What is the role of government in economic instability and what are the most effective policies to address unemployment?

In economics, unemployment is an economic problem that is categorized into frictional, structural, and cyclical unemployment based on its causes and solutions. Each school of thought proposes policies that balance market autonomy and the role of government to address unemployment.

 

In economics, unemployment is defined as the absence of jobs for people who are both willing and able to work, and an increase in unemployment leads to economic problems such as a lower quantity of goods or services that society can produce. Higher unemployment reduces the purchasing power of consumers, which reduces overall demand in the market, which leads to lower sales and less investment by businesses, which negatively impacts economic growth.
Economics categorizes unemployment into frictional unemployment, structural unemployment, and cyclical unemployment depending on the cause of unemployment, and suggests solutions in relation to the role of the government. First of all, frictional unemployment is unemployment that is inevitably caused by workers changing jobs or workplaces by personal choice under normal economic conditions. It doesn’t cause much economic loss in terms of overall output, so it doesn’t require much of a government role. However, to minimize frictional unemployment, policies are needed to improve the efficiency of employment information systems and strengthen job matching services.
Next, structural unemployment is unemployment caused by a mismatch between the skill level supplied by workers and the skill level required by firms. This can occur when the demand for labor in a particular field decreases dramatically due to changes in industry structure or technological innovation. Structural unemployment can be addressed through methods such as retraining workers, which requires the government to set policies to address it. To this end, governments should expand vocational education and training programs and encourage the acquisition of new skills.
Finally, cyclical unemployment is unemployment that occurs as a result of a decrease in business activity due to the effects of an economic downturn, which in turn reduces the demand for labor, leading to a reduction in employment. In other words, assuming that the supply and demand for labor is in equilibrium in the labor market, cyclical unemployment is caused by a downturn in the economy that causes prices to fall, which causes firms to reduce production, which in turn reduces the demand for labor. Because cyclical unemployment can be economically costly in terms of lost output compared to other types of unemployment, economists have different opinions about the role of government in addressing it.
First, the classical school of thought views cyclical unemployment as a temporary phenomenon that can be resolved naturally because price variables such as wages and prices are fully elastic in the market. According to them, if the nominal wage (the amount of money workers receive) remains unchanged and prices fall due to an economic downturn, the real wage (the nominal wage divided by prices), the actual value of the wage, will rise. For example, if prices fall by 10%, the amount of goods that can be purchased with nominal wages may increase by 10%, meaning that real wages are 10% higher than they were before the price drop. This increase in real wages encourages workers who were unemployed due to cyclical unemployment to actively search for jobs in the labor market, which creates an excess supply of labor. This forces workers to compete in the labor market, and this competition causes nominal wages to fall elastically. The decline in nominal wages leads to a decline in real wages, and real wages return to the same level as before the recession. Eventually, firms are able to increase their demand for labor to the extent that nominal wages have fallen, so the excess supply of labor disappears and unemployment is eliminated naturally. Therefore, the classical school opposes the government’s role in reducing cyclical unemployment through artificial intervention.
However, the Keynesian school argues that economic unemployment cannot be eliminated naturally because price variables such as wages and prices are not fully elastic in the market. In other words, even if nominal wages remain unchanged and real wages rise due to a fall in prices caused by a recession, it is unlikely that nominal wages will fall elastically, as the classical school says. The Keynesian school of thought offers a number of reasons for this, one of which is the phenomenon of monetary illusion. Monetary disillusionment refers to the phenomenon that workers do not realize that their real wages are the same as before the nominal wage decrease when prices fall due to an economic downturn and nominal wages are affected by it. Therefore, even if prices fall due to a recession, workers do not accept the decrease in nominal wages due to monetary illusion, and nominal wages remain similar to the level before the economic unemployment occurred. The Keynesian school of thought argues that governments should play an active role in reducing cyclical unemployment by increasing the demand for labor through policy. For example, governments can reduce cyclical unemployment by stimulating the economy through fiscal policy and creating jobs in the public sector. These policies provide direct economic benefits to workers and have the effect of stimulating overall economic activity.
In conclusion, unemployment is an important issue in economics, and its causes and solutions are presented differently by different schools of thought. While frictional and structural unemployment have relatively clear solutions, cyclical unemployment requires different approaches depending on the economic situation. To address unemployment, economists propose policies that balance the role of government with the autonomy of the market, which is essential for economic stability and growth for society as a whole.