The Beveridge Curve Explained
By Steve Bain
Despite having been around for a long time, the Beveridge Curve model of unemployment has received relatively little attention in economic circles, until recently. Research by some of today's leading economists has adapted the theory, with accompanying claims of highly accurate accounting of employment patterns over recent decades.
Whilst the old theory presented a simple downward sloping curve that illustrated the relationship between job vacancy rates and unemployment rates (i.e. when vacancies are high unemployment tends to be low and vice-versa) in an economy, the latest adaptation includes a more sophisticated model of job matching flows into and out of the labor market.
In this report I will give an elementary explanation of the Beveridge curve, and go on to relate it to the main forms of unemployment that exist in the economy (with particular focus on cyclical and structural unemployment).
What is the Beveridge Curve
The Beveridge curve is named after Lord William Henry Beveridge (1879 - 1963), the founder of the modern British welfare system, and whilst he never illustrated his ideas into the standard graph below, he did write extensively on the main ideas behind it.
The two basic variables under investigation are the jobs vacancy rate and the unemployment rate. The vacancy rate is usually illustrated on the vertical axis of the Beveridge Curve graph, whilst the unemployment rate goes on the horizontal axis. The curve, sometimes called the uv curve, illustrates that the relationship between these two variables is a negative one, i.e. as one increases the other decreases.
The simple idea here is that, in times of rapid economic expansions, business will increase the job openings rate as they seek to expand economic production. As a consequence, more people will enter employment and so the unemployment rate will fall. The reverse logic applies in times of recession.
In the graph, we can see that an economy which is at point a is at a higher point in the business cycle than an economy at point b. In other words, movements along the Beveridge curve are associated with changes in cyclical unemployment.
Job Separation and Vacancy Matching
Now, as mentioned above, modern adaptations of the model focus on flows of vacancies and unemployment rather than stocks. These variables are in constant flux and never settled and so the flow concept works better. It also leads us to realize that one of the key metrics to think about is the 'matching' of unemployed people to the existing job opening rate, and the 'separation rate' of workers from their jobs.
The range of factors that can influence the vacancy matching process (i.e. the prevailing rate of unemployment) is extensive, and there has been plenty of research done to try and estimate the most important types that have affected real world unemployment rates over recent decades. The most important of these include:
- Wage Rates - since higher wages will encourage workers to accept more jobs.
- Generosity of Unemployment Benefits - will discourage workers to accept jobs.
- Productivity Growth - will usually increase demand for workers.
- The Real Interest Rate of Savings/Assets - increases income from non-work.
- Employment Protection Laws - may deter firms from recruiting.
- Barriers to Labor Mobility - prevent workers from taking jobs.
- Labor Market Policies - may help to increase job take up.
- Labor Taxes on employers - make recruitment more expensive.
- Labor Taxes on employees - make work less rewarding.
- Terms of Trade with foreign countries - increase or decrease demand for workers via changes in demand for domestic goods/services.
The list goes on, but I think you can see that there are lots of factors at play here.
The inclusion of wage rates in the list is a little controversial since it is not independent of the other factors, and will in large part be determined by those other factors in the same way that unemployment is determined by them.
When the separation rate and/or job matching process results in a greater or lesser number of people in employment relative to the number of vacancies that exist, there will be a shift of the Beveridge curve, as discussed below.