What is Unemployment? Definition, Causes, Types, and Measurement

Unemployment is one of the key economic indicators. Traders and investors often follow it to anticipate the impact of the latest data on the markets. However, it is difficult to use this indicator in your trading strategy without understanding its importance to the economy as a whole.

Let’s fix that and understand what unemployment is, the types and causes of unemployment, and its potential impact.

What is Unemployment?

The meaning of unemployment refers to people who have the desire and ability to work and are in active search of work but, for whatever reason, do not have a job. Many researchers quite reasonably consider unemployment to be one of the most important economic indicators. It can be used to assess the general state and stability of the labor market and the economy. For example, a high unemployment rate may indicate a dysfunctional economy, while a low unemployment rate may indicate a good growth rate.

However, unemployment data, which investors often pay attention to, do not always reflect the full picture. Official statistics usually do not take into account several voluminous groups of people:

Discouraged workers – people who have stopped looking for work due to a lack of opportunities.
Underemployment – people who work part-time or in jobs below their skill level and are looking for full-time work.
Informal workers – people in unregistered jobs that may not be reflected in official data.

In the following section, we will talk about how unemployment is measured.

How is Unemployment Measured?

Unemployment in economics is measured by specialized government agencies. For example, in the U.S. there is the Bureau of Labor Statistics (BLS), which collects unemployment data through the Current Population Survey (CPS). This “Survey” is conducted regularly in cooperation with the U.S. Census Bureau. As you can see, a vast network of workers from different agencies are involved in the calculations.

The most common indicator is the unemployment rate, which is calculated as follows:

Unemployment Rate=(Number of Unemployed/Total Labor Force)×100

Here, the labor force includes both those who are working and those who are actively looking for work but excludes people who are not looking for work, such as retirees, students, and the unemployed. This formula is not perfect, but no better one has yet been devised.

To better understand unemployment trends, let’s look at how the US unemployment rate has changed over the last ten years (info is provided by Trading Economics based on BLS statistics):

Types of Unemployment

There are several types of unemployment. Each is caused by different economic and social factors. The main types include:

Frictional unemployment

Frictional unemployment occurs when a person moves from one job to another. For example, if you decide to quit your job and find another job, you will be counted in the unemployment statistics during this interval.

The same is true for college graduates, or people who have not had time to find a job at their new place of residence.

Structural unemployment

The reasons for unemployment of the structural kind relates to a mismatch between the skills of workers and the demands of employers. It occurs when technology changes the nature of occupations and people lose demand; when industries are transformed and workers do not have time to adapt; when production capacity moves to other regions or countries.

This form of unemployment is long-term because it requires workers to retrain and adapt to new market conditions.

Cyclical unemployment

Cyclical unemployment is related to fluctuations in economic activity and occurs during recessions and downturns. When the economy recovers, the number of jobs increases and cyclical unemployment decreases.

Seasonal unemployment

This type of unemployment is caused by seasonal changes in the demand for labor. It occurs in industries where employment depends on the time of the year, for example:

• In agriculture: during the planting and harvesting season.
• In tourism and hospitality: during periods of high tourist demand.
• In construction: where workloads may be reduced in winter.

Seasonal unemployment is predictable and usually does not cause serious economic consequences because workers are aware of temporary employment in advance.

10 Causes of Unemployment

You probably already have an idea of why unemployment occurs, but it’s worth highlighting the key contributing factors. To make it clearer, we’ve identified the top 10 causes of unemployment for you:

1. Economic downturns and recessions: A decrease in demand for goods and services leads to job cuts. A concrete plant doesn’t make sense to pay the same number of workers as before because its sales (and therefore the need for output) have decreased amid the recession.
2. Automation: Machines and algorithms replace workers, reducing the need for human labor. The recent boom in artificial intelligence, after which marketers, designers, developers, and others were seriously talked about as unnecessary.
3. Globalization: Production is moving to countries with cheaper labor. This is not always bad. However, for objective reasons, it is cheaper to sew sneakers in South Asia than in the U.S., which means that one seamstress may lose her job.
4. Skills mismatch: Workers do not have the necessary competencies for new jobs.
5. Structural changes in the economy: The closure of obsolete industries and the growth of new industries lead to job losses. This reason is directly related to the previous one. People simply do not have time to adapt to the changes and lose the opportunity to find employment in the field of interest.
6. High taxes and heavy regulation of business: Restrictions in the labor market and the high cost of hiring discourage job creation.
7. Minimum wage increases: Higher wage standards make it more expensive for employers to hire workers. This in turn forces businesses to maximize the workload of employees and equipment to avoid paying extra money to new hires.
8. Seasonal fluctuations: Temporary employment in agriculture, tourism and construction leads to periodic unemployment. It makes little practical sense to hire a hostess for a hotel when room occupancy is expected to be below 20% for the next couple of months.
9. Demographic changes: More young people in the labor market or an aging population.
10. Political instability and crises: Sanctions, trade wars, military conflicts and social upheavals reduce investment activity and hinder job creation.

What Are 5 Negative Effects of Unemployment?

Unemployment has a significant impact on the economy and society. When people are unemployed, they do not participate in production, which reduces GDP and weakens the economy. At the same time, consumer spending falls as people without a steady income spend less, resulting in lower demand and slower business growth.

For example, here’s how GDP and unemployment rate correlate in the US over the last 10 years:

Prolonged unemployment also increases poverty, debt, and social insecurity, reducing the quality of life for many families. In addition to financial hardship, job loss becomes a serious psychological stressor, causing anxiety, depression, and lowered self-esteem.

Another long-term consequence is the degradation of professional skills. The longer a person remains unemployed, the more difficult it is for him/her to return to the labor market, as employers prefer more active and experienced candidates.

Government Policies to Address Unemployment

In addressing the problem of unemployment, governments use several fiscal and monetary tools, which can paradoxically stimulate financial markets, despite the negative economic and social consequences of the high unemployment.

This is due to the reaction of central banks and governments, which respond to deteriorating labor market conditions by easing monetary and fiscal policies, stimulating economic activity, and creating favorable conditions for investors.

When unemployment rises, central banks (the Federal Reserve (Fed) or the European Central Bank (ECB)) seek to support the economy by lowering interest rates and implementing quantitative easing (QE) policies. These measures make credit cheaper, increase the availability of liquidity, and lower bond yields, causing investors to seek higher-yielding assets such as stocks. As a result, stock markets often rise on expectations of loose monetary policy.

We recommend you reading our recent article about the role of central banks to understand the situation better.

On the fiscal side, governments can increase public spending on infrastructure projects, social benefits, and business subsidies. These measures create additional jobs, increase consumer spending, and stimulate corporate profits, which in turn boost markets.
Thus, despite the negative impact of high unemployment on the economy, the reaction of monetary and fiscal authorities can lead to an increase in asset values and improved investment conditions, which is often observed in periods of crises and recessions.