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investment more appropriate to the country under consideration will be chosen.

iii) Generally investors do not recruit directly from the unemployment register.  They are much more concerned with supply of suitable labour from schools and third-level education.  The education system in the host country tends to be investigated carefully by investors.

Q3  Suppose there was a sudden and unexpected increase in wage settlements in the economy. What policies would you propose to deal with the threatened rise in unemployment and inflation?

The trade-off between two different targets in economic policy management is evident in this question.  Economic authorities have to decide whether or not to tighten monetary policy.

i). If they tighten monetary policy, they put a stop to the possible inflationary spiral that could arise following the wage increase.  From a business perspective, aggregate demand will fall and it will be difficult to raise prices to compensate for higher wages. In order to protect profits, firms will cut production.  Hence, price stability would be maintained at the expense of higher unemployment.  If the labour market were flexible, at the time of the next settlement, workers would accept lower wages thereby reversing the process described above.

ii). If authorities relax monetary policy, firms will increase prices.  In real terms, the equilibrium will be maintained at the previous level of employment but inflation will be allowed.  There will be also the risk that workers, at the next wage settlement, will ask for a new pay increase, thus starting an inflationary spiral.

Q4  Explain why unemployment hits the unskilled worker harder than the highly skilled. List some of the implications of this different incidence for policy.

A recession often requires a re-shaping of both the economic system as a whole and the production process of the single firm. Labour-intensive sectors with low productivity and mainly unskilled workforce are replaced by new capital-intensive sectors in which technical knowledge and high skills are required from workers. At the micro level, firms substitute away from labour to machines which are cheaper and highly productive. A different type of worker, who has the technical knowledge of programming and fixing the machine, is now required.

Unemployment of skilled workers is mainly cyclical (due to a lack in aggregate demand) while unemployment of unskilled workers is mainly structural (the structure of the economy changes). Therefore policies should be differentiated according to the type of unemployment. With reference to unskilled unemployment, emphasis should be given to training policies, education and the elimination of labour market rigidities.

31/07/97

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