People are either employed, unemployed or out of the labour force. The level of
unemployment rises when inflows to the pool of the unemployed exceed outflows. Inflows
and outflows are large relative to the level of unemployment.
As unemployment has risen, the average duration of unemployment has increased.
Women face lower unemployment rates than men. The unemployment rates for older
workers, and especially for young workers, are well above the national average.
Unemployment can be classified as frictional, structural, classical or demand-deficient. In
modern terminology, the first three types are voluntary unemployment and the last is
involuntary unemployment. The natural rate of unemployment is the equilibrium level of
voluntary unemployment.
In the long run, sustained rises in unemployment must reflect increases in the natural rate of
unemployment. During temporary recessions, Keynesian unemployment is also important.
Supply-side economics aims to increase equilibrium employment and potential output, and
to reduce the natural rate of unemployment, by operating on incentives at a microeconomic
level. Supply-side policies include reducing mismatch, reducing union power, tax cuts, reductions in unemployment benefit, retraining and relocation grants, and investment
subsidies.
A 1 per cent increase in output is likely to lead to a much smaller reduction in Keynesian
unemployment. Some of the extra output will be met by longer hours. And as
unemployment falls, some people, effectively in the labour force but not registered, look for
work again.
Hysteresis means that short-run changes can move the economy to a different long-run
equilibrium. It may explain why European recessions have raised the natural rate of
unemployment substantially.
People voluntarily unemployed reveal that the private benefits from unemployment exceed
the private cost in wages forgone. Society derives no output from transfer payments to
support the unemployed. However, society would not benefit by driving unemployment to
zero. Some social gains in higher productivity are derived from improved matching of people
and jobs that temporary unemployment allows.
Keynesian unemployment is involuntary and hurts private individuals who would prefer to be
employed. Socially it represents wasted output. Society may also care about the human
misery inflicted by involuntary unemployment.
Most European countries took two decades to reverse the high unemployment of the
1980s.
