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A person is unemployed when he or she is willing and able to work given the prevailing terms and conditions of employment but does not currently have a job. Depending on its causes, unemployment can pose severe problems for both individuals and societies alike. For example, since most households derive most of their income from participation in the paid labor market, unemployment can be a source of considerable material hardship and distress. Furthermore, unemployment can challenge the sense of identity and self-worth that individuals derive from their jobs. Finally, unemployment represents, in the aggregate, a waste of productive resources: society as a whole would be better off if the unemployed were engaged in productive activity.

Measurement Of And Variations In Unemployment

Because of its importance, economists have long had an interest in the accurate measurement of unemployment. But unemployment statistics are subject to several measurement problems. For example, official statistics usually measure unemployment by requiring that a person’s willingness to work be demonstrated by evidence that they are actively searching for a job. Some economists, however, identify discouraged workers—those who are willing and able to work, but have ceased to search for work because they do not believe that jobs are available—as being unemployed. Despite this, discouraged workers are not included in official measures of unemployment because they are not actively looking for work. They are instead categorized (along with full-time students, retirees, and others) as not participating in the labor force.

Another measurement problem is associated with disguised unemployment. This was originally identified as a condition afflicting developing countries, wherein individuals might engage in very low-productivity work in the agricultural sector for want of a job that would more fully utilize their productive potential. But some economists now identify involuntary part-time or temporary work— that is, part-time or temporary work performed by those who would prefer a full-time, year-round job—as a form of disguised unemployment. Once again, disguised unemployment is not reflected in official measures of unemployment. This is because all those who have jobs are automatically categorized as employed, regardless of whether or not the jobs they perform fully utilize their productive potentials or satisfy their preferences with respect to the number of hours of paid work they perform.

Whatever their potential flaws, official unemployment statistics reveal a number of important stylized facts about unemployment. First, it has long been established that unemployment varies over the course of the business cycle, rising when the economy enters a recession and falling during a boom. Second, a more recently established stylized fact is that unemployment varies over time between lengthy “episodes” of higher or lower unemployment. For example, average annual unemployment rates in the major industrialized economies were much lower during the 1950-1973 period than they were during the preceding interwar period (1918-1939) or than they have been since 1973. Third, unemployment rates differ across countries at any particular point in time and during the episodes of high or low unemployment referred to above. Prior to 1973, for instance, it was commonly observed that unemployment in the United States was higher than that in Europe. Since the 1980s, however, the United States has tended to experience unemployment below the average rates witnessed in Europe. Finally, unemployment rates differ by age, sex, and race. Unemployment is typically highest among the young (ages sixteen to twenty-five) and members of racial or ethnic minorities. Older workers and women also frequently experience more unemployment than prime-age males, although since the 1970s, unemployment rates for women have become comparable to those for men in some of the major industrialized economies.

Explanations For Unemployment

What factors cause unemployment and so explain the stylized facts described above? According to some economists, the labor market operates like any commodity market, with variations in the level of wages serving to “clear” the market—that is, equate the supply of and demand for labor. But even when the labor market clears in this fashion, unemployment will exist. This fictional unemployment is often associated with the normal workings of the labor market. It arises because even if the number of jobs available is exactly sufficient for the number of job seekers at currently prevailing wages, the process of matching employers with employees takes time. It is therefore possible for some workers to be without jobs at any point in time. The amount of frictional unemployment is affected by a variety of factors, including the choices of workers themselves. For example, a currently unemployed person might decline to accept an offer of employment in anticipation of a superior subsequent offer. Unemployment that is the product of individual choice in this fashion is termed voluntary.

Other economists, however, claim that labor market clearing is a special case, sometimes called full employment (although not all economists who use the term full employment would agree that it is best conceptualized in terms of labor market clearing). These economists claim that observed unemployment is largely involuntary. According to the conventional definition, involuntary unemployment occurs when the labor market does not clear but is instead characterized by a surfeit of job seekers relative to the number of jobs available at currently prevailing wages. In this situation of “too many workers chasing too few jobs,” the unemployed are without work not by virtue of individual choice but as a result of a constraint that exists on their ability to sell labor. Some economists locate the source of this constraint on the supply side of the economy. For example, there may be impediments to the workings of the price mechanism that prevent wages from varying in the manner required to equate the demand for and supply of labor. Or alternatively, the stock of capital accumulated by firms may be insufficient to warrant the employment of all those willing to work, given the number of workers that need to be combined with a single unit of capital to produce a unit of output.

Other economists, however, locate the source of involuntary unemployment on the demand side of the economy. They argue that the demand for labor (and hence the quantity of employment offered by firms) is derived from the quantity of goods that firms can profitably produce and sell, so that the aggregate demand for goods is the ultimate determinant of employment and unemployment. According to this view, even when wages are free to vary and output can be produced by different combinations of capital and labor inputs (so that the existing stock of capital does not determine the level of employment that can be achieved), it is possible for an insufficient aggregate demand for goods to give rise to an insufficient derived demand for labor relative to the number of persons who wish to work at currently prevailing wages. This is the theory of employment and unemployment originally developed by John Maynard Keynes (1883-1946). Its most important feature is that it identifies as the source of involuntary unemployment a deficient demand for goods, rather than any problems with the functioning of the aggregate labor market that might prevent the latter from clearing.

The distinction between supply-side and demand-side theories of involuntary unemployment leads to a further distinction between classical and Keynesian unemployment. Classical unemployment—which includes frictional unemployment and supply-side involuntary unemployment—is determined on the supply side of the economy and is unresponsive to variations in aggregate demand. Classical unemployment is often associated with the concept of a natural rate of unemployment or a nonaccelerating inflation rate of unemployment (NAIRU). Keynesian unemployment, meanwhile, is determined on the demand side of the economy and does respond to variations in aggregate demand.

It is possible in principle for voluntary and involuntary or classical and Keynesian unemployment to exist within the same economy. However, economists disagree as to what extent observed unemployment is voluntary, involuntary, classical, or Keynesian, and hence on the extent to which these categories, and the theories of unemployment associated with them, are useful for explaining the stylized facts outlined earlier.

Policy Implications

The policy implications of unemployment depend greatly on the theorized causes of unemployment. For example, if unemployment is a product of individual choice (i.e., a voluntary condition), it would not appear that any form of policy intervention is merited. Even if unemployment is entirely frictional, however, it may be prudent to use public policy to reduce unemployment—including voluntary unemployment—by improving the process whereby employers and employees are matched. In this case, supply-side, microeconomic policies designed to affect the choices or attributes of job seekers are appropriate. Unemployment insurance programs might be altered to influence the propensity of those searching for work to accept job offers, or training programs might be established in an effort to imbue the unemployed with the sorts of skills required by currently vacant jobs. If unemployment is involuntary and Keynesian, however, an altogether different approach to policy intervention is required. In this case, macroeconomic policies (such as a reduction in interest rates or an increase in government spending) are needed to raise aggregate demand in order to remedy the deficient demand for goods and hence the deficient derived demand for labor that is the ultimate cause of unemployment. As with the theories of unemployment from which these policy interventions derive, the appropriate policy response to unemployment is— and will likely remain—a subject of controversy among economists.

Bibliography:

Cornwall, John, and Wendy Cornwall. 2001. Capitalist Development in the Twentieth Century: An Evolutionary-Keynesian Analysis. Cambridge, U.K.: Cambridge University Press.
Davidson, Carl. 1990. Recent Developments in the Theory of Involuntary Unemployment. Kalamazoo, MI: Upjohn Institute for Employment Research.
Friedman, Milton. 1968. The Role of Monetary Policy. American Economic Review 58 (1): 1–17.
Keynes, John Maynard. 1936. The General Theory of Employment, Interest, and Money. London: Macmillan.
Lawlor, Michael S., William A. Darity, Jr., and Bobbie L. Horn. 1987. Was Keynes a Chapter Two Keynesian? Journal of Post Keynesian Economics 9 (4): 516–528.
Lucas, Robert E., Jr. 1978. Unemployment Policy. American Economic Review 68 (2): 353–357.