Because of unemployment’s narrow definition, many people that you might consider unemployed or underemployed are not captured in the official unemployment statistic.
The BLS publishes several unemployment rates in addition to the official unemployment rate:
Economists make qualitative distinctions in the reasons for various classifications of unemployment. Not all unemployment is the same. Some types are actually positive for the individual and the economy. Other types are bad for the individual but benefit society. Last, there is one type of unemployment that is both bad for the individual and is costly to society. The three types of unemployment are frictional, structural, and cyclical.
Is 0% unemployment a good goal for society? It is most definitely not. A 0% unemployment goal ignores the presence of frictional unemployment. Frictional unemployment occurs when people voluntarily enter the labor force, or when they are between jobs for which they are qualified. It is frictional because the labor market does not automatically match up all available jobs with all available workers.
Instead, a job search requires time for the right worker to find the right job. Both workers and society benefit when job applicants are matched to the appropriate job. You want mechanical engineers to get jobs in mechanical engineering, not pet grooming.
The rate of frictional unemployment is relatively low, and as technology increases and search times diminish, it becomes even lower. The advent of online job search sites and social networking has reduced job search times for many workers.
Government incentives create variations in frictional unemployment rates between countries. Generous unemployment benefits give workers an incentive to spend more time searching for a job and thus increase the rate of frictional unemployment for the country. Compared to Europe, American unemployment benefits are less generous. As a result, Americans spend less time searching for jobs and the rate of frictional unemployment is relatively lower.
Structural unemployment occurs when job seekers’ skill sets are not in demand because of geography or obsolescence. As industries die out in certain regions of the country or relocate to other regions, the workers may not be able to move with the job. This leaves workers with a skill set that is no longer in demand. These workers must either retrain or accept a lower-paying job in an industry that requires less skill. Structural unemployment is often the outcome of what economist Joseph Schumpeter called creative destruction. As innovation occurs, old technologies and industries are destroyed, which frees up the resources for the new technology and its industry.
The invention of the personal computer was the death knell for the typewriter. As the new technology advanced, the old technology and its industry were destroyed. Over time, skilled typewriter repair technicians found that their skill set was no longer in demand and faced the permanent destruction of their jobs. As this was occurring, new jobs were being created in the new industry. The problem for workers is that their skill sets may not translate into the new industry. The solution for structural unemployment is education and retraining.
Is it possible for a person to be both frictionally and structurally unemployed? The classification of unemployment is not an exact science. A person who voluntarily leaves a job to search for another job for which he is unqualified would be both frictionally and structurally unemployed. Throw in a recession and this person might find himself frictionally, structurally, and cyclically unemployed.
Another reason for the presence of structural unemployment is the presence of efficiency wages in the labor market. Efficiency wages are those that exceed the equilibrium market wage. The purpose of efficiency wages is to encourage worker productivity. Employees who earn efficiency wages know that they are unable to earn equivalent wages with competing firms, so they are motivated to produce more output for the paying firm. The efficiency wages have the added effect of enticing more people to enter the labor market. Because these entrants are attracted to the efficiency wage and not willing to work for the lower market wage, they represent an increase in the level of structural unemployment. As more entrants are attracted to the market, less skilled workers face more competition for jobs and suffer higher rates of unemployment.
The most insidious type of unemployment is cyclical. Cyclical unemployment occurs because of contractions in the business cycle. It is not voluntary, nor is it the result of a skill-set mismatch. During periods of recession, the official unemployment rate increases as cyclical unemployment adds to the always-present frictional and structural rates of unemployment. The recession that began in 2007 saw the official unemployment rate increase from 5% to 10%. The additional increase is directly attributed to cyclical unemployment.
The real problem with cyclical unemployment is that it creates a feedback loop. As one group becomes cyclically unemployed, they cut back on spending, which leads to more cyclical unemployment. This feedback loop resulted in 25% unemployment during the Great Depression. Policymakers respond to cyclical unemployment with discretionary fiscal and monetary policy. In addition, automatic stabilizers like unemployment compensation help to dampen the feedback loop by allowing affected workers to have some capacity for spending. Ultimately the goal of policymakers is to eliminate cyclical unemployment altogether.
When the economy is producing at its optimum capacity, cruising down the road at the speed limit, neither speeding nor driving too slowly, it is safe to assume that the economy is also at full employment. Full employment occurs when cyclical unemployment is not present in the economy. This economic nirvana is the goal that policymakers seek to maintain.
Economists associate full employment with the natural rate of unemployment. The natural rate hypothesis advanced by Nobel economists Milton Friedman and Edmund Phelps suggests that in the long run there is a level of unemployment that the economy maintains independent of the inflation rate. The idea is that left alone, the economy will maintain full employment and experience the natural rate of unemployment most of the time.
It is possible for the natural rate of unemployment to vary. If frictional or structural rates of unemployment were to change, then the natural rate of unemployment would change. A technology that permanently reduces search times for job seekers would have the effect of reducing both frictional unemployment and the natural rate of unemployment. Permanent changes in unemployment compensation that encourage or discourage lengthy periods of unemployment would also affect the natural rate. Finally, lasting increases in worker productivity would reduce the natural rate of unemployment.
Different countries have different natural rates of unemployment. Economies that are more market oriented like the United States have low natural rates of unemployment. Socialist economies tend to have higher natural rates of unemployment. Economists theorize that socialist economies have both higher frictional and structural rates of unemployment because of government policies that lead to less flexible labor markets. The highest natural rates of unemployment occur in countries where labor is unskilled and immobile, and job creation is stymied by corrupt, inefficient governments.