced with limited further economic growth a huge pressure on welfare resources.

The article highlights some examples of cyclical and frictional unemployment; one
woman, Lalanya Tevyaw, has been unemployed since June 2013, and is worried that
she will lose the skill required in her trade if she remains jobless. Another man, Kevin
Bingham, who has faced redundancy since 2012, has switched trades altogether and is
looking for a job in culinary arts after being a machinist for numerous years. In
general, 35.8 percent of the unemployed in the USA have been in such a situation for
27 months or longer.

Furthermore, research conducted by economist Alan Krueger has shown that the
chance of employment grows smaller the longer someone remains jobless. This is
worsened by the fact that a systematic bias against the jobless has been found; people
who have been unemployed for a while are often discriminated against and are
rejected regardless of qualifications. The article concludes that this, along with the
stubbornness of growth post-recession, is the main cause of long-term
unemployment.

Theory Review and Analysis

Economic growth is an increase in the amount of goods and services produced by a
country over a period of time. It is most conventionally measured in real Gross
Domestic Product (GDP).

The unemployment of a country is defined as the amount of its labor force that is out
of work despite actively seeking employment. The unemployment rate is calculated as
the ratio of the amount of people in the labor force without work to the amount of
people in the labor force. Unemployment is often directly linked to the economic
growth of a country, as it is a determinant of aggregate demand. The economic
fluctuations of the GDP can be illustrated on a business cycle, such as (figure 1.1).
The cyclical process shown in (figure 1.1) reflects the USAs current status coming
out of a recession. As expected, the USA is facing economic growth; however, the rate
of growth is significantly lower than desirable due to factors such as long-term
unemployment in the country. (Figure 1.2) below illustrates the effect of
unemployment on the GDP of the USA.

As shown in (figure 1.2), the distance between quantities demanded (Q 1/Q2) and full
employment (YFC) represents the unemployment of the country. When unemployment
rates are lowered, the unemployment gap reduces from Q 1 Yfc to Q2 Yfc. This
causes a right-shift in the aggregate demand curve, from AD to AD 1. As evident, the
decrease in employment has a direct effect on the aggregate demand, and thus the
GDP of the country.

The American government must aim to reduce unemployment in order to stimulate

further growth in the economy. In order to do this, the government must implement
further fiscal measures, as stated in the article. Specifically, expansionary fiscal
measures would involve increasing government spending and decreasing taxes in
order to boost aggregate demand and indirectly reduce unemployment.

Unfortunately, as well as the implementation lag of the policy and its undesirable
connotations, a negative aspect of increased government spending involves
opportunity cost through reallocation of resources; the money spent and not earned
due to the implementation of fiscal measures and tax cuts could instead be used in
other necessary sectors; for example, government investment in increased basic
education could ensure a more productive and possibly larger work force.

As shown in the production possibility frontier (figure 1.3), the aforementioned

government spending would lead to the reallocation of resources from A, a great
emphasis on fiscal measures, to B, a higher focus on basic education. Due to this
reallocation, we can see that the output of government spending will reduce from GS 1

to GS2, and in turn, the output of basic education will increase from E 1 to E2. (Figure
1.3) clearly demonstrates the concept of opportunity cost in this hypothetical situation.

The only way the market could avoid opportunity cost entirely and accommodate both
an investment in basic education subsidization and contribute to fiscal measure is to
stimulate further economic growth, and thus see the PPF shift outward, as shown in
(figure 1.4). As apparent, the outward shift, from curve PPF1 to curve PPF2, promises
not only increased output of basic education from E 1 to E2, but also increased fiscal
funding from GS1 to GS2. The same focus as basic education could also be put in for
job centers or for professional retraining, which would allow frictionally unemployed
workers to find jobs more easily. Additionally, frictional and structural unemployment
could be combatted through government investment in increased job centers or
retraining of the labor force. The implementation of the policy, however, may also
lead to increased inflation.
Alternatively, the Federal Reserve could also consider monetary policies; again, an
expansionary monetary policy could be used, in which interest rates would be lowered
in order to promote consumer spending. A rapid increase in the supply of money to
the country will also occur, emphasizing the aforementioned effect; since consumer
spending is a component of aggregate demand (Aggregate Demand = Consumer
spending + Investments + Government spending + (Exports Imports)), the reduced
interest rates would correlate to an increased aggregate demand and thus boost real
GDP. Again, however, inflation rates will soar due to the increased firm and
household expenditure.

Conclusion
In my opinion, the American government should not be concerned regarding inflation
rates and should pursue the implementation of monetary and fiscal policies in order to
decrease unemployment. Inflation has a majorly short-term effect; the inflation rate
can be relatively easily controlled, and inflation will not be detrimental unless extreme
in suitable amounts, it may even help to promote economic activity. Contrastingly,
unemployment has significant long-term effects. Unemployment over long periods
may affect members of the labor force psychologically, as well as financially, and
dishearten their desires to work, making them obsolete. Already this has been the
case, as mentioned in the article; one year later, 34 percent gave up looking for jobs
and dropped out of the work force altogether.

Furthermore, the low GDP and aggregate demand will eventually lead to
accumulation of debt in the USA, and possibly to extremes such as homelessness, and
thus creating a circle of poverty. Ultimately, upon eventual economic recovery, job
vacancies may not even be filled. The extended period of long-term unemployment
not only forces the government to dedicate resources towards unemployment benefits,
but also hinders the governments potential wealth through income tax.

Due to these reasons, I believe that the American governments and the Federal
Reserves decision is wise, and targeting long-term unemployment is a key factor in
the promotion of economic growth, and the government should aim to reduce the long
term unemployment through the discussed tactics in order to be as effective as
possible.

Appendix
Figure 1.1: The Business Cycle

Pea
k
Growt
h
Recessi
Growt Trend
on
h

Economic activity (real GDP)

Trough

Time (years)

Figure 1.2: Unemployment on AD/AS Diagram

LRAS
AD 1
AD

P1

SRAS
Q

Yfc

Price Level ($)

Output

PE

Unemployment

Appendix (continued..)
Figure 1.3: Reallocation of resources on PPF

Q
u
a
GS
n 1
ti
t 2
GS
y
o
f
Fi
s
c

A
B

Quantity

Basic Education

E1

of

E2

Figure 1.4: Economic growth on PPF

PPF2
Q 1
PPF
u
a
GS2
n
ti
GS
1
t
y
o
f
Fi
s
c
E1
Education

E2

Quantity

of

Basic