Economics Terms A-Z
Unemployment refers to the people of a country or region that are currently without a job and seeking employment. It is one of the main economic indicators given that low unemployment rates are associated with high levels of production and economic growth, and are consequently a key concern for economists and policy makers alike.
Measuring the unemployment rate
Each country has its own system of measuring unemployment and most of them are based on surveys. The OECD calculates the unemployment rate based on labour force surveys. According to this survey a person is unemployed if he or she is of working age i.e., aged 15 to 64, without work and actively seeking employment. The unemployment rate is then calculated as the number of unemployed people relative to the labour force, where the labour force is the sum of employed and unemployment people.
This means that a person is only classified as unemployed if he or she is actively looking for a job. At the same time a person is considered to be employed if he or she is aged 15 or above and has worked for at least one hour in the week before the taking part in the survey. Only paid work is included in the definition of the OECD.
Anyone without employment, who is not actively searching for a job, is not considered unemployed. This means that full-time students who are not working are not considered unemployed. Similarly, persons who take care of household or childcare duties, such as housemen and housewives, are not unemployed either. Another group of people that is not included in the unemployment rate are so-called “discouraged workers”. These are workers who were previously unemployed but have stopped looking for work because of lack of success/opportunity. This indicates that the unemployment rate – despite being an important indicator of the healthiness of the labour market – is not sufficient and other indicators like, for instance, participation rates, need to be taken into account as well. The participation rate measures the labour force relative to the working age population and therefore includes the groups of people mentioned above that are not adequately represented by the unemployment rate.
Different types of unemployment
According to economic theory there are different types of unemployment and not all are equally worrisome.
- Frictional unemployment, for example, refers to people that are in between jobs or have just graduated and have just started looking for a job. Frictional unemployment can never be eliminated entirely and there is also no reason why this should be the priority, because people that are temporarily unemployed because they are transitioning from one job to another will not be out of work for long.
- Another type of unemployment is seasonal unemployment. As the name indicates this type of unemployment is caused by the seasonal nature of certain types of work, like, for instance, in the tourism industry or in the construction industry.
- Cyclical unemployment is the unemployment associated with the business cycles. During a recession, firms lower production and lay off workers, which means that unemployment increases. During a boom, unemployment decreases because firms expand production and hire additional workers.
- Structural unemployment arises when technological change destroys certain jobs that simply become obsolete. As an example you can think you of switchboard operators whose job was to establish a connection during the early days of telecommunication. While certain jobs get lost due to technological innovations, new jobs are also created. The problem, however, is that retraining people who lost their jobs to take over the newly created ones may be difficult and can be costly. Therefore, structural unemployment often leads to long-term unemployment or people dropping out the labour force entirely.
- Institutional unemployment refers to unemployment that is the result of the absence of incentives that normally motivate the unemployed to actively seek employment, as well as a whole host other institutional factors. Generous unemployment benefits, for example, are thought to disincentivise people from searching for employment, whereas a high minimum wage may make it unattractive for firms to hire additional workers. Other government policies such as restricting competition in certain industries may also adversely affect the labour market.
So far, we have talked a lot about how to measure, calculate and classify different types of unemployment. Yet, we still have no idea what high or low unemployment means when talking about actual numbers. Let us have a look at a few numbers from the European Union. In the subsequent graph we can see the unemployment rates for four different European countries: Germany, Greece, France and Spain from 2005 until 2020 (Source: OECD). During the time period shown in the graph Germany’s unemployment rate is decreasing until 2020 and starting from 2007 was always below 10%. France as well has a comparatively low unemployment rate of around 10%. At the same time Spain and Greece – two countries that were particularly affected by the financial crisis in 2008/09 – had unemployment rates which at times even exceeded 25%.
Unemployment rates can be compared not just across countries but also age groups. Usually unemployment tends to be higher among the younger and older generations. Policymakers have to decide which public policies and measures are most suitable to the specific characteristics of the unemployed. Therefore, it is important to look at a variety of demographic characteristics such as education, gender, and so on, as this can help to decide which measures are most adequate. For example, policies that aim to tackle youth unemployment will differ from measures targeted at unemployment of older generations.
Maybe you already have heard of “Okun’s law”? Okun’s law refers to the relationship between the unemployment rate in an economy and its output growth. The economist Arthur Okun (1928-1980) stated that for every 1 percentage point increase in the unemployment rate, the output of the country will shrink by 3 percentage points. In “Okun’s Law: Theoretical Foundations and Revised Estimates” (The Review of Economics and Statistics, 1993), Prachowny shows that the output reduction associated with an increase in the unemployment rate is less severe when taking into account the output gap.
Good to know
For economists there exists something called the “natural rate of unemployment”. The natural rate of unemployment is the unemployment that arises due to frictional and structural unemployment. When we talk about “full employment”, we do not have in mind an unemployment rate of 0%. This would be impossible as there will be always some people (temporarily) without a job even if the economy is fulfilling its potential output.