Labour Market: Imperfections

Causes of labour market failure

There are several causes of labour market failure which occur due to imperfections. Let’s study these today.

Unemployment

Don’t forget that labour is a factor input. If a factor input is not being utilised, then it means there is a waste of scarce resources. Labour is not different – if labour is not being utilised, then labour resources are being wasted.

Unemployment is only a serious market failure if levels are too high – at a level that is affecting social welfare and harming economic growth. It’s particularly problematic when it’s for a long period of time. This is called long-term unemployment, and this can impede economic growth.

However, some unemployment is actually good (just a little bit) – it helps keep wages and prices down – too much employment leads to more demand which can lead to inflation.

What can the government do about unemployment?

To ensure unemployment is minimised, the replacement ratio must be low.

The replacement ratio is how much somebody would earn if they were unemployed, compared to how much they would earn in employment.

For example, if somebody can earn £200 a month from doing nothing and just claiming benefits, but they can earn £3000 a month from going to work, then this ratio would be 1:15 (your unemployment benefits is 6.7 % of what your working income would be).

If benefits were raised an increased to £300 a month, then this ratio would rise to 1:10 (your unemployment benefits have risen to 10% of what your working income would be).

If unemployment benefits are too high, this will increase the replacement ratio – some people may feel that they’re better off not working and being voluntarily unemployed. This is called the unemployment trap.

Therefore, the government must ensure the replacement ratio is low enough to keep people interested in working.

Skill Shortages

Sometimes employers face the problem of skill shortages. There are not enough people in the workforce with enough skills/training needed to perform the job needed.

A shortage of a resource drives up the price: that means those who do possess the necessary skills are paid a higher wage – this increases costs for firms.

A shortage means firms may have to employ people with inadequate skills: so, firms may have no other choice but to employ people who do not have the skills/experience necessary to do a job properly. This can lead to a reduction of productivity and quality.

Imperfect Information

Imperfect information occurs in all real-world labour markets. There are many people today who are not in their ideal job. They feel like they’re not being paid enough, and they hate what they do. Yet, they feel like they must stay at work because it pays the bills. This leads to a reduction in welfare. If workers and employers had perfect information, this problem would not exist. Everybody would be in their ideal job.

So, imperfect information leads to people working in the wrong jobs, which decreases productivity and welfare.

Furthermore, employers can act on imperfect information which leads to them paying increased wages for lower productivity. We can relate this problem to the problem of labour market discrimination, which exists because of imperfect information.

So, imperfect information leads to employers paying increased wages with lower productivity, which increases the average cost of labour.

Imperfect information also leads to frictional unemployment. When workers are between two jobs there is a period of take that is needed to find another job. If people had perfect information, the time between two jobs would be minimised.

What can we do about information failure?

We can use the internet to help with this problem. If the government and firms invest into putting more jobs online, then information will be easier to access. For example, job sites where people can search for jobs applicable to them, or where employers can search for people with certain skills. Sites like Indeed or Reed help – but also sites like LinkedIn where we have a community of workers connecting with each other.

Immobility of Labour

There are two kinds of labour immobility: geographical and occupational.

Geographical immobility: when workers are not able to (or not willing to) move to locations where their ideal job is.

It means that employers may find it difficult to attract people with the necessary skills for a job. This means there’s a misallocation of resources.

Why would workers not want to move to where jobs are?

Workers are human beings. They have families, friends and emotional reasons for not wanting to move away.

It’s also expensive and time consuming to move to a new house. It may not be worth the cost or hassle.

Geographical immobility leads to variations in skills from area to area. In some areas there may be a surplus of skills. In other areas, there may be a shortage.

What can be done to improve geographical immobility of labour?

The government could invest into new and improved forms of transport. This may make it easier for some to travel and this will help alleviate some of the skills shortages in certain areas.

Technology could develop to a level where people are not held back by where they live. Improvements in internet infrastructure will no doubt be a solution to this problem. If people can work from home in their own offices, then where you live will no longer be such an issue.

However, this is only really relevant to job roles in the tertiary and quaternary sectors. Jobs in the primary and secondary sectors would probably still need the presence of a physical workforce in a dedicated place of work e.g. factory or farm work.

Occupational immobility: when workers aren’t able to move from one occupation to another one easily.

This is because different occupations require different skill sets. Workers sometimes need to retrain in order to be applicable for a desired job. This problem can be worsened if a worker is highly specialised in a certain field because they cannot carry over their set of specialist skills to all jobs.

e.g. a brain surgeon cannot carry over his/her skills and become a salesperson.

Certain jobs need qualifications in order for you to be applicable. This can be time consuming and costly. This is why people generally only have one university degree and not two are three.

Other jobs need a special kind of person to be able to perform the duties required. For example, not everybody can be salesperson. You have to have the “gift of the gab” and this doesn’t come naturally to many people.

Not everybody can become a doctor. You may be smart enough but can you handle seeing people die or dealing with blood and guts all day?

Occupational immobility can lead to unemployment. A specific type of unemployment called structural unemployment is the worst kind. This is when people do not hold the specific skill sets that are being demanded by employers. This can lead to long-term unemployment.

What can the government do about this?

The government can invest into more education and provide job retraining schemes to make it easier for people to be more occupationally mobile.

Don’t confuse labour market failure with all economic inactivity

I mentioned earlier that unused labour resources lead to labour market failure. This is true, but don’t forget that sometimes people are unemployed for a good reason.

You could be in full-time education

You could be looking after a dependent - like your child

You could be looking after a sick or old person – a family member for example or a volunteer worker

You could be ill or have a disability

These are perfectly valid reasons for not being economically active!

People in education are our investments into the future. They will improve the country’s overall skill set and cause the economy to grow.

People who are looking after the sick and elderly are actually saving the government money. Without volunteers, the government would spend more looking after sick and elderly people, and this would cost the taxpayer.

People who have an illness or disability may not be fit to work – this is not a wasted resource because these people are not willing or able to work. (You need to be willing and able to work for your unemployment to be classed as a wasted resource.)

So, in summary we have learned: