Anatomy of unemployment in Latvia

Oļegs Krasnopjorovs
Oļegs Krasnopjorovs
Senior Economist of the Macroeconomic Analysis Division, Monetary Policy Department
15.02.2011.

Unemployment reached a record high in Latvia at the beginning of 2010 and has been on a downward trend since then. Nevertheless, unemployment problems are far from being resolved.  The unemployment rate remains elevated; moreover, concept of structural unemployment is increasingly mentioned in public debates.  What risks does structural unemployment inherit and can it be effectively grappled with? These issues are in the centre of discussions in Delfi columns.

Frictional unemployment

At a first glance, government's objective is to reach the unemployment rate of zero. Yet in each economy, a part of economically active population find themselves between two workplaces, i.e. upon leaving one job, they are in search of a new job opportunity. How many people are just between jobs?  For instance, if the average stay with one employer is five years and a new job is found in three months on average (in reality, these figures tend to differ across countries, sectors and periods), around 5% of all economically active population find themselves between two jobs. In the economic science, this is known as frictional unemployment.  

It may seem that in the circumstances of lower frictional unemployment the economic performance is more effective, or, in other words, the available labour resources generate higher value added, i.e. labour productivity is higher. It is true, albeit in part: in some countries where the average job with one employer lasts longer (e.g. in Japan), not only frictional unemployment but also the historical unemployment level vis-á-vis other countries is lower. However, the indicator of frictional unemployment is not a sole measure of the economic efficiency: of importance is not only the time of finding a new job but also the quality of the new job found. On numerous occasions, skipping the very first job offer and taking a longer time to seek a suitable workplace increase the probability of finding a better job (and higher remuneration).  Be it so, the efficiency of the economy will also be boosted, as the skills and qualifications of more people will match the offered jobs. It is obvious, however, that  seeking a job over a longer period is disadvantageous,  as longer jobless period may have adverse effects on skills and qualifications of job-seeker. 

Cyclical unemployment

The economic activity is characterised by cyclicality: the economic expansion and boom are followed by recession and trough, to be again succeeded by an expansion. The drivers behind economic cycles are still an object of controversy for the representatives of various economic schools arguing whether aggregate demand or aggregate supply shocks are underlying factors of cyclical movements; furthermore, the length of economic cycles may also differ across countries and time periods. Yet it is obvious that governments should strive, as their key objective, to minimise the range of business cycles, i.e. to pursue counter-cyclical policies by restricting the economic activity during the economic expansion phase and enhancing it during the recession phase.  

Governments have long attempted to save in good days to spend more, even above the earned, in tougher times. Some indications of counter-cyclical policies of governments can be found already in the Old Testament: Joseph called upon the Pharaoh to store harvest of the seven years of abundance to consume it in the following lean years; thanks to this advice, Egypt was spared of famine. Despite seven fat years being announced in Latvia, however, no savings were made: the state budget was with a deficit for the entire period. As a consequence, the government's ability to boost the economic activity in the tougher times was quite limited. Even today, Latvia is still spending much more than it earns, i.e. around 2.5 million LVL of unearned income each day. So despite massive budget consolidations and the reduced spending, the country is still stimulating the economy with a quite notable budget deficit financed by borrowing.  

With the economic activity abating in the period of downturn, the unemployment level rises. Layoffs primarily hit the unskilled labour and the sectors with the greater elasticity in respect to economic cycle.  Thus, cyclical conditions affect the automobile sales  stronger than manufacturing of food products. The wave of labour force dismissals in the construction sector in Latvia was triggered, among other things, by the burst of unsustainable real estate price bubble.  

Structural unemployment

Economy structural changes could lead to a situation of a job seekers skill mismatch in respect of employer demand.  Then labour shortages and a high unemployment rate could be observed simultaneously. Thus, when the coal production sector narrowed in Poland, the problem of employing the dismissed coal miners ranked important for a prolonged time. In Latvia in the days of real estate bubble, good wages could be earned by doing unqualified construction jobs, and a part of young people lost any motivation for augmenting their professional skills or opting for university studies. During 2002–2007 construction sector employment doubled, partly on account of secondary school leavers. When the real estate bubble burst, many young people were laid off, while their qualification did not meet the needs of other sectors but remuneration demands were too high to be met by those exporting enterprises that expanded their production and hence also payrolls. As a result, a part of these jobless youths opted to seek jobs abroad, while those who stayed home had to get new or improve the existing qualification.

Structural unemployment could be a geographical phenomenon as well. If failing branches get concentrated within a particular territory and the job-seekers' mobility is low, a situation of high unemployment in one region in the face of labour shortages in other regions can be incurred. This, however, is not strongly pronounced in Latvia.  Historically, Latgale has always boasted of the highest levels of registered unemployment partly associated with a high motivation for registering with the State Employment Agency (SEA), although real unemployment indicators are not as much diverse in a regional breakdown.

Why is structural unemployment dangerous? First, structural unemployment threatens with long-term joblessness. The average duration of frictional unemployment, as a rule, is only some months; cyclical unemployment can last for a couple of years; structural unemployment may continue for several years or even decades, with people sometimes  becoming economically inactive and exiting from the official unemployment statistics forever. As a rule, the longer the jobless period, the more difficult for an individual to find an occupation; hence the return of the structurally unemployed to the labour market is most complicated. Second, structural unemployment triggers a combination of high-level unemployment and labour shortages with all relating consequences of wage boosts. In terms of wages, this may amplify social stratification: the long-term unemployed lack means of subsistence, while welfare of the rest of community gradually rises. In addition, a potential up-coming wave of wage rises, if not supported by an equivalent increase in labour productivity, may translate into a subsequent wage-inflation spiral with an adverse effect on economic competitiveness and upward pressure on the component of cyclical unemployment. 

Structural unemployment is most destructive for the economy; hence it is not surprising that promoting employment of the structurally unemployed is the priority of active employment policies of many governments. In Latvia, the State Employment Agency is the entity implementing active employment measures, among them professional training and retraining courses, psychological support and provision of basic skills, assistance to business start-ups and subsidised employment programmes for population groups particularly exposed to unemployment risks.  

There is a single effectiveness measure of these programs, and it is the ratio of people who manage to find a permanent job after completing one of the programmes and to stay in the position for at least one year. On the one hand, it might be premature to evaluate the effectiveness of these SEA's programmes, as along with structural unemployment cyclical unemployment is a widely-spread phenomenon in Latvia. It is most likely that an individual, even after completing a set of perfect qualification improvement seminars, is unable to find a job due to labour demand lagging seriously behind labour supply. On the other hand, it is important for people to acquire the professions required by the labour market in adequate amount and quality as well as to find jobs as soon as possible, for it is not only the acquired professional skills but also resoluteness to find a job is that fade away over time. 

 


The article was published by Delfi  on 15 February 2011.

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