Definition, Measurement, and Importance of Unemployment

Define

The official definition of unemployment is civilian, non-institutionalized people sixteen and over who had no paid work in the past week, want ajob and are immediately available for one, and are actively seeking employment.

Figure 1: Official US unemployment

Unemployment is one of the main targets of macroeconomic policy. Ingeneral, unemployment refers to people who are unable to work for
economic reasons. All else equal, low unemployment is preferred tohigh unemployment. The lowest possible or feasible level of unem-ployment is called full employment.

There are a variety of ways of defining and measuring unemploy-ment. The official or “headline” measure of unemployment is called
U3. U3 defines someone as unemployed if they (a) are at least 16years old, and are not in the military, in prison, or otherwise insti-
tutionalized; (b) had zero hours of paid work in the past week, andno more than 15 hours of unpaid work in a family business; (c) do
not have a regular job from which they are temporarily absent due tovacation, sickness, a strike or lockout, etc.; (d) are currently available
for work – that is, would take a job if one were offered to them; and(e) have actively looked for work in the past 4 weeks, by sending out
resumes, contacting an employer, visiting a job center, etc.

If someonehad even one hour of paid work (or 15 hours or more of unpaid workin a family business) they are not counted as unemployed. Otherforms of unpaid work are not considered employment, however.The unemployment rate is defined as the number of unemployedpeople, divided by the people in the laborforce – that is, the sum of those employed, and unemployed. It measures the fraction of people who currently wish to work, but are unable to find jobs. 

U3, like other unemployment measures, is released by the Bu-reau of Labor Statistics each month. When you see a reference to the
“unemployment rate" without further detail it normally means U3.Unemployment matters because of the hardship it creates for individuals; because it is a waste of society’s productive capacities; because it isan indicator of how close output is to potential; because it affects bargain-ing power between workers and employers; and because high unemployment is a source of social and politicalinstability.

Unemployment is one of the most-watched macroeconomic aggregates. Along with output and inflation, it is one of the targets thatpolicymakers in the US and most other rich countries focus on most.Unemployment is important for several reasons: 

Individual Wellbeing

Individual Wellbeing

Losing a job, or being unable to find one, is apainful and disruptive event in most people’s lives.2 For most peo- 2 ple under capitalism, our main claim on society’s resources comesfrom our paycheck. So loss of a job means a loss of income, and temporary or permanent reduction in living standards. In addition, for many of us, our job is a central part of our identity and our most important connection to the world beyond our immediate family and friends. Unemployment can lead to social isolation and loss of self-respect, and make it hard to sustain other relationships. These “nonpecuniary” costs of unemployment may be even more destructive than the loss of income.

 Potential Output

One way of looking at unemployment is that it is awaste of people’s capabilities, of their potential to engage in useful work. Someone might be able to contribute to society as a nurse,a cook, truck driver, a musician, etc. – by producing something of value to others. As long as they are unemployed, these productive capacities go unused. So unemployment is costly not only for the individual but for society, which is being deprived of the fruits of the person’s labor. Unemployment is by definition a sign that output is falling short of potential in addition, high unemployment rate is usually seen as a sign that other productive resources buildings and machines, ideas and technology are also not being fully utilized. 

Labor Market Slack

For economists, one of the most important effects of unemployment is that it changes the bargaining power between workers and employers. When unemployment is high, there are likely to be many applicants for each new job; this makes it hard for workers to demand higher wages, since they know they could easily be replaced and they will have trouble finding another offer. In other words, there is a great deal of slack in the labor market. When unemployment is low, workers are in a stronger bargaining position: Employers will have a harder time replacing them, and they will have an easier time finding a new job if they’re not satisfied with this one.

This means that businesses are more likely to raise wages when unemployment is low. Low unemployment can also reduce employers’ power more generally – when there is not much unemployment, getting fired is less frightening, so workers can exercise more control over the terms of their work.From the point of view of macroeconomic policymakers, excessive wage growth and a breakdown of discipline in the workplace are dangers when unemployment gets too low.

Social Stability

Connected to the nonpecuniary costs described above,high unemployment often undermines social and political instability. At the least incumbent governments are less likely to win reelection when unemployment is high. And in many parts of the world, persistently high unemployment has been followed by increases in crime, civil unrest, political violence and revolutionary upheavals. 

When output grows quickly, unemployment falls; when output grows more slowly or falls, unemployment rises. This statistical relationship is known as Okun’s law.

                   U = 0.6(g-2).

where DU means the change in the unemployment rate, and g is the real (inflation-adjusted) growth rate of GDP. This implies that if a
year passes with no growth in real GDP, unemployment will rise by 1.2 points. It takes a real growth rate of 2 percent to hold unemploy-
ment constant. And to reduce unemployment by 1 point, requires a year of 4 percent growth, or two years of 3 percent growth, etc. While
this relationship is not perfect, it is quite reliable as far as macroeconomic laws go. Similar relationships hold in other countries, but the coefficients are different.