Contents
What’s is: The unemployment rate is the percentage of the labor force that is currently unemployed. Economists define the labor force as the share of the working-age population currently employed plus unemployed workers who are actively looking for work.
Indeed, the unemployment rate is closely related to the business cycle. It decreases during economic expansion and increases during recessions. However, it is never zero, even when the economy is prosperous.
Unemployment rate formula
Calculating the unemployment rate is easy. You only need to divide the number of unemployed by the total labor force.
- Unemployment Rate = Number of unemployed / Labor Force
You can find figures at national statistical agencies or the Department of Labor. For comparisons between countries, you can look for them at institutions such as the World Bank, OECD, and IMF or on websites of statistical providers such as ceic.com and tradingeconomics.com.
Types of unemployment
Economists classify the unemployed into four groups, namely:
- Structural unemployment. This unemployment arises because unemployed workers do not have skills. Or, they have skills but don’t match the demand. The cause is due to changes in the economic structure, for example, due to changes in technology.
- Frictional unemployment. It arises from the natural churn within a healthy labor market. It occurs when there’s a temporary gap between jobs for individuals actively seeking work. Unlike structural unemployment, which stems from a mismatch between worker skills and available jobs, frictional unemployment is a consequence of transitions and is considered a normal part of a functioning economy.
- Cyclical unemployment. During the business cycle, it is not only real GDP that fluctuates but also the unemployment rate. Although labor supply remains unchanged, the demand for labor changes during phases of the business cycle. Thus, there are periods when demand is high (cyclical unemployment is low). And there are periods when demand is low (cyclical unemployment is high).
- Seasonal unemployment. This is like cyclical unemployment, but the problem stems from seasonal factors. It is not caused by the ups and downs of economic activity. For example, the demand for certain jobs during holidays is often higher than in the regular season.
Structural unemployment plus frictional unemployment forms the natural rate of unemployment. It will exist over time, even though the economy is at full employment (GDP is at its potential level). So the unemployment rate never equals zero.
Causes of the Unemployment Rate
Unemployment occurs when the demand for labor is higher than the supply of labor. Demand refers to how much employment is available. When it is low, job availability is insufficient to absorb the labor supply, resulting in a high unemployment rate. Conversely, when demand is high, people find it easy to find a job, and the unemployment rate falls.
The demand for labor depends on the profit prospects of businesses. Better profit prospects encourage them to increase production. They will recruit more workers. Demand is high when the economy is prosperous (economic expansion).
But, if the profit outlook worsens, they streamline operations. They don’t just stop recruiting but may fire employees. It usually happens during an economic recession.
Labor supply refers to the number of people available and ready to work. Labor supply depends on population growth, labor force participation rate, and net immigration.
Please remember. The demand-supply of labor does not only discuss quantity but also quality—some types of work demand higher-skilled workers than others. Thus, even though labor demand is high, the unemployment rate may remain high because most workers do not meet the qualifications.
Let us discuss the causes of each type of unemployment.
Causes of structural unemployment
People are unemployed because they don’t have the skills that businesses demand. Problems may stem from fundamental changes in the economy caused by factors such as technology, competition, or government policies.
For example, when the economy shifts from industry-based to service-based, some individuals are unemployed. The demand quantity may remain the same, but the quality does not meet business requirements, resulting in unemployment.
For example, a business needs workers who can operate computers. Workers with manual skills are likely to remain unemployed because they don’t meet the qualifications unless they take courses to improve their skills.
So, the solution to tackling structural unemployment is to retrain workers.Recently, technological changes have the potential to increase structural unemployment in the future. Those without expertise in technology will be marginalized. Due to high job redundancy, even those who have skills can also be unemployed.
Causes of frictional unemployment
The Central Bureau of Statistics categorizes individuals as unemployed because they do not have a job, even though they are currently active in looking for work. Thus, frictional unemployment occurs due to the transition from one job to another. Or, recent graduates are unlucky and unable to find the right position.
People move to other jobs for various reasons, including better opportunities, wages, and benefits, or because they are unsatisfied with their previous jobs.
Frictional unemployment occurs because the labor market is imperfect. What does it mean?
Workers do not have perfect information about supply, demand, or even wages in the labor market. Therefore, even if they have found the right job, they have to negotiate a salary first. They may ask for a lower or higher salary because they do not know the market’s equilibrium wage.
Not only wages but the mismatch of supply and demand also comes from skills, working time, location, attitudes, or tastes. Of course, that prolonged their unemployment.
In this case, imperfect labor market information creates labor immobility. Those who change jobs take more time to find the right job.
Causes of cyclical unemployment
Cyclical unemployment is related to economic cycles. It is the ups and downs of economic activity.
During economic expansion, the demand for labor is high. Businesses need to increase production.
During that period, they saw more robust profit prospects due to strong consumer demand. So they want to increase the output. For that, they employ more workers. As a result, cyclical unemployment was low during this period.
Conversely, during an economic contraction or recession, the demand for labor decreases. Businesses cut production as their profit prospects deteriorate. They not only stopped hiring new workers but also chose to fire existing employees in line with the efficiency program. That results in high unemployment during recessions.
Causes of Seasonal Unemployment
Seasonal unemployment is high during regular seasons and falls during peak seasons. For entrepreneurs, the peak season is the best time to generate more revenue and profits, so they recruit more workers.
The demand for jobs in specific industries is more seasonal than others. Tourism and recreation, construction, agriculture, and retail are some of them. For example, fruit pickers were heavily employed during the summer. Likewise, retail jobs are more prospective during pre-Christmas than on regular days.
The domino effect of a high unemployment rate
The unemployment rate is a critical gauge of an economy’s health. It reflects the percentage of people actively seeking work but unable to find it. But unemployment isn’t just a number on a chart; it has a cascading impact, affecting individuals, society, businesses, and the entire economy. Let’s delve deeper into this domino effect of a high unemployment rate:
Individuals
Financial strain: Job loss is a financial blow. It means a significant drop in income, making it difficult to afford basic necessities like housing, food, and healthcare. Savings goals are put on hold, and long-term financial security takes a hit. This financial strain can ripple outward, affecting families and dependents. Children from unemployed households may experience educational disruptions or have limited access to extracurricular activities.
Mental and physical well-being: The stress of unemployment can be immense, leading to anxiety, depression, and even physical health problems. The loss of routine and social interaction that comes with a job can further erode well-being. Studies have shown a correlation between unemployment and increased risk of heart disease, stroke, and even suicide.
Skills erosion: Long-term unemployment can be a double-edged sword. Skills can become outdated as technology and industries evolve. This can make it harder to re-enter the workforce and secure a new job that matches your qualifications. The longer someone is unemployed, the greater the risk of becoming disconnected from the labor market. They may face challenges refreshing their skills or keeping pace with industry advancements.
Society
Social unrest: When large numbers of people are unemployed, social tensions can rise. This can lead to increased crime rates and even social unrest as people struggle to make ends meet. A weakened social fabric can have long-term consequences for communities, hindering civic engagement and fostering a sense of hopelessness.
Widening inequality: Unemployment often disproportionately affects disadvantaged groups, such as recent graduates or single parents. This widens the income gap between the wealthy and the poor, creating social tension. Unemployed individuals may also face social stigma, further marginalizing them and hindering their ability to find new opportunities. According to studies in the United States, if the unemployment rate rises by 1 percentage point, it increases the poverty rate by 0.4 to 0.7 percentage points.
Strained social programs: As unemployment claims rise, it puts a strain on government social programs like unemployment benefits and welfare. This can limit resources available for other essential services like education and healthcare. Governments may need to make difficult choices about how to allocate resources in the face of high unemployment, potentially impacting the quality of social safety nets.
Businesses
Reduced demand: Fewer employed people means less disposable income circulating in the economy. This translates to decreased demand for goods and services, potentially hurting businesses across various sectors, from retail to restaurants. Businesses may be forced to cut costs, reduce hours, or even lay off additional workers, creating a vicious cycle of declining demand and economic slowdown.
Recruitment challenges: Filling open positions can be a challenge during periods of both high and low unemployment. There may be a surplus of unqualified candidates during high unemployment, making it difficult to find the right fit with the specific skills and experience needed. Conversely, during low unemployment, businesses may struggle to find workers with the specific skills they need, especially in rapidly evolving industries. This can lead to talent shortages and hinder business growth.
Lowered productivity: Job insecurity can cause employee morale to suffer, especially during periods of economic uncertainty. This can lead to lower productivity, higher absenteeism, and increased turnover. Businesses may also experience difficulties attracting top talent if there’s a perception of job instability. A demotivated workforce can stifle innovation and hinder a company’s ability to compete effectively.
The economy
Reduced output: A smaller employed workforce means the economy produces less overall. This impacts Gross Domestic Product (GDP), the total value of goods and services produced in a country. Lower GDP translates to slower economic growth, impacting everything from tax revenue to investment opportunities. Reduced economic activity can lead to a decline in living standards for everyone.
Deflation or inflation: Unemployment can lead to deflation, where prices fall due to decreased demand. This can discourage businesses from investing and hiring, further hindering economic growth. On the other hand, governments might try to stimulate the economy by pumping money in, which could lead to inflation, or rising prices. Inflation can erode the purchasing power of consumers, especially those on fixed incomes, further reducing demand and hindering economic recovery.
Tax revenue decline: With fewer people employed and paying taxes, government revenue shrinks. This limits the government’s ability to invest in public services like infrastructure and education, further hindering economic growth. The government may need to raise taxes or cut spending to balance the budget, impacting individuals and businesses alike. A decline in tax revenue can also limit the government’s ability to respond to economic downturns or invest in programs that promote long-term economic growth.
Policies to achieve full employment
Ideally, an economy aims for “full employment,” a state where everyone who wants a job can find one. However, achieving this balance is a delicate act, akin to walking a tightrope. A very low unemployment rate can lead to inflation, as businesses compete for a limited pool of workers and wages rise. This can put upward pressure on prices, eroding consumer purchasing power. On the other hand, too high an unemployment rate has the negative consequences we’ve explored earlier.
Economists refer to this sweet spot as the “natural rate of unemployment.” It’s the lowest unemployment rate achievable without causing inflation. This rate isn’t fixed and can change over time due to factors like demographics, technological advancements, and labor market regulations.
Policymakers and the quest for full employment
Governments implement various policies to try and steer the economy towards full employment while maintaining price stability. Here are some common approaches:
Stimulating demand: This can be achieved through both fiscal policy and monetary policy. Fiscal policy involves government spending on infrastructure projects or tax cuts to encourage businesses to invest and hire more workers. Increased government spending injects money into the economy, boosting demand for goods and services and potentially leading to job creation. Tax cuts can also incentivize businesses to expand their operations and hire new employees. Monetary policy can also play a role in stimulating demand by lowering interest rates. This makes it cheaper for businesses and consumers to borrow money, which can lead to increased investment, spending, and ultimately, job creation.
Improving job skills: Investing in education and training programs can help equip individuals with the skills employers are seeking. This can improve the match between job seekers and available positions, reducing unemployment and boosting productivity. By focusing on in-demand skills and retraining programs for displaced workers, governments can help individuals adapt to a changing job market.
Promoting labor market flexibility: Policies that make it easier for businesses to hire and fire workers can help the labor market adjust to changing economic conditions. This might involve streamlining regulations or reforming unemployment benefits to encourage faster re-employment. However, it’s important to strike a balance between flexibility and worker protection.
Beyond the headline: Unveiling Hidden Unemployment and the Full Picture
While the unemployment rate is a crucial indicator, it doesn’t tell the entire story. A significant segment of the workforce experiences what’s known as hidden unemployment or underemployment, painting a more nuanced picture of labor market conditions.
Hidden unemployment: These individuals are not counted in the official unemployment statistics, even though they’re not actively employed and would likely take a job if suitable opportunities arose. This can include discouraged workers who have given up their job search after facing prolonged unemployment and individuals not actively seeking work due to various personal circumstances like childcare or health issues (voluntary unemployment).
Underemployment: This describes people who are working but aren’t employed at their full capability. They may desire and be available to work more hours (visible underemployment), or be in jobs that don’t utilize their skills and experience (invisible underemployment). Examples include part-time workers who prefer full-time hours or someone with an engineering degree working at a coffee shop.
Why does hidden and underemployment matter?
Both hidden unemployment and underemployment highlight inefficiencies in the labor market.
Hidden unemployment can underestimate the true extent of underutilized talent and skills. A high number of discouraged workers can indicate a mismatch between skills and job opportunities or inadequate support systems for re-entry into the workforce.
Underemployment suggests the economy isn’t fully utilizing its available labor force. It can impact worker morale and productivity and limit economic growth. For example, underemployed individuals with valuable skills may not be contributing to their full potential.
