Economics of Employment and unemployment from the Islamic Perspective

1. Economics of Employment and unemployment from the Islamic Perspective IDsB/IRTI Video-Conferencing DLP

2. 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.

3. 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: • Neoclassical equilibrium model of the labour market • Kenynesian model of labour market disequilibrium.

4. 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.

5. 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.

6. Model- INeoclassical 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.

7. Model- IFull 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.

8. Model- IInvoluntary 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.

9. Neo-classical equilibrium model

10. 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.

11. Employment and natural UE in an interest-free economy.

12. Model-IIKeynesian 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.

13. Model-IIKeynesian Demand-Deficient UE

14. 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

15. Model-II in an interest-free economy