June 28, 2022

Understanding Unemployment

“The real impact of recession is felt directly on the unemployed and their families, in lost income, lost opportunities, and a host of social problems, including impaired mental health, domestic violence, and substance abuse.” ~ Robert F. Mulligan

Unemployment statistics are prepared by the Department of Labor for the US from surveys. The Census Bureau sends out the monthly household survey to 60,000 households, separating adults into those who are working for pay, and those who are not currently working for pay but are actively participating in the labor force. Most unemployed members of the labor force are actively looking for work. Small percentages are temporarily laid off, waiting for new jobs to start, or on strike due to a labor action. In each of these cases, the person has a job which is not currently providing income. These unemployed workers will presumably start or return to these jobs in the future. The labor force explicitly excludes certain categories, like anyone under 16, homemakers, retired people, or institutionalized adults. Institutionalized adults include students, patients in hospitals or other medical facilities including mental health facilities, retired people, disabled people, members of the armed forces, etc.

The unemployment rate is the ratio of the number of unemployed members of the labor force divided by the total labor force. It seems to hover around 5-6 percent, which we can consider the natural rate of unemployment, though it rises during and after a recession. Normally it takes about two years after the end of a recession for unemployment to recover fully.

Figure 1. U.S. unemployment, 2000-2022

(Source: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, February 6, 2022.)

In Figure 1 we can see that unemployment was around 4 percent prior to the mild 2001 recession, peaking above 6 percent in 2003, two years after the official end of the recession. The far more severe 2007-2009 Great Recession saw unemployment hit 10 percent, and stay above 6 percent until 2014. Unemployment was lower in 2019 before the COVID-19 recession than in 2000, but peaked at nearly 15 percent. Although unemployment fell very quickly below 6 percent, the COVID-19 recession has been very disruptive to U.S. labor markets.

The labor force participation rate is the ratio of the labor force divided by the total adult population. The labor force includes all employed and all unemployed people, but it does not include institutionalized adults or anyone who is not actively looking for work, unless they fall into one of the three special categories—waiting for a new job to start, temporarily laid off, or on strike. During a recession, especially one that drags on for more than about a year, the labor force participation rate tends to fall as unemployed workers become discouraged from looking for work. As this happens, these workers are no longer counted as unemployed, because they’re no longer counted in the labor force. This can make the unemployment rate start to fall, even though many people have still not found jobs. Looking at Figure 2, we can see about a two-year decline in labor force participation over some recessions but not for others. Falling labor force participation is most prominent for the 1961, 1970, 1990, 2001, 2007-2009, and 2020 recessions. Sometimes it starts to fall almost a year before the official start of the recession, and continues to fall until well after the recession officially ends. Another thing that is most pronounced in this figure is the growth in the labor force from roughly 1965-1995 as women increasingly entered the labor force over this period. Labor force participation rose from about 59 percent of the adult population to 67 percent during this period, mainly due to women joining the workforce. The 2001 recession seemed to reverse some of that progress, and the decline accelerated further after the 2007-2009 Great Recession, though it seemed to have stabilized at around 63 percent by 2015. The COVID-19 recession prevented many people from working, and it remains unclear whether labor force participation will recover, or how fast.

Figure 2. U.S. Labor Force Participation Rate 1960-2022

(Source: U.S. Bureau of Labor Statistics, Labor Force Participation Rate [CIVPART], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CIVPART, February 6, 2022.)

There are four different kinds of unemployment: structural, frictional, cyclical, and seasonal. Structural unemployment is associated with long-term, permanent changes in the economy, including technological progress that makes established industries obsolete. When textile firms in New England relocated to the South, that migration increased unemployment in New England, and lowered it in the South. When those same activities moved overseas to China or the Asian tigers, this increased unemployment in the Southeastern US, but lowered it in Malaysia, Indonesia, Vietnam, Guatemala, etc. Structural employment accompanies long-term structural changes in the economy, technology, and the structure of production.

Frictional employment is voluntary, and a certain amount is normal for a healthy economy and even beneficial. This occurs when workers quit one job to search for a new one. Workers are more likely to do this when their job prospects are favorable. The better the economy, the easier it is for workers to find a new job, so the higher frictional employment will be. Frictional employment tends to indicate that workers are in demand and that it will be easy for them to find new, higher-paying jobs. Structural and frictional unemployment add up to the natural rate of unemployment, which is thought to be about 5-6 percent for the U.S. This natural rate is generally higher in countries with more generous unemployment and welfare benefits, and less flexible labor markets.

Cyclical unemployment is associated with recessions. In a recession, aggregate demand collapses and the economy contracts. There is less demand for output, and firms respond by cutting back on production and laying off workers, so unemployment rises during recessions, as shown in Figure 1.

Seasonal unemployment affects some job categories more than others. During the Christmas season, retailers hire extra staff, as well as department store Santas. There is less demand for these seasonal workers in July. Extra retail staff are also needed for firms that audit their inventory between Christmas and New Year’s Day. Extra accountants are needed between February 1 and April 15. Similarly, construction workers are in greater demand during the spring, summer, and fall, than in the winter, when they generally cannot work outdoors. These seasonal spikes in labor demand go away after their busy season ends.

Unemployment is the most important measure of the business cycle’s impact. The macroeconomic impact of a recession may be measured in trillions of dollars of lost GDP, but that is essentially an abstract and meaningless statistic. The real impact of recession is felt directly on the unemployed and their families, in lost income, lost opportunities, and a host of social problems, including impaired mental health, domestic violence, and substance abuse.

This article, Understanding Unemployment, was originally published by the American Institute for Economic Research and appears here with permission. Please support their efforts.