The part of Indonesia contains 33 provinces which is divided into three regions; west, central, and east. This is a labour market with a relatively high unemployment rate and a relatively low labour force participation rate. Another feature of the labour market in the east of Indonesia is a lower educational level. There is a relatively low demand of individuals who have received higher education. Highly-educated individuals will withdraw from the region. The development of employment is an important indicator of the labour market (SEAN 2003). Vermeulen (2005) explains that regional labour markets can exist, because migration is costly for labour and capital.
A high unemployment rate is costly to the community. For instance, if there are many unemployed workers, more money is needed to pay for the social security system. Therefore, an economic policy aimed at increasing the labour force participation rate has several economic and social benefits. An important benefit of a higher labour force participation rate and a lower unemployment rate is that the costs of the social security system will be reduced.
It is therefore interesting to know how labour force participation and unemployment will develop in the future.
This post investigates how employment and unemployment will develop in the period 2010-2030 in three different scenarios. These scenarios are: quick recovery, double dip and the new common. The quick recovery scenario contains an autonomous employment growth path of 1.75 percent. The second scenario, double dip, contains a second economic dip in 2011. After this dip, the economy will improve slowly to an autonomous employment growth path of 1.75 percent annually. The last scenario, new common, assumes that after 2009, there is a small improvement of the economy after 2009 and it expects a lower autonomous employment growth path, namely one percent per annum.
In reality, labour force participation will decrease if unemployment increases. This is for example due to the discouraged worker effect. This means that disappointed job seekers leave the labour market. Because the disappointed job seeker is not longer part of the active working force, the individual drops out of the unemployment rate and thus the labour force participation rate will decrease. Several authors, for instance Fleisher and Rhodes (1976) and
Elmeskov and Pichelmann (1993), describe this negative relationship between unemployment rate and labour force participation rate.
This post will use the three scenarios described above of employment growth and investigates what the effects are of an endogenous labour force participation rate on unemployment and labour force participation. We use the model of Blanchard and Katz (1992) and argue that these simulations represent more realistic expectations.
Future expectations of labour force participation
Indonesian government has developed ambitious targets for labour force participation within the country. For 2020, the Government wants to realize an overall participation rate of 75 percent for the entire country. Indonesian government wants to realize these targets through a higher participation of women, of elderly people and a better integration of migrants in the labour market. In general, the labour force participation rate of these groups is below the average labour force participation rate.
The 75 percent target is in line with the expectations for Indonesia. Government expects that labour force participation rate will increase to 75 percent in 2014. After 2014, the labour force participation rate will be constant. We assume that economic policy does not change, so that future adjustments in the participation are caused by (1) the effect of earlier chosen policies, (2) the growth of labour force participation of women and through (3) changing in demography.
Social policies have chosen earlier strongly influence the development of labour supply in the future. The two most important policy effects are: (1) the cancelling of the possibilities to retire prematurely, and (2) a revision of the prerequisites for invalidity insurance benefits. Through this change in policy, the number of individuals assumed to be incapable to work will diminish. These policy decisions therefore lead to an increase in labour force participation.
The growth of labour force participation among women springs from two causes. First, older cohorts of women are replaced by younger cohorts. Since younger cohorts of women have higher participation rates than older cohorts, participation increases. Secondly, there is a trend that younger cohorts participate more in the labour market than the same cohorts did in previous years. It is expected that this cultural trend will persist in the following years.
Demography influences the labour force participation rate when the relative size of population groups changes. There is an inverse U-shaped relationship between age and labour force participation rate. For example, ageing leads to a lower participation rate, because in general elderly individuals will participate less than younger individuals. Moreover, younger individuals will follow education when there is high rate of unemployment (Elhorst 2008).
Three scenarios of employment growth
This post uses the model of Blanchard and Katz (1992) to simulate the unemployment rate, the labour force participation rate and the employment growth rate simultaneously in the period 2010-2030. The advantage of such a simultaneous model is that the effect of every exogenous variable can be determined on every endogenous variable; so with a demand shock, it is possible to analyze what the effects are for the unemployment rate and the labour participation rate. According to Armstrong and Taylor (2000) a positive demand shock leads to an increase in employment. This increase in employment implies that new jobs must be filled by unemployed workers; therefore the unemployment rate will be reduced.
For a specific region, the rise in employment has two effects. First, the employment growth will lead to a growth in the real wages which will lead to net migration into the region and also to an increase in the labour force participation rate.
A second effect of higher employment is that the regional income of households will increase. An increase in households’ income means that there is more money available for consumption. The demand for consumption goods will thus also increase. Hence, the demand for output in the region will increase, which leads as well to an increase in employment.
Broersma and Van Dijk (2001) present the effects of a positive regional labour demand shock in Indonesian labour market. They find that in the north, unemployment will mainly absorb the shock in the short run. An increase in the labour force participation, however, will absorb the biggest part of the long run effects of this shock. This long run effect is even higher than the share of migration and unemployment. This can be explained by a relatively high unemployment rate in the eastern part of Indonesia. The underlying argument is that through relatively high unemployment rate, jobs can be filled relatively easily by unemployed workers. Broersma and Van Dijk (2001) also observe an adjustment speed of three to five years. This adjustment speed is high in comparison with other regions of Indonesia. A higher adjustment speed means that the labour market is more flexible because the labour market needs less time to adjust to a demand shock.
The paper of Schudde et al. (2010) computes what happens to unemployment and employment growth in three different scenarios. These scenarios are: quick recovery, double dip and the new common. The quick recovery scenario contains an autonomous employment growth path of 1.75 percent. The scenario double dip contains a second dip of three percent in
2011. After this dip, the economy will improve slowly to an autonomous employment growth path of 1.75 percent annually. The new common scenario contains a small improvement of the economy in 2010, so an employment growth of a half percent is assumed. After 2010, there will be an autonomous employment growth path, namely one percent per annum.
From the first scenario, quick recovery, the unemployment rate will achieve the highest value of 7.41 percent in 2011. After this year, employment will increase and the unemployment rate will decrease and become zero after 2017. This is caused by the assumption of an autonomous employment growth rate of 1.75 percent. In addition, the unemployment rate is taken as the difference between labour force and employment. This means that the labour force participation rate is exogenous. In this scenario a labour shortage will arise.
In the second scenario, double dip, it takes more time to recover from the second dip in 2011. Initially the unemployment rate will increase to six percent in 2012-2013. After that, one can observe a downward sloping trend and this leads to an unemployment rate of approximately four percent in 2017. In addition, it takes more time to achieve the autonomous employment growth path of 1.75 percent. This growth path will only be achieved in 2014.
Finally, the new common scenario will exhibit an employment decrease after 2009 with the rate reaching is at its lowest level in 2011. After this year, employment will rise very slowly and will stay below the level of 2009 until 2020. The unemployment attains its highest value of seven percent in 2011. After that, a downward sloping trend commences and the unemployment rate will be approximately six percent in 2016.
In general, one can observe in all three scenarios that when the economy recovers from the negative employment growth in 2009 or from the second dip in 2011, the unemployment rate will fall. The unemployment rate in the scenarios double dip and quick recovery will fall more rapidly in comparison with the new common scenario. This is caused by the relatively lower autonomous employment growth path in the new common scenario.
There are possibilities of two demographic variations of the quick recovery scenario, namely a strong decline in the labour force and an extra migration of workers to the East. In the demographic scenario of strong decline, the labour force will decline stronger in the period 2010-2020. Via this stronger decline in the labour force, the unemployment rate will decline faster after 2010, so a labour shortage arises after 2014. Moreover, the unemployment rate will become zero earlier, namely in 2016.
Secondly, the effect of positive migration to the East. In this scenario, we assume that there is a positive migration of 40.000.000 people each year, in the period of 2010-2020. Via this positive migration, the size of the labour force will be almost the same in the period 2010-2020. The consequence of a larger labour force is that the unemployment rate will be higher and will remain high over a longer period. In 2014, it will return to its 2009 level. In the quick recovery scenario without demographic variations, the unemployment rate will return to its 2009 level in 2013. Finally, positive migration will also lead to employment growth, which will concentrate in economic centres.
In general, one can observe in the three scenarios, that a larger labour force will lead to a longer period with a higher unemployment rate. When there is a smaller labour force, the unemployment rate will be lower.