One purpose of this project is to assess the impact of welfare reform on the unemployment rate. The unemployment rate, as defined by the Bureau of Labor Statistics (BLS), is an estimate of the percentage of persons who want to work who are not employed. Hence, it is intended to capture involuntary unemployment and does not include those who do not want to work (i.e., who are voluntarily unemployed).
In the conceptual model we have presented thus far, there is no involuntary unemployment, by definition. When shifts to the demand or supply curves occur, wages adjust so that everyone who is willing to work at the prevailing wage is employed. While there are some who might be willing to work only at a higher wage, they are voluntarily unemployed.
As discussed above, the influx of workers into the labor market as a result of welfare reform will lead to the displacement of existing workers unless the expansion of demand is sufficient to completely offset the negative effect of the supply shift on wages. Displacement occurs because workers who were employed before welfare reform lose their jobs to welfare recipients who are willing to work for a lower wage. From a theoretical standpoint, displaced workers might be voluntarily unemployed, because they are not willing to work at the lower wage that now prevails in the labor market. However, from a practical standpoint, BLS defines displaced workers as unemployed as long as they are looking for work. If displaced workers eventually decide that they cannot get a job at a wage they would be willing to accept, they might drop out of the labor force and no longer be counted as involuntarily unemployed by BLS.
We assume that job displacement does increase the unemployment rate in the short-run, as displaced workers are not perfectly aware that the prevailing wage in the labor market has fallen. Displaced workers are replaced by welfare recipients who are willing to work for a lower wage. We assume displacement is the primary means through which welfare reform leads to unemployment in the low-skill labor market.
An inability of wages to adjust to new conditions in the long run would, however, result in long-term unemployment. One reason why this might occur is downward wage rigidity, an issue that we turn to next.