What Causes Unemployment

Among the many metrics used to gauge the health and condition of our national economy—GDP, Current Account Balance, National Income, Producer Price Index—none is so politicized or so prominent in the minds of the American people as the national rate of unemployment, which, after years of ineffective policies, remains officially at 7.6%, but is more likely closer to 10.7% once Americans who have given up the search for work are accounted for.

Despite unemployment being placed at the forefront of our economic debates, there are pervasive misunderstandings as to the role and nature of employment in an economy. A high level of employment is popularly perceived as the cause of a healthy economy, rather than its product or correlate. Politicians perpetuate the myth that they or the government are responsible for creating jobs. The creation of government jobs is treated as economically equivalent to private sector employment. Unfortunately, as many such myths have been publicly challenged in recent years, others linger on. The subject is undoubtedly massive and complex, with seasoned professional economists frequently challenged to understand or overcome it through analysis and policy prescriptions.

Nonetheless, as with so many issues that ail us today, some of the most common and essential misconceptions clouding the field can be refuted with a less-than-expert knowledge of the subject. Namely: what does and does not cause unemployment.

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What Causes Unemployment

For those who have not recently taken an economics course: the unemployment rate is generally understood as composed of three subtypes—structural, frictional, and cyclical. Structural unemployment arises from broader, long-term changes in the employment market that leave laborers previously employed in some sector temporarily out of work (think auto workers when the manufacturer moves its operations overseas). Frictional unemployment is the product of laborers who are between jobs and the amount of time that it takes one to find new work after losing a previous job. Finally, cyclical unemployment is the result of business cycles—periodic recessions that dampen economic activity nationwide, stifle investment, and lead laborers to face potentially prolonged periods without gainful employment.

How inevitable are these? Structural employment, at least as a short-term phenomenon, is generally a rather inevitable product of the sort of changes that follow when capital is reallocated to more profitable investments elsewhere. It is a recurrent theme in our era of rapid globalization, though structural changes are not always constant or long lasting, and in the absence of market restrictions or contrary incentives (such as welfare and unemployment benefits) there is little reason to believe that laborers will not learn new skills or quickly adapt to new industries in order to regain employment. Structural employment carries some political clout in today’s culture, as Americans, encouraged by their political leaders, frequently feel threatened by the exporting of jobs to foreign countries in search of lower wages.

Frictional employment is, in some measure, patently inevitable, as there will always exist, even in the healthiest economy, some number of people who are between jobs. As unemployment sources go, frictional certainly carries the least political weight. It is primarily an information problem of connecting workers with employers, and, on its own, is rarely a major target of government policies.

Cyclical employment, however, is the greatest contributor to the sort of pervasive, high unemployment that dampens our economy and becomes the subject of political debate and controversy in the media. In popular discussions of business cycles, careful observers will note contrary themes: on one hand, in the media and political circles, there will be wide-scale debates over who was at fault for the market distortions that precipitated the decline; on the other, in economics classrooms and textbooks such cyclical recessions are too frequently treated uncritically as occurrences divorced from cause, leaving otherwise critical and conscientious economists to suddenly refer to the subject of their science like weather and tides that come and go as they please, and rendering graduating students without a sound grasp of the economic processes that most affect them.

As Jason Riddle has written elsewhere in these pages, however, there is nothing inherent in a free, capitalist system that mandates the cyclical pattern followed by modern economies. This ‘boom-and-bust’ cycle is the direct result of the control and manipulation of credit by central banks. The history of developed capitalist economies before the advent of central banks affirms that, in the absence of government manipulation and distortion of incentives, significant misallocations of resources and bad investments resulting in market shocks tend to be limited to certain companies or sectors and, graciously, tend to be similarly limited in their duration as in their scope.

Even government-led corrections that respect the principles of sound currency, fiscal responsibility, and a market-driven (as opposed to state-driven) economy tend to be profoundly quicker and more effective, as witnessed in the less interventionist, more free market approach of Warren G. Harding in the 1920-21 downturn, versus the unending, painstaking interventionist policy approaches of Herbert Hoover and FDR after the 1929 crash.

Thus, if we embrace a view of recessions and economic fluctuations as resulting from state controls—both through the control of currency and credit by a central bank, and through broader economic regulations and distortive policies of the government at large—we acquire a clearer implication of how a free, capitalist economy might differ from that which we live in. In such a system, without cyclical recessions or depressions and without incentives for segments of the population to remain unemployed for prolonged periods, there is no theoretical basis for believing that the economy in general would not continue to create jobs at a rate equal to or greater than population growth.

Indeed, without regulatory restrictions and persecutory policies toward businesses or inflationary central bank policies that erode savings and investments, supply and demand for jobs would meet—just as they do for all other goods and services—at a given price (in this case, a wage). In a free and expanding economy, it is entirely possible that the creation of jobs could at times outpace population growth, bidding up wages and creating an ever more profitable condition for laborers. Such profitability and prosperity then encourages further population growth in two ways: more people tend to have children, and immigration increases.

Contrary to the one-pie model popularized by politicians of the left and right, in which one person’s gain is always at the expense of another and more parties in the economy means someone necessarily loses, growth in a country’s population has multiple effects, all of which are overall positive. As every worker is also a consumer, a larger population means larger markets and greater demand, increasing profitability to businesses. Conversely, in the short term, population increases also mean fewer vacancies in the labor market as businesses with open positions are able to fill them, increasing their productivity. Increased profits and productivity mean increased investments in new capital and greater efficiency. Greater efficiency means a lower price level and a higher quality of living. Lower price levels mean more savings. More savings makes for more investments. More investments make for new business ventures and a growing, thriving economy. The cycle continues.

What is conspicuously absent from this scenario, however, is a lower bound to the unemployment rate. By eliminating the cyclical recessions brought by government controls, unemployment is kept to a bare minimum. The elimination of incentives to stay out of work (government benefits and welfare payments) further erodes structural unemployment. Meanwhile, technological advancements and the information age have already brought creative innovations—greater access to job postings, easy long-distance communication, and a growth in the headhunting industry—that work to keep frictional unemployment low.

Granted: none of this is to say that full employment is a realistic possibility, as certain kinds of unemployment are, as mentioned earlier, simply a fact (if a temporary fact) of life. Nonetheless, what we should recognize is that prolonged, high unemployment of the kind seen in the US economy today is the result of government policies: market distortions; credit controls; inflation; regulations; and taxes that destroy investment, wage increases, and potential job creation. It is impossible to know for certain what the unemployment rate would be in the absence of this destructive political culture. What can be said with certainty, however, is that it would be considerably lower, that more than one in ten Americans wouldn’t be unemployed, and that by repealing this anti-business milieu, America can be set on a road to greater freedom and prosperity.

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2 thoughts on “What Causes Unemployment

  1. Loved you piece Slade. As we used to say in Vietnam whenever we heard the truth or a profound expression of common sense: “There it is.” The (government) distortions that are now going on are just mind boggling. One of the things that really galls me (and briefly addressed at the beginning of the above) is what seems to be a deliberate covering up in plain sight of the actual and common sense unemployment and underemployment figures. Instead, we have politicized figures in the public consciousness and, thus, tolerance of the status status quo (oft referred to as “the new normal”).

    Last time I took macro-Economics was in 1973. As I recall, it seemed an important concept — when discussing the Money Supply and its various components — was also the “velocity of money”, or turnover. Yet, it seems that never seems to be mentioned now in popular written or broadcast media. With all the (distorted) money being pumped into the economy by the Federal Reserve, I hear some — mainly conservative — commentators and other observers say that all the “Quantitative Easings” are not getting down to main street. Thus, low velocity or “churn”. Would this be correct?

    1. Hi Mark,

      Sorry for the delay in response. Essentially, what you’ve described is correct. Observant economists have noted since the huge fiscal measures taken through TARP and the bailout binge, and continuing on through the Fed’s cycles of Quantitative Easing, that the money the government has sought to pump into the economy–whether by fiscal or central banking means– is not traveling through the economy as they would expect. Part of this is due to a low demand for credit, as companies have sought to reform their balance sheets and proverbially get their ‘houses in order’, choosing not to take on more loans during a risky period and opting to correct past imbalances. Another significant part of it, however (at least as I see it), is a lack of confidence in the economy as a whole. Whatever the poll numbers and Bureau of Labor Statistics’ claims say, there remains the sense that this storm may not have completely passed– or that another one may come before long as a consequence of our policy-makers’ mishandling of this one.

      One concern that we have to bear in mind is that the funds provided to banks through quantitative easing (a four-fold increase in the Fed’s balance sheet) have largely sat unused in banks’ ‘excess reserves’ accounts at the Fed. However, as it is doubtful that these huge reserves will remain there forever, we must consider what will happen when they start to be lent out.

      Whether Americans can be convinced of the recovery by Obama’s recent statements against re-inflating ‘bubbles’ and encouraging prudence, a possible Republican senate in 2014, more productive fiscal budget debates, a new administration in 2016, or–we can dream(!)– actual, substantive policy change to prevent the recurrence of what happened in 2007-2008, only time will tell.

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