Unemployment

Unemployment occurs when people who are able and willing to work, and actively seeking work, cannot find a job. There are several types, each with a distinct cause.

Frictional unemployment is short-term unemployment of people between jobs or searching for their first job. It is caused by the time and imperfect information involved in matching workers to vacancies, and exists even in a healthy economy.

Structural unemployment is caused by a mismatch between the skills or location of workers and the jobs available, arising from the long-term decline of industries (for example, the closure of coal mines or the shift away from manufacturing). Workers' skills become obsolete (occupational immobility) or the new jobs are in different regions (geographical immobility), so it is often long-term.

Cyclical (demand-deficient) unemployment is caused by a fall in aggregate demand during a recession. As demand for goods falls, firms cut output and lay off workers; it rises and falls with the economic cycle and can affect the whole economy.

Seasonal unemployment is caused by regular, predictable seasonal changes in the demand for labour, such as in tourism, agriculture or construction.

Technological unemployment is caused by new technology and automation replacing workers — a form of structural unemployment in which machines and software do jobs people used to do.

Identifying the type matters because the cause determines the appropriate cure: cyclical unemployment requires demand-side policy (raising AD), while structural, frictional and technological unemployment require supply-side measures such as retraining, better job information and help with mobility.

The source describes two types of unemployment.

The fact that unemployment "rose sharply after a recession" points to cyclical (demand-deficient) unemployment — a fall in aggregate demand caused firms to cut output and lay off workers.

However, the detail that the newly unemployed worked in "industries that have permanently closed" points to structural unemployment — these workers' skills are no longer demanded, and there is a mismatch between their skills and the jobs now available.

The best policy depends on which dominates. For the cyclical element, demand-side policy is appropriate: boosting AD (e.g. lower interest rates or higher government spending) to raise output and re-employ workers as the economy recovers. For the structural element, demand-side policy is not enough — even with strong demand, these workers lack the skills the new jobs require. They need supply-side policy: retraining and education to give them new skills, and help with relocation to where jobs exist.

Because both types are present, the most effective approach is a combination: stimulate AD to address the cyclical unemployment, while investing in retraining and mobility to address the structural unemployment.

The most effective policy to reduce unemployment depends on its cause, so a government must first diagnose the type of unemployment.

Demand-side policy for cyclical unemployment. If unemployment is cyclical (caused by a fall in AD in a recession), the appropriate cure is expansionary demand-side policy — for example, lower interest rates (monetary policy) or higher government spending / lower taxes (fiscal policy) — to raise AD, increase output and re-employ workers. Strengths: it acts relatively quickly and directly addresses deficient demand. Limitations: near full capacity it causes demand-pull inflation rather than more jobs; it can worsen the government budget or the current account; and it does nothing for unemployment that is not demand-related.

Supply-side policy for structural/frictional unemployment. If unemployment is structural (skills/location mismatch) or technological, the cure is supply-side: retraining and education to update skills, subsidies or incentives for firms to hire, better job-search information (for frictional), and help with geographical mobility. Strengths: it tackles the root cause and improves the economy's long-run capacity (shifting LRAS right). Limitations: it is slow (training takes years) and costly, and it cannot help if there is simply no demand for output.

Judgement. There is no single best policy for all unemployment; effectiveness depends on the cause. For a recession-driven rise in cyclical unemployment, demand-side policy is most effective in the short run. For long-term structural or technological unemployment, supply-side policy is essential, even though it works slowly. Using the wrong policy fails — boosting AD will not re-employ workers who lack the right skills, and retraining will not help if there is no demand for output. The most defensible conclusion is that a government should diagnose the type of unemployment and match the policy to the cause, often combining demand-side and supply-side measures, with the balance depending on whether the problem is deficient demand or a structural mismatch.

Unemployment imposes serious costs, but whether it is the most damaging macroeconomic problem must be weighed against other problems such as inflation and a current-account deficit.

The case that unemployment is highly damaging. Unemployment causes lost output — the economy produces inside its PPC, wasting resources permanently. The unemployed suffer falling incomes, poverty, loss of skills (hysteresis) and ill-health and stress. The government faces higher benefit spending and lower tax revenue, worsening its budget. There are wider social costs — crime, inequality and regional decline. High, long-term unemployment is therefore deeply damaging to welfare and to the economy's capacity, supporting the view.

The case that other problems may be as or more damaging. Inflation, especially hyperinflation, can be devastating — eroding the value of money and savings, destroying confidence, distorting decisions and harming international competitiveness; runaway inflation can collapse an entire economy. A persistent current-account deficit can be unsustainable, leading to rising debt and a falling exchange rate. Moreover, some unemployment is unavoidable (frictional and seasonal) and not especially damaging, so the severity of unemployment depends on its type, level and duration — a small amount of frictional unemployment is far less damaging than high cyclical or long-term structural unemployment.

Judgement. Unemployment is one of the most damaging macroeconomic problems — particularly when it is high, cyclical or long-term structural — because of its large output, human and fiscal costs. However, it is not unconditionally the most damaging: severe inflation can be equally or more destructive, and low frictional unemployment is relatively harmless. The most defensible conclusion is that the most damaging problem depends on the circumstances: in a deep recession, mass unemployment is likely to be the worst problem; but where inflation is spiralling, that may do greater harm. So unemployment is among the most serious problems, but its ranking is context-dependent rather than absolute.