Qu.

Analyse the causes of unemployment and its effects on the Australian

economy. (2013 HSC)
Unemployment refers to the situation where individuals want to work, but are unable to find
employment in the labour market. Unemployment is measured by the unemployment rate
which is the percentage of the labour force that is unemployed. The main causes of
unemployment in the Australian economy are because of cyclical factors such as a deficiency in
aggregate demand (AD) and because of structural change. Increases in unemployment have
significant economic costs on the Australian economy including lower output and allocative
efficiency, falling living standards and a deterioration of the budget position. As such, the
causes of unemployment and its effects on the Australian economy will be explored.

Cyclical factors is one of the major causes of unemployment and this occurs due to a deficiency
in AD which is prevalent during an economic downturn, thereby resulting in cyclical
unemployment. Since labour is a derived demand i.e. it is determined by the level of AD within
an economy, any decline in AD will result in less consumer expenditure in the economy. Firms
respond to this weak consumer demand by producing less output and laying off workers, since
they need less resources (labour is a factor of production) involved in the production process.
This will consequently result in an increase in cyclical unemployment. This situation is illustrated
below on the Keynesian Aggregate-Expenditure model.

As seen above, an insufficiency in total spending evident by a decrease in AD from AD1 to AD2
will result in an unemployment gap arising from Y1 to Yf, causing cyclical unemployment to
increase in the economy. This will also mean that the economy is operating below full
employment (Yf), which refers to a situation where all resources in the economy are in use and
cyclical unemployment is zero. Cyclical unemployment was the major source of unemployment
in Australia during the 1992-1993 recession and during the GFC of 2008-09. Inadequate AD
resulted in a rise in unemployment from 6.1% in 1989 to over 11% in 1992/1993. This occurred
as firms stopped hiring and reduced their labour force levels to meet the weak consumer
demand. Similarly, unemployment began rising in late 2008 after the onset of the GFC,
increasing from 4.1% in August 2008 to 5.8% in May 2009. Therefore, one cause of
unemployment is because of cyclical factors such as the level of AD.

Additionally, another cause of unemployment that has been prevalent in the Australian
economy is because of structural change in the economy. This involves changes in the patterns
of production that reflects changes in technology, consumer demand, global competitiveness
and other factors. Structural changes in the economy will often result in structural
unemployment which occurs due to a mismatch of skills and job vacancies. One of the
structural changes that the Australian economy has seen is a decline in its manufacturing
industry which occurred as a result of trade liberalization. Reduced protection (eg. through
tariff cuts) forces uncompetitive industries to compete at a world price for goods. If they are
unable to compete they will have to contract and be forced to lay off workers, causing an
increase in structural unemployment. Because of this, manufacturing employment has
declined from 25% of total workforce in the 1950s to less than 10% in 2014-15. Hence,
structural unemployment caused by structural change in the economy is another major cause
of unemployment in the context of the Australian economy.

A high level of unemployment holds considerable economic costs for the economy. One of the
most important negative consequences of unemployment is reduced output and allocative
efficiency. This is because unemployment represents unused labour resources, limiting the
economy’s productive capacity. As a result, the economy would be operating below its
production possibility frontier. This would also result in reduced output as firms are using less
resources, thereby hindering economic growth.

Apart from lowered output and efficiency, unemployment also causes a decrease in overall
material standard of living in the economy. This is because as workers are no longer employed,
they will experience a decrease in their household disposable income, relying only on private
savings or government benefits. As a result, unemployed individuals will have a lower marginal
propensity to consumer (MPC) as they would decrease consumption and total expenditure. This
reduced income would therefore cause a fall in the material standard of living in the economy
since consumers will be forced to give up some of their needs and wants, achieving less
marginal utility. This relationship between high unemployment and a lower standard of living is
indeed evident in the Australian economy. For example, as unemployment rose from 5.9% in
1989-90 to 10.7% in 1992-93, average income fell from $40,000 to $38,000 during the same
period, thereby representing a decrease in material standards of living. It is thus evident that a
negative economic effect of unemployment is falling living standards.

Moreover, high unemployment can also deteriorate the budget position as it represents fiscal
policy challenges for the government. This is because as fewer people are working, there will
be fewer people earning enough income to pay income tax. This consequently results in an
erosion of the tax base as the government is receiving less taxation revenue, which has a large
impact on the government’s finances. This was evident during the GFC where taxation receipts
in 2008-09 were $272.6billion which was $20billion lower than forecasts. Furthermore, the
deterioration of the government’s budget position is further exacerbated since the government
is obliged to increase its spending on social welfare payments as well as funding the costs of re-
skilling the structurally unemployed in order to find them work in a new industry. Indeed, as
unemployment rose to 5.8% in 2008-09 due to the GFC, more people became eligible for
Centrelink’s NewStart Allowance. As a result, the government’s social welfare expenditure
rose from $97,842M in 2008-09 to $124,581M in 2009-10. This was one of the main reasons
for which Australia’s underlying cash outcome fell from a surplus of $19.7b in 2007-08 to a
deficit of -$27.1b in 2008-09. Therefore, increased costs to the government and a deterioration
of the budget position is a negative economic effect of increased unemployment.

On the whole, the main causes of unemployment in the Australian economy are due to cyclical
factors resulting in cyclical unemployment and because of structural change in the economy.
Unemployment holds considerable negative effects on the economy. Not only does
unemployment entail reduced output and allocative efficiency, it also results in lowered
standards of living due to decreased income. In addition, it results in lower taxation revenue
and higher government expenditure, leading to fiscal policy challenges and deteriorating the
budget position. Therefore, unemployment is considered to be a serious economic issue that
needs to be resolved.