Economics of Employment and unemployment

from the Islamic Perspective

IDsB/IRTI

Video-Conferencing DLP

Introduction• The importance of employment economics cannot be overstated –

employment is the immediate means of livelihood in human societies.

• Unemployment, on the other hand, is the gateway to poverty and social unrest - unless it is aggressively attacked through appropriate policy.

• Nonetheless, employment economics in the Islamic perspective has remained overshadowed by research in Islamic banking and financial economics – why?.

• Admittedly, riba elimination lies at the heart of Islamic economics, whereas Islamic labour contracts are similar to their mainstream counterparts.

• Yet, riba elimination should be viewed as an integral part of an equitable macroeconomic strategy that takes full employment targets and job security as top priorities.

• More research is needed to project riba elimination into practical employment strategies.

Introduction

• The objective of this lecture is to shed light on salient theoretical features of free market labour economics with relevant Islamic implications.

• Due to time constraint, attention will be focused on the impact of riba elimination on employment although there definitely more about employment from an Islamic perspective.

• Again, we cannot introduce all real and monetary macroeconomic variables that affect the theory of employment.

• Two models will suffice for the current objective:1. Neoclassical equilibrium model of the labour market2. Kenynesian model of labour market disequilibrium.

Basic definitions

• Adults in the working age are normally classified three broad groups as – Employed (E)– Unemployed (UE)– Not in the labour force (NLF)

• Hence, the Labour Force (LF) consists of E+UE• LF Participation Rate at any point of time is the

percentage of the population of working age who declare themselves to be in the LF

• In practice this may not be an adequate measure of the true situation PR in the labour market.

Types of UE

• Frictional UE: an irreducible minimum level of UE in a dynamic economy = people in shifting times between jobs.

• Structural UE: caused by changes in the structural long term pattern of demand and production – thereby affecting mismatch of skills and job opportunities.

• Demand-deficient UE: This is the Keynesian UE where actual aggregate demand falls short of the full employment aggregate demand – wages and prices have not yet adjusted to restore full employment.

• Classical UE: where wage rates are held artificially above the full employment equilibrium – trade union power or minimum wage rate legislation.

Model- INeoclassical Equilibrium model

• The first model measures represents real wage (w) on the vertical axis and number of workers (N) on the horizontal axis.

• Then the following schedules are drawn:• Labour Demand (LD) schedule: firms takes on more

workers at lower wages.• Labour Force (LF) schedule: workers willing to be in the

labour force at each real wage ( upwards sloping).• Workers Accepting Job offers (AJ) : this schedule lies to

the left of LF because some LF members are between jobs and that some optimists hang on for an even better wage rate.

Model- IFull Employment and the Natural rate of

Unemployment

• Full employment level is the equilibrium level (Nnatural rate of unemployment (ne) is the difference N1- N*

• Thus *) at real wage rate ( w* )where LD intersects with LD.

• The size of LF at this equilibrium is N1.• The, the natural rate of unemployment is the rate

of unemployment when the labour market is in equilibrium.

• This is entirely voluntary- including frictional unemployment and structural unemployment.

Model- IInvoluntary Unemployment

• Suppose trade unions maintained the real wage rate at w2 well above the full employment wage rate w*.

• This depresses employment level to N2 and unemployment now becomes bigger N2- N1

• Individual workers willing to work at w2 cannot find work – therefore this is involuntary UE.

• Yet, from the viewpoint of workers’ collective action, this is voluntary UE- the classical version of voluntary UE.

Neo-classical equilibrium model

Full employment, the natural rate of UE and the interest rate

• Movement along the LD depends on real wage, but the position of the LD depends, among other things, on the rate of interest.

• A rise in the interest rate causes LD to shift backwards towards the origin – reducing N*

• A fall in interest rate causes LD to shift forwards – raising the level of employment

• Hence, in an interest-free economy, more labour force will accept job offers and fewer workers will be ‘naturally’ unemployed.

Employment and natural UE in an interest-free economy.

Model-IIKeynesian demand deficient UE

• The Keynesian theory is a disequilibrium model of involuntary unemployment – the economy has not fully adjusted to the new level of aggregate demand.

• The basic model consists of• 45-degree Aggregate Supply curve:

– Aggregate expenditure = aggregate income.• AD = Aggregate Demand function

Private consumption ( C ) + private investment (I0)• Income level ( Y0 ) is below the full employment

income level.

Model-IIKeynesian Demand-Deficient UE

Model – II in an interest free economy

• Investment expenditure in inversely related to the interest rate

• Hence, a rise in the interest rate will reduce investment and hence aggregate demand, leading to an even lower level of output.

• Conversely, in an interest-free economy, rise in investment will recover the deficient aggregate demand towards full employment.

• Compare The impact of I1 with that of I0

Model-II in an interest-free economy