Unemployment: Types & Effects

Why governments target low unemployment

This was covered in topic 12 (macroeconomic aims), but the highlights:

• Reduces poverty and raises living standards.
• Raises tax revenue and cuts welfare spending.
• Uses the economy's productive capacity efficiently rather than letting it sit idle.
• Improves social wellbeing (long-term unemployment is linked to poor mental and physical health).

Most developed countries therefore aim for full employment rather than for zero unemployment, which is neither possible nor desirable because some frictional unemployment is normal as people move between jobs.

2. The four types of unemployment

A 4-mark "explain two types of unemployment" question gives one mark for naming each type and one for explaining it. The syllabus names four.

Cyclical (demand-deficient) unemployment

Cyclical unemployment is caused by a fall in aggregate demand during a recession. When firms cannot sell as much output, they need fewer workers and lay people off.

The mechanism: a recession → AD falls → firms cut output → firms hire fewer workers / make existing workers redundant. As the economy recovers, AD rises again and cyclical unemployment falls.

This is also called demand-deficient unemployment because the underlying cause is too little demand for goods and services.

Structural unemployment

Structural unemployment is caused by the long-term decline of an industry, or a mismatch between the skills of unemployed workers and the skills required by the new jobs available.

Two distinct sources:

• Industry decline. Coal mining, shipbuilding, manual telephone-exchange operating and high-street retail have all shrunk dramatically over recent decades. The workers in those industries cannot all be redeployed in the new growing sectors.
• Skills mismatch. Even when total demand for labour is fine, individual workers may lack the specific skills the open jobs require. A former coal miner without IT skills cannot easily take a software-engineering job.

Structural unemployment is long-term. It does not go away when the economy recovers, because the underlying problem is not weak demand. The solution is retraining, education and regional policy.

Frictional unemployment

Frictional unemployment is the short-term unemployment that arises when workers are moving between jobs: leaving one position and looking for the next.

This kind of unemployment is voluntary and temporary. A worker who has resigned from one job to look for a better one is frictionally unemployed for the days, weeks or months until they find the new position. Almost every healthy labour market has some frictional unemployment, simply because matching workers to jobs takes time.

Better information about available jobs (online job portals, job centres) reduces frictional unemployment by shortening the search.

Seasonal unemployment

Seasonal unemployment is caused by demand for labour varying with the seasons in particular industries.

Examples:

• Ski resort workers are out of work in summer.
• Fruit pickers are needed only during the harvest months.
• Construction workers in cold climates face winter slowdowns.
• Tourism workers in coastal resorts may have very low demand in off-season months.

Seasonal unemployment is predictable; workers in seasonal industries often have second jobs or move between industries with opposite seasons.

The four types at a glance

3. Measuring unemployment

The unemployment rate is the percentage of the labour force that is unemployed.

The labour force = people in work + people actively seeking work. Children, retirees, full-time students and discouraged non-seekers are not part of it. So:

$\text{Unemployment rate (\%)} = \dfrac{\text{Number unemployed}}{\text{Labour force}} \times 100$

Unemployment is measured using the Labour Force Survey.

The Labour Force Survey (LFS)

The Labour Force Survey is a sample survey of households that asks people directly whether they are working, looking for work, or neither.

Strengths:

• Accurate measure of true unemployment because it asks people directly, picking up those who are looking for work but not registered with any benefit office.
• Internationally comparable because countries use the same survey definitions (ILO standards), so unemployment rates can be compared across borders.
• Captures details that administrative records cannot, such as demographic breakdowns and how long people have been out of work.

Weaknesses:

• Expensive to run, because it involves surveying a large sample of households regularly.
• Sample-based, so subject to a margin of error: the figure is an estimate, not a complete count.
• Available with a lag, because the survey results take time to collect and process.

4. Effects of unemployment

Unemployment harms more than just the unemployed person. The syllabus lists its consequences for the individual, firms, the government and the economy.

Effects on the unemployed individual

• Loss of income. The most immediate effect. Living standards fall.
• Deskilling. Skills decay during long periods without work. The longer someone is unemployed, the harder it becomes to find a new job (a "scarring" effect).
• Mental and physical health. Long-term unemployment is associated with depression, anxiety, and poorer physical health.
• Social stigma. Unemployed people may face discrimination from employers and judgement from peers.

Effects on the government

• Higher welfare spending. Unemployment benefits, housing support and free school meals all rise when unemployment rises.
• Lower tax revenue. Less income tax (fewer wage-earners), less VAT (people on benefits spend less), less corporation tax (firms earn less).
• Larger budget deficit. Both directions push the government's books into deficit.
• More pressure for action. Voters dislike high unemployment, and political pressure for stimulus rises.

Effects on the wider economy

• Output below potential. Some of the economy's productive capacity sits idle. Real GDP is below what it could be.
• Lower aggregate demand. Unemployed people spend less, which feeds back into lower demand for firms' products.
• Lost productive capacity. Long-term unemployment causes permanent skill loss; the economy's future capacity is reduced.
• Higher inequality. Unemployment is concentrated among already-vulnerable groups (low-skilled workers, certain regions, ethnic minorities).

Effects on firms

Firms see a mix of harm and benefit:

• Harm: lower sales. Unemployed customers spend less, so firms in consumer-facing industries lose revenue.
• Benefit: cheaper labour. With more job seekers per vacancy, firms can hire at lower wages and put less effort into retention.
• Benefit: less wage pressure. Existing workers are less likely to demand pay rises because the threat of unemployment is real.

On balance the harm usually outweighs the benefit, which is why business groups generally support job-creation policies despite the cheap-labour upside.

The effects spread out across every stakeholder group at once, as this summary shows.

The downward-spiral pattern

In a serious recession, the effects feed back into each other:

1. AD falls → firms cut output → workers lose jobs.
2. Unemployed workers spend less → AD falls further.
3. Firms cut output again → more workers lose jobs.

The spiral is what makes a deep recession so hard to escape without policy intervention.

5. Policies to reduce unemployment

The right policy depends on the type of unemployment. Broadly, cyclical unemployment calls for a demand-side response while the other three types call for supply-side labour-market policies.

Cyclical unemployment: expansionary AD policy

Cyclical unemployment is a problem of too little demand. The response is to raise aggregate demand.

• Expansionary fiscal policy. Cut taxes and/or raise government spending. Both increase AD: households have more to spend, government injects money directly. Firms hire more workers to meet the higher demand.
• Expansionary monetary policy. Cut interest rates. Borrowing becomes cheaper, households spend more on credit-purchased goods (cars, homes), firms invest more. AD rises.

Both work over months to a year. The trade-off is that excessive stimulus can trigger inflation (topic 12's growth–inflation conflict).

Structural unemployment: supply-side policy

Structural unemployment is a problem of mismatched skills or declining industries. The response is to change the supply side of the labour market.

Main tools:

• Retraining programmes. Government-funded courses to teach unemployed workers new skills for growing industries.
• Subsidised apprenticeships. Firms get money to take on and train new workers, especially the previously unemployed.
• Education reform. Schools and colleges adjust the curriculum to match labour-market needs (more vocational pathways, more STEM).
• Regional aid. Tax incentives or grants for firms to set up in high-unemployment regions, or subsidies for workers to relocate to where the jobs are.
• Encouraging geographic mobility. Housing support, transport investment, easier credentials transfer between regions.

These policies take years to bear fruit; structural unemployment is not solved overnight.

Frictional unemployment: search-and-information policies

Frictional unemployment is a problem of job search taking time. The response is to speed up matching.

• Better job-information services. Online job portals, well-funded job centres, employer-matching services.
• Tighter benefit eligibility. Some governments shorten the period during which unemployment benefit can be claimed, to incentivise faster job search. (This has obvious downsides for vulnerable workers.)
• Job-search support. CV-writing classes, interview practice, career guidance.

Frictional unemployment can never be fully eliminated, but it can be kept very low with good information and incentives.

Seasonal unemployment: income smoothing

Seasonal unemployment is predictable and recurring. The response is usually to smooth incomes across seasons rather than to eliminate the unemployment.

• Income support during off-seasons.
• Encouraging off-season work for seasonal workers (e.g. ski instructors who work as climbing guides in summer).
• Subsidising employers to keep workers on the books year-round.