Unemployment represents people in the labor force who currently do not have work but are actively looking for a job. Unemployment consists of frictional, structural, seasonal, and cyclical unemployment.
Why unemployment condition matters
The unemployment rate measures how well the economy is performing. By working, people get the money they can spend on goods and services.
In many countries, household consumption is the primary driver of aggregate demand and economic growth. When unemployed get a job, they will increase spending. The higher consumer will encourage a positive multiplier effect on the economy. Thus, low unemployment is essential to maintain healthy economic growth.
A prolonged period of high unemployment can worsen people’s living standards. Unemployment is responsible for increasing poverty and crime. It also leads to higher payments for social security, such as unemployment benefits and food aid.
Unemployment can also affect other parts of the economy. For example, low unemployment can motivate central banks to raise interest rates. In such situations, the economy is overheating, and a further decline in unemployment will increase the inflation rate. An increase in interest rates, in turn, affects stock and bond prices. It also attracts foreign capital into the domestic capital market.
Types and their causes
In economics, being unemployed does not mean not wanting to work at all. The latter term refers to who have not a job and are not actively looking for work, maybe because of the full-time college, working at home, disabled, or retired. They are not considered part of the labor force and therefore excluded in the unemployment calculation. In economics, people are said to be unemployed if they are not working but actively looking for work.
Unemployment can be classified into four categories.
- Frictional unemployment comes from immobility in the labor market. It takes time for unemployed workers to find new jobs. And, during the waiting period, they are categorized as unemployed.
- Structural unemployment occurs because of significant changes in the economic structure. Such changes may stem from technological changes or evolution in international competition. These factors cause some skills to become obsolete, and the workers being unemployed forever.
- Seasonal unemployment comes from seasonal factors such as holidays or Ramadan. The demand for some jobs rises during peak season and falls during the regular season. This phenomenon is common in industries such as tourism, construction, and agriculture.
- Cyclical unemployment arises when the economy goes through the phase of the business cycle. Unemployment falls during the expansion phase and rises during the contraction phase.
Frictional and structural unemployment will persist in the economy over time. Both form the natural rate of unemployment, which refers to the lowest level of unemployment in the economy. It means, even if an economy operates at its potential output, unemployment will never be zero.
Meanwhile, seasonal and cyclical unemployment can be overcome through economic policy. During the contraction, for example, the government would adopt an expansionary policy. This policy will encourage economic growth, help businesses to increase production, and boost economic activity. As a result, job creation increases, driving more demand for labor.
How to calculate the unemployment rate: formula and data in Indonesia
Before calculating the total unemployment rate, let us first divide the entire population into three parts:
- Non-productive age population. They are 15-64 years old outside. They include children and retirees.
- Productive age population (aged 15-64 years) but not actively looking for work. They include housewives, full-time students, and retirees.
- Productive age population (aged 15-64 years) and actively looking for work. We call this group the labor force. From the labor force data, the Central Bureau of Statistics then divides it into two, those who are working, and those who are unemployed.
We calculate unemployed workers by the total labor force. Usually, this statistic is expressed as a percentage.
Unemployment rate = Number of unemployed / Total labor force
The unemployment rate usually goes up and down after the economic conditions change (thus, called a lagging indicator). When the economy expands at a healthy pace, the demand for workers increases because businesses need to increase output. Higher production activity creates more jobs and employs more workers. Hence the unemployment rate falls.
Conversely, when the economy is contracting, more businesses cut their output and lay off employees. This situation causes the unemployment rate to increase.
How economic policy affects unemployment
Economic policymakers often cite the unemployment rate indicator as to the input for their policy. Low unemployment is one of the goals of macroeconomic policy, besides healthy economic growth and low inflation rate.
During economic contraction, the unemployment rate rises. A higher unemployment rate urges policymakers to loosen economic policy. For example, in this situation, central banks will cut interest rates to increase aggregate demand and stimulate economic activity. Higher aggregate demand will encourage businesses to increase their production. It creates not only more demand for raw materials but also labor.
The relationship between inflation and unemployment
At a certain level, the unemployment rate cannot fall further without sacrificing inflation. If unemployment continues to decline, the economy will become too hot, and inflation will rise. We call this lowest level the non-accelerating inflation rate of unemployment (NAIRU).
The inverse relationship between unemployment rate and inflation is illustrated in the Philips curve.
