Unemployment exists in every economy around the world. However, the percentage of workers who are unemployed and the reasons why they were laid off can be very different. Therefore, economists can use unemployment data as an economic indicator to assess the health of an economy. To do this, they differentiate between at least three types of unemployment: structural unemployment, cyclical unemployment, and frictional unemployment. We will look at each of them in more detail below.
Structural unemployment describes a form of unemployment that arises from a mismatch between the skills offered by workers and the skills demanded by employers. This situation usually occurs because of changes in demographics, industrial reorganization, or technological innovation. To adapt to those changes, firms constantly need new skills while some existing skills become outdated. As a result, some workers will find it hard to get a new job, because their skill set is simply not needed anymore.
To illustrate this, think about cars. Before the automobile was invented, people traveled in horse-drawn carriages. Thus, demand for coachmen was high. However, after the invention of the automobile, the market for horse-drawn carriages eventually collapsed and it became increasingly difficult for coachmen to find employment.
Cyclical unemployment is a form of unemployment that relates to cyclical trends in the business cycle. Whenever the economy contracts (i.e. falls into a recession) unemployment increases, because firms have to lay off workers in order to cut costs. However, cyclical unemployment is temporary. That means, once the recession is over, many of the workers have a good chance to find another job in the same field.
To give an example, let’s compare the job market for construction workers before, during and after the financial crisis of 2008. Before the crisis, the housing market was booming. That means, there was more than enough work for construction companies. Unfortunately, once the housing bubble burst, the economy collapsed and fell into a recession. Suddenly, the was no more demand for new houses or other real estate and construction industries (like most other industries) had to lay off many of their workers. However, once the recession was over, the job market recovered and many construction workers were able to find a new job.
Frictional unemployment describes a form of unemployment that arises due to workers who are in the process of moving between jobs. This includes workers who voluntarily quit their job to look for a better one, people who are on job search because they just recently moved to a new area, etc. There are plenty of reasons why people move from one job to another. Therefore, it is important to note that frictional unemployment can never be fully eliminated. The reason for this is that in reality, information is always imperfect. This makes the process of finding a job complicated and time consuming.
For example, let’s assume you just moved to a new state. You are looking for a job in your particular field of employment. To do this, you may ask friends and family, search online or scan your local newspaper for job ads. Meanwhile, companies who are looking to hire new employees have to post job ads, wait for applications and then screen the applicants thoroughly. This takes a lot of time and therefore makes it impossible to eliminate frictional unemployment.
Digression: Natural rate of unemployment
As implied above, it is impossible to reach a level of zero unemployment (i.e. an unemployment rate of zero percent). There is always a certain percentage of frictional and structural unemployment that cannot be prevented. However, from an efficiency perspective this is not necessarily a bad thing. In fact, economies are said to work most efficiently with what we call the natural rate of unemployment. Without a certain level of unemployment, the economy wouldn’t be able to expand and develop. In the United States the natural rate of unemployment is estimated to be between 4.5 and 5 percent.
In a Nutshell
Economists use unemployment data as an economic indicator to assess the health of an economy. They differentiate between at least three types of unemployment: structural, cyclical, and frictional unemployment. Structural unemployment arises from a mismatch between the skills offered by workers and the skills demanded by employers. Meanwhile, cyclical unemployment is caused by cyclical trends in the business cycle. And last but not least, frictional unemployment arises due to workers who are in the process of moving between jobs. In reality, it’s impossible to completely eliminate unemployment. Thus, in the United States the natural rate of unemployment is estimated to be between 4.5 and 5 percent.