The costs of unemployment

The costs of unemployment

The achievement of full employment is a key macro-economic policy objective because unemployment can create significant costs to individuals, families, businesses, and the whole economy. The severity of the costs depends upon the level and rate of unemployment, and whether it is temporary or longer term.

Unemployment of all types creates a range of costs to those involved, and to others.

Costs to the individual

Loss of income and living standard

Employment is the major source of income for most individuals, so being unemployed results in a fall in income, and a loss of living standard. Of course, welfare payments provide some level of support, but are unlikely to be generous as this can create a disincentive to seek work.

Loss of skills and worsening employment prospects

As skills depreciate, individuals may become trapped in an extended period of ‘long term’ unemployment. The loss of work-based skills reduces an individual’s employability in the future. When applying for new jobs, periods of unemployment will be revealed in an individual’s resume (CV). With imperfect knowledge of the reason for unemployment potential employers may make certain assumptions about the quality of the applicant, and rightly or wrongly, not call them forward for interview.

The unemployment trap

Some unemployed individuals may become dependent on welfare and increasingly trapped in unemployment. In this sense, welfare payments could be said to create moral hazard where out-of-work benefits are seen as an insurance against unemployment, but perversely increase the likelihood of remaining unemployed.

Reduced health

The unemployed are more likely to suffer from poor physical and mental health. This, in turn, increases the probability of remaining unemployed.

Costs to the family and children

Likelihood of poverty

An unemployed ‘breadwinner’ will mean that family income falls, which could push individuals below the poverty line. Poverty is clearly a major cost of unemployment, and once pushed into poverty individuals can be trapped there – the so called ‘poverty trap’.

Costs to the economy

There are significant costs of unemployment for the wider economy, including:

Opportunity cost

Every individual that is not employed creates an opportunity cost to society. The opportunity cost is the lost output that could have been produced if the unemployed had worked.

Waste of resources

An economy uses scarce resources to educate and train individuals as they progress from childhood to adulthood and into the labour market. If individuals become or remain unemployed then these resources have been wasted – if only temporarily.

Erosion of human capital

Human capital is the total stock of human resources existing in an economy, including the quality and skills of labour. Given that many important skills are gained while at work, unemployment can mean that new skills may not be acquired, and existing ones eroded – hence a depreciation in human capital.

Inefficiency

When an economy is fully using all its scarce resources it is said to be operating on the edge of its production possibility frontier (curve, or boundary), which indicates that the economy is operating at an efficient level.

Inefficiency and unemployment

Unemployment signifies that the economy is not operating at an optimal level.

Loss of government revenue

Given that the unemployed have reduced levels of income, and are likely to spend less on a range of normal goods, less revenue will go the government both in terms of lower income tax and indirect tax receipts. This direct effect is accompanied with an indirect multiplier effect, where lower spending causes less income for others, and falling tax receipts.

Additional public spending

However, at the same time, government is likely to have to spend more on welfare support for the unemployed. If this cannot be raised through taxation, then the public sector will have to increase its borrowing – as happened in dramatic fashion because of the pandemic.

Loss of revenue and profits to firms

Like the government, some firms will also experience a fall in potential revenue from falling sales, which is also likely to lead to falling profits for producers. The downturn in profits is also likely to feedback into a fall in demand for labour, and increase the probability of more unemployment.

Unemployment may become embedded

Unlike episodes of inflation, unemployment may not be temporary, and can become embedded in an economy as workers displaced from the labour market become long-term unemployed. This creates a ‘deadweight’ loss to the economy.

Unemployment rates can continue to rise even when the initial cause of unemployment has ceased to exist. The tendency for unemployment to continue to rise is called ‘hysteresis’ – a term first used by the 19th Century Scottish physicist, Sir James Erving.

The clear conclusion from this is that unemployment imposes a considerable range costs to individuals, firms, and society, and that reducing unemployment should be a high priority for policy makers.



Unemployment

What causes unemployment?

Unemployment
Supply-side policy

Can supply-side policy reduce unemployment?

Supply-side policy
Demand-pull inflation

What causes demand-pull inflation?

Demand pull