Question

Currently, when a firm lays off a worker, the firm pays part of the worker’s unemployment compensation (the rest of the money comes from the system’s general revenue). One suggested reform would require firms to pay all of the worker’s unemployment compensation. How will this reform affect the natural rate of unemployment? Explain your answer. Use the equation for the natural rate of unemployment to explain your answer.

Answer 1

If the ratio of benefits to paid employment is high, then there is little incentive to take a job. For example, since the early 1980s unemployment benefits have been index-linked ( this means increased in line with inflation). Wages have tended to rise faster than inflation. Therefore, the difference between benefits and paid employment has grown increasing the incentive to get a job, and therefore, reducing the natural rate of unemployment in the UK.

Similarly, the wages of the lowest paid will greatly affect the incentives to take a job. In the UK the govt has introduced a national minimum wage and increased it from £3.60 (1997) to £7.83 (2018) This has made work relatively more attractive compared to staying on benefits. Also, government policies have been introduced to try and encourage the unemployed back into work. The New Deal involves giving workers retraining schemes and interviews to help them find work. Also, if workers are offered a job after six months they have to accept it or risk losing benefits, and hence they will be not counted as unemployed. This has helped reduce the natural rate.
The equation for natural rate of unemployment is ; (frictional unemployment + structural unemployment)/total labour force. Now , even with the presence of full employment this natural rate of unemployment may be present whereas if total rate of unemployment is present then full employment cant prevail,and unemployment benefits are given only in cases of natural rate and not total rate, because in natural rate workers are compelled to stay unemployed due to some natural reason but in total unemployment it may be that a person is unemployed but not searching to get employed, so in that case they do not get unemployment benefits.