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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

The Economics of Unemployment

There’s not much that people won’t do to find a job. They’ll leave their homeland, leave their families and put up with almost any hardship for the chance to make a living. Employment, one of the greatest economic incentives the world has ever known, has been a driving social factor for millennia. And one could argue that it’s one of the main reasons America exists today.

The Puritans were some of the first American homesteaders. Reviled by the Church of England and discriminated against in their home country, Puritans were barred from most jobs in England. In fact, Puritan was a derogatory term that the extreme Calvinists never called themselves. As farming became unprofitable for single families in England, the group decided to start a new community in a land where they would not be barred from jobs and, as a secondary concern, where they could found an ideal Christian state.

Just like any other component of a free market, supply and demand of labor determines what wages will be paid and how many people will be employed. Depending on the state of the economy, there could be a glut or a deficit of workers. When an economy is booming, workers are needed and wages tend to rise. When an economy contracts, workers are laid off and wages tend to fall.

Full employment is an indication of economic health. To understand the numbers is to have a stronger indication of where the economy is headed.

Each month, the Bureau of Labor Statistics (BLS) at the United States Department of Labor surveys a sample of about 140,000 businesses to gather detailed data on employment, hours and wages. They also contact 60,000 households -- about 110,000 individuals -- to round out the data.

The data first separates Americans into three broad categories:

1) Employed: To be categorized as employed, a person must be part of the civilian labor force, regardless of whether on vacation, sick-leave, or the like.

2) Unemployed: To be categorized as unemployed, a person is jobless but must be able to work and must have been looking for a job for at least four weeks.

3) Not in the Labor Force: If a person is not in the labor force, he’s not included in either the employment or unemployment numbers. To be categorized as not in the labor force, a person is neither employed nor has he or she been looking for a job during the last four weeks. These people are often retired, attending school, in nursing homes or prisons or are on active military duty.

There is a significant subset of people not in the labor force called Discouraged Workers. They are not employed and have not been looking for jobs because they were previously unable to find work, they believe there is nothing available, they lack the necessary skills or they face some sort of discrimination.

Discouraged workers can throw a wrench in unemployment statistics. In some cases, increases in unemployment are actually a good sign because a large number of discouraged workers are optimistic enough to start looking again for work. By looking for jobs, their categorization changes from "not in the labor force" to "unemployed." Conversely, workers dropping out of the labor force and moving from "unemployed" to "discouraged workers" can cause an unintended decline in the unemployment rate.

Who's Working?

You can get a more detailed account of who is working in an economy by visiting the BLS Civilian Labor Force Participation Rate table, which you can find here. It breaks down the labor force by ethnicity, gender and age for the past 20 years and projects labor trends for the next 10 years.

According to BLS reports, during the last 10 years there was a +.5% increase in Hispanic labor force participation and a -1.3% decrease for whites. This is not to say that there was a demographic attitude shift about work, instead it has to do with an increasing Hispanic population as a percent of the total population.

#-ad_banner_2-#Getting to Full Employment

Economists love to contradict one another, but one thing on which they do agree is that there is no such thing as 0% unemployment.

The Keynesians of the early 20th century believed that the Central Bank could induce full employment by constantly increasing the money supply. Years later, Nobel Prize winner Milton Friedman explained that this tactic will cause inflation to rise faster than jobs can be made. He coined the term the "natural rate of unemployment" to indicate the lowest level of unemployment that can be sustained in an economy, usually where GDP equals potential output. For the last 20 years, the natural rate of unemployment in the U.S. has hung around 6%.

But not all unemployment is created equal. There are three types of unemployment, one permanent and two temporary:

1) Frictional unemployment: Frictional unemployment is permanent. People are always getting fired or leaving jobs to find new ones. Because of this natural tendency for people to change jobs, the unemployment rate can never reach zero.

2) Cyclical unemployment: Cyclical unemployment is caused by the business cycle, and it's what most people think of as traditional "unemployment." In an economic downturn, employers need to cut costs and must lay off workers.

3) Structural unemployment: Structural unemployment is caused by changing demand for skills or a change in a geographic area's labor demand. Workers find themselves unemployed because they cannot acquire the necessary new skills or cannot move to the new region the market demands.

Job Lags

It's easy for unemployed workers to become frustrated when they hear that an economy is on the mend and they are still unable to find jobs. How can things be improving with so many still out of work?

When an economy starts to mend, companies do not immediately hire. As we continue to work through the damage cause by the most recent recession, economists predict that Americans will be slow to increase spending money on goods and services. Most will continue to pay down debt.

This is bad news for businesses that rely on the American consumer, and they will have no incentive to ramp up production and hire more workers. Furthermore, when demand finally does increase, businesses generally pay overtime to current employees before investing in the training and start-up costs of hiring new people.

This lag in hiring can be anywhere from six months to two years behind a recovery.

If you're ready for some good news and you want to learn more about how the world has successfully survived recessions in the past, please click here for our must-read article, A Review of Past Economic Downturns.