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 market
2. 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- I
Neoclassical 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- I
Full 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- I
Involuntary 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-II
Keynesian 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-II
Keynesian 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