The Macroeconomics Series (IV): Is unemployment really unavoidable?

Welcome back to the Macroeconomics Series! In this article, we are going to take a look at the last “big” concept that economists work with when handling macro: unemployment. We’ve talked about inflation and GDP, but the labour market is definitely closer to us (individuals) than the other two concepts, which I’m sure will make things easier to understand. After reading this article, you should be able to put together all the information available in previous entries and understand why things happen.

GDP is an aggregate measure that focuses on the goods market. Inflation, on the other hand, focuses on the prices of goods and services. Finally, the labour market translates all these changes and market fluctuations into “how does this affect people?”. Let’s do some theory-crafting to clarify things: at one point, there is an increase in demand for certain goods or services. Firms respond to this increase by producing a bigger amount of said goods and services. How can firms deal with having to produce more than before? By hiring new workers (more employment = less unemployment). Lower unemployment means wages go up, because it becomes harder to find workers now. Higher wages lead to higher costs, which lead to an increase in prices (inflation!). We got all three concepts in just a few lines of text!

Time to get a bit more formal (and Economic). Unemployment does not mean you don’t have a job. Many people don’t work because they can’t (children, elderly people), so we never count them as unemployed. We need to focus on the population in working age (this concept varies slightly depending on your country’s laws, but it’s usually something between 16 and 70 years old). Of course, some of them can’t work even though they are in working age (I was thinking about people with severe disabilities, but there are a few crazy dudes who just want to live life. Good luck to those people!), so we’re not counting them either. All these exclusions leave us with the labour force. People who are in working age and want to work. Some of them do have a job (congratulations), and we call them employed. Some of them don’t have a job and are looking for one. We call them unemployed.

Employed and unemployed people are just a part of the total population.

Unemployment can be a consequence of a variety of economic phenomena, some of which are common to every country. For example, having a pandemic strike every single place on earth and kill millions of people is something that affects everyone and everything, including your job. Unemployment figures in the EU went from 6.5% to almost 10% in just a few months earlier this year as a consequence of lockdown and a general slowdown of economic activity. Of course, an economy that needs to move slower or recover after a crash will not be able to employ as many people as a healthy one.

However, there is one issue that doesn’t have to do with economic cycles or exogenous shocks: I’m talking about the natural rate of unemployment. According to theory, there is an equilibrium in the labour market that works just like equilibrium in the goods market. However, this so-called “natural” rate is not actually “natural”; we cannot determine what the natural rate of unemployment for a country is because it can fluctuate (not too much).

A “natural” level of unemployment typically includes movement from workers (quitting your job because you got a more competitive offer), workers whose skills are not deemed necessary by the market, and workers whose tasks have been replaced by robots. We’re talking about frictional unemployment and structural unemployment.

Many economists consider an unemployment rate of 4% or less to be “full employment”, since it is virtually impossible to reach full employment, and real full employment would do more harm than good. But why is this a thing?

Think about it this way: if everyone is employed, companies will have zero bargaining power and nominal wages will increase because they cannot afford to lose any of their workers. When nominal wages increase, there is an increase in the price level (i.e. if everyone gets a million dollars, are you actually a millionaire? Ask inflation about that). Money printers would have to go brrrrr like never before and a cup of coffee would be ridiculously expensive after a few years.

The answer to my question is (sadly) no. In a way, some unemployment is necessary for an economy to stay healthy. If you’re unemployed, I wish you luck and I’m sure that you will find a job very soon, but I want you to look at the bright side of it: even in your current situation, you’re playing an important role in your country’s economy! Stay strong, stay Economic 🙂

 

Read more about unemployment, NAIRU and economic theory:

BLANCHARD, O. et al. (2017): Macroeconomics: a European Perspective. Pearson.

BALL, L. and G. MANKIW (2002): “The NAIRU in Theory and Practice”. National Bureau of Economic Research.

PICHELMANN, K. and A. SCHUH (1997), “The NAIRU-Concept: A Few Remarks“, OECD Economics Department Working Papers, No. 178, OECD Publishing.

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