According to the Office of National Statistics, the unemployment rate in the UK currently sits at 8%, the highest figure since 1994. The unemployment rate has been in a range between 7.5% and 8.0% since early 2010. The current trends show that youth unemployment is at its highest level since 1992 and that there is no end in sight for the unemployment problem in the UK (Office for National Statistics, 2011). These figures do not include those who are considered inactive -- not actively seeking work. Their numbers have increased as well, to 23.3% of the working age population.
Office for National Statistics
This paper will analyze the current unemployment problem. It is understood that the current problem is related to the recent recession, as the unemployment rate spiked during and after the recession phase. Some of the causes will analyzed, and the paper will then conclude with an outline of potential solutions to bring the unemployment rate back down to normal levels. The advantages and disadvantages of each option will be covered, and ultimately a recommendation will be made with respect to the best combination of options available to the government to address the problem of high unemployment.
The recent recession was a global phenomenon with many different contributing causes. In the UK, a significant portion of the problem was a crisis in the banking sector dramatically reduced lending. As a result of this, business investment declined and consumers became less willing to spend. The decline in business investment began to lead to job losses, which drove consumer savings rates higher. Ultimately, this created a feedback loop wherein a decline in consumer demand caused ever-greater business contraction. Exports also declined as many foreign markets also faced demand declines. Thus, the decline in the economy was broad-based and demand driven (BBC, 2009).
There are three main types of unemployment -- cyclical, frictional and structural. Frictional unemployment is normal in any economy and refers to unemployment created by people changing jobs, and as a result of young people entering the workforce (About.com, 2011). Structural unemployment relates to unemployment in certain sectors of the economy, matched by shortages of workers in other parts of the economy. The evidence suggests that because the recession was broad-based that this unemployment is not structural in nature. Rather, the unemployment currently facing Great Britain is cyclical, relating to a downturn in the business cycle, one that happened to be caused by a financial crisis.
Cyclical unemployment is strongly correlated to the level of economic activity, for which a good measure is GDP. If one examines the GDP accounting identity, the causes of the unemployment are relatively clear: GDP = C + I + G + X -- M where C = consumer spending, I = business investment; G = government spending and (X-M) = net exports or imports.
In this identity, the recession brought about a decline in consumer spending and a decline in business investment. Government spending did not increase to make up the difference, nor did the trade balance. Thus, the level of economic activity declined. This would be expected to increase the rate of unemployment under normal circumstances. The response to the unemployment situation on the part of the UK government has also contributed to the lack of improvement in the unemployment rate over the course of the past year. The government has chosen to address the situation by instituting sharp spending cuts. This runs against the logic inherent in the accounting identity. The government's logic is that the recession was related more to a lack of business confidence, and that this confidence could be restored by making spending cuts. There was no evidence to suggest that the business confidence issue was related to government spending (as opposed to the battered banking system and lack of consumer demand), so the government's plan has not only reduced G, but failed to increase I. That there was no empirical evidence to support the government's theory was borne out in practice. The unemployment has seen no improvement in the past several months as there has been little reason for businesses to increase investment. For their part, consumers may be willing to spend, but the high unemployment rate makes this difficult. Unemployed workers simply do not have the same degree of spending power that employed workers have.
If the unemployment rate remains high over the long run, the economy will begin to suffer long-term impacts. Unemployed workers see their job skills deteriorate and many eventually join the ranks of the permanently unemployed. This is already happening as the number of inactive workers rises -- people have given up on finding employment. This puts more people onto the dole, and creates not only a drag on public spending but also a drag on economic productivity. Indeed after the first austerity budget, the government's economic projections have been revised downward (Buckle & Fraher, 2011) Britain benefits from having these people working, but the longer they are unemployed the harder it will become for them to find work. Millions could be permanently unemployed or underemployed as the result of the unemployment rate staying so high for so long.
Analysis of Solutions & Recommendation
The solutions to the unemployment problem must address the problem at its roots. The current unemployment is cyclical, which implies that only an upswing in the business cycle will solve the problem. There are a number of theories as to how to kick start an upswing in business, including the failing course presently chosen by the government. Using the accounting identity, an increase in any of C, I, G or (X-M) could work. Consumers could be encouraged to spend more, but in an economy characterized by high unemployment and worse by high consumer debt this option is unlikely to be the first to work.
The government's chosen approach is just one theory as to how to spur business investment. Business investment can also be spurred by increases in consumer spending, which has already been identified as a key challenge. Business investment can be improved by improving exports as well. Alternately, monetary policy can be used to help spur business investment. Even with low interest rates, however, business investment has remained too low to kick start the economy, indicating that business confidence is low, and has remained so. This leaves government spending -- fiscal policy -- as a potential option. Fiscal policy can be an effective means of spurring economic growth -- World War Two is a good example -- but is comes with risks. The first risk is that the fiscal policy needs to be well-targeted, lest the money spent be spent inefficiently. The second risk is that fiscal policy increases the national debt and could increase the cost of borrowing, thus having long-term negative impacts on the ability of government to spend in the future.
The other option is to increase net exports. An effective way to encourage this is to lower the value of the pound -- that is to essentially print money. This form of monetary policy would make UK exports more competitive in foreign markets, thereby spurring demand for those exports. The result of this would be increased investment, which in turn would create jobs in the economy. Thus, the two main options are to lower the value of the pound to make UK exports more competitive, or to engage in government spending on jobs directly.
It is recommended that the government follow a combination of lowering the value of the pound to spur sales in foreign markets and the use of well-targeted fiscal policy. There is no real debt crisis in the UK, and borrowing rates remain historically low at 3.75% for a 10-year bond (Bloomberg, 2011). This means there is no need for austerity that throws thousands…