Unemployment has a great importance in determining the economic policies of developed and developing countries, as it contains a direct indicator for the labor market. Rather than dealing with the tight labor market problem during inflationary periods, rising unemployment is desirable. The fact that the increase in interest rates loosens the labor market and thus an increase in unemployment is one of the things that policy makers want to see in the fight against inflation.
If we need to give an example outside of Turkey, we can show how much the tight picture in the labor market bothers Fed Chairman Powell, despite the sharp rate hikes in the USA. This is exactly the reason why Powell, who is still waving two interest rate hike sticks, points to the tight labor market and unrelenting unemployment in every speech.
Especially in periods of high inflation, it is possible to see an increasing effect of interest rate increase weapons and tight fiscal policies on unemployment. This is what is essentially desired.
So what is the relationship of the labor market to inflation? Why do policy makers want interest rate hikes to increase unemployment during inflationary periods?
The Adam Smith school of “classical economists” believe in supply-side economics. According to them, the main thing is “supply, not demand”. Money, on the other hand, is a cover that covers real activities in the economy. It is no different from any other commodity. It consists of another generally accepted good, unlike other goods that are used only for exchange. However, demand generally does not dominate supply. Conversely, as expressed by Say’s Law, “every supply creates its own demand”.
In this direction, economists who belong to the “Classical Economics” school gather around a phrase called “Laissez faire”. “Let them do it”… This saying is based on the premise that decision makers and the state, in general terms at that time, should not interfere with real economic life, and leaving the economic freedom completely to the private sector would be the right choice for the economy. It is the rejection of the mercantilist system and the slogan of capitalism!
Keynes leads the way for intervention
The word “Laissez faire” of the classical school is the expression of the desire for a free market economy under a liberal administration. Economic life should be independent and the state should not interfere with it. The market system is built on such equilibria that all equilibria, including full employment, operate in a regular equilibrium, except for short-term deviations. Adam Smith’s “hidden hand” puts everything back on track…
Keynes, on the other hand, says the opposite. There is neither a hidden hand nor full employment at all times. Just as the economy is not in balance, it is impossible to achieve this balance when left to its own devices. The state or decision makers should intervene in the economy from time to time and put it back on track, and they should make some decisions contrary to the market economy.
The two opposing views on which these two schools are based, freedom and relative intervention, summarize the basic function of unemployment on economic life.
Unemployment is important because, as the Adam Smith school advocated, today it is not “supply creates its own demand” but “demand creates its own supply”. In an overheated economy with monetary expansion and low unemployment, the demand is so high that if there is no intervention, prices will rise with the limited supply, which will lead to inflation. Since the rise in unemployment will have a negative effect on the total disposable income of the household, there will be a decrease in demand, thus a slowdown or a decline in inflation will occur as the falling demand will affect its own supply.
So what is the situation in Turkey?
Turkey is a country with chronically high unemployment, high inflation and an ‘unfortunate’ economic outlook. However, the unemployment problem seems to have been resolved, especially in the last few years.
Unemployment, which peaked at 14.2 in July 2020, dropped to 9.5 percent as of today, the lowest level since February 2014. This rate, which decreased from 14.2 percent to 9.5 percent, gives us a signal that the total demand has risen as well as showing that unemployment has decreased in Turkey.
This signal is actually positive for a developing country. Because, from an external perspective, it is possible to see the positive effect of economic growth on employment in the country. In addition, the unemployment rate, which has remained below the 5-year average of unemployment, which is shown with the red line in the graph, for about 1 year, may lead to the thought that unemployment has decreased due to some structural reforms in Turkey.
Really? So, really, Türkiye has made some structural reforms and unemployment is falling? Are rapidly rising prices and wages increasing the supply to the labor market? Or do unemployment rates have a somewhat illusionistic appearance?
The chart above, expressed as the “Broad Unemployment Rate”, is a more comprehensive calculation, unlike the classical “Unemployment Rate” calculation. The rate that we know as the classical unemployment rate, which decreased to 9.5 in Turkey in May 2023 and fell to a single digit again, gives us the rate of people who have been unemployed in the last 4 weeks and have applied for a job. Broad unemployment is a calculation that includes the proportion of people who have not applied for a job in the last 4 weeks but are still unemployed.
Dr. In Mahfi Eğilmez’s blog series titled “Writings to Myself” titled “The Ostrich Theory”, there is a comment about the “Broad-Definition Unemployment” rate that “The real unemployment rate in us is close to the broad unemployment rate”. However, Egilmaz adds that in developed economies, the difference between the broad unemployment rate and the normal unemployment rate is not very high.
For Türkiye, the situation is the opposite. The gap between the broad unemployment rate and the single-digit unemployment rate is quite high. While the broad definition of unemployment indicates an unemployment rate of 22.5 percent, the normal unemployment rate indicates an unemployment rate of 9.5 percent. So which one is correct?
Actually, neither is wrong, but one is right. That’s the “broad definition of unemployment” rate. According to Mahfi Eğilmez, the real rate is the broadly defined unemployment rate, which is included in the TUIK data under the name of the idle labor force rate. The idea that this rate is close to real unemployment is that job applicants give up after a while and start not applying for a job.
Recently, it is possible to see that the gap between broad unemployment and normal unemployment has widened, especially since the beginning of 2020.
In addition, as can be seen from the graph, while in some periods the coordination between broad-defined unemployment and normal unemployment was completely lost, in some periods, especially in 2020, broad-defined unemployment experienced sharp jumps.
In the midst of inflation, what about unemployment?
After all this, interpreting whether unemployment is increasing or decreasing will vary depending on which data are viewed from which point of view. If we take a look at the normal unemployment rate from 2014 to the present, we can say that unemployment in Turkey is below the average and unemployment has decreased. However, if we look at the broadly defined unemployment rate between the same dates, it is possible to interpret that unemployment has increased and that there may be some deterioration in the labor market, especially by increasing the wave sizes from time to time. In addition, the idle labor rate is chronically above the average, except for a short time falling below its 5-year average.
Does unemployment need to rise sharply for inflation to fall? Although there are different opinions according to different economic schools, there are strong beliefs that the tight labor market makes it harder rather than preventing a recession in inflation. If we look at the situation from the perspective of Turkey, we will see whether what economists have recently presented as the bitter prescriptions for a recession in inflation will not be unemployment. Because despite all expansionary economic policies, the broadly defined unemployment rate is anchored above the 20s and has been there for a long time…
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