What Is Unemployment?

Definition, Measurement and Types of Unemployment

In general sense of the term, unemployment means lack of jobs even for those who are able and willing to work at the prevailing wage.

This definition is however ambiguous from the policy point of view as it does not specify the persons who should be and who should not be included in the category of job-seekers.

This problem arises because of undesirability of including persons of certain category and age-group among the job seekers. For example, should children below 15 years of age, and the persons above 65 or 70 years—even if they are looking for a job—be included among the job-seekers or be considered as part of the labor force?

According to the ILO Opens in new window, only those belonging to the age group of 15 to 65 years should be included in the labor force of country. In the US, persons belonging to the age group of 16 years and above are included among the employment seekers.

From the measurement point of view, the unemployment may also be defined as the gap between the potential “full employment” and the number of employed persons.

What Is Full Employment?

The concept of full employment has been variously defined. However, the UN definition of full employment is more sound and acceptable. According to UN experts on the National and International Measures of Full Employment,

Full employment is “a situation in which employment cannot be increased by an increase in effective demand and unemployment does not exceed the minimum allowance that must be made for effects of frictional and seasonal factors.”

Going by the UN definition of full employment, unemployment exists only if there is unemployment in excess of frictional and seasonal unemployment.

From employment policy point of view, therefore, unemployment is measured more specifically as follows:

Unemployment = Labor force – (number of employed + frictionally unemployed)

Definitionally, labor force of a country consists of persons belonging to the age group of 15 to 65 years (or so) who are employed and those who are unemployed but are looking for a job. Labor force does not include full-time students, full-time house-wives and retired persons.

Measuring Unemployment Rate

The rate of unemployment in a country is measured by the following formula.

Unemployment rate = Labor force – Employed labor X 100
                                                              Labor force

or Unemployment rate = Number of unemployed X 100
                                                                Labor force

This measurement of unemployment can hardly be applied strictly to the Indian conditions because there is a large scale of underemployment.

In India, therefore, the National Sample Survey Organization (NSSO) Opens in new window, the organization entrusted with the task of measuring employment and unemployment in the country, uses three concepts of unemployment.

  1. Usual status of unemployment,
  2. Current weekly status of unemployment, and
  3. Current daily status of unemployment.

The usual status of unemployment or chronic unemployment is measured in terms of number of persons who are unemployed for major part of the year.

The weekly status unemployment is measured in terms of number of persons who did not find job one day during the entire survey week.

The daily status unemployment includes those who do not find job even for an hour on a day of the survey week.

The unemployment rate is measured in terms of unemployment, and underemployment. The NSSO Opens in new window estimates of unemployment rate (on Current Daily Status Basis) in the country for the recent years are given below.

YearUnemployment Rate %

Based on the data, obviously, the unemployment rate in India is very high—over 8 percent.

Types of Unemployment

The unemployment may be classified as follows.

  1. Frictional unemployment,
  2. Structural unemployment,
  3. Natural unemployment, and
  4. Cyclical unemployment.

The nature and the reasons for these kinds of unemployment are described here briefly.

1.    Frictional Unemployment

The concept of frictional unemployment can be better understood with reference to the classical postulate that there is always full employment. There is therefore no unemployment.

If there is any unemployment at any time, it is of temporary nature. This kind of unemployment is called frictional unemployment.

The temporary unemployment is caused by some extraneous disturbance in the economy and friction in the labor market throwing some workers out of job. Besides, the labor market in a free economy is “always in a state of flux”.

For these reasons, the labor supply mismatches with labor demand for a short period.

These kinds of changes in the labor market often cause an abnormal gap between demand for and supply of labor. The excess of labor supply takes the form of frictional unemployment.

According to classical postulates, frictional unemployment is quickly wiped out through an automatic process of market mechanism and adjustments.

The neoclassical economists, on the other hand, focused on the imperfections in the labor and product markets in the real world and on the frequent emergence and continuation of frictional unemployment. They have argued that, in real world, imperfections in the labor market arise due to:

  • lack of information about vacancies,
  • cost of information,
  • cost of training,
  • slow occupational mobility, and
  • cost of transportation and displacement in case of spatial movement of labor, monopoly powers of labor unions and business corporations.

In an imperfect market setting, the upward adjustment in the wages in response to price-rise is quick but the downward adjustment is slow and rigid.

Therefore, labor market remains uncleared even if there is change in wages, i.e., some persons willing to work at the prevailing wage rate remain out of job.

Therefore, under imperfect labor market conditions, some unemployment of frictional nature becomes a regular affair, especially where technological changes are regular in the economy Opens in new window.

According to the neoclassical view, frictional unemployment can be defined as the number of unemployed persons under the condition that the number of job-vacancies equals the number of job-seekers who somehow fail to get the job.

In other words, frictional unemployment is said to exist when job vacancies equal the job-seekers and yet some persons are unemployed.

Furthermore, the neoclassical economists postulated that, notwithstanding the existence of frictional unemployment, the economy Opens in new window is deemed to be in the state of full employment.

For example, “for the American economy, the frictional rate of unemployment is thought by many economists to be about 4 percent, and therefore full employment is said to occur when the rate of employment is approximately 96 percent.”

In simple words, with 4 percent frictional unemployment and 96 percent employment, the American economy was considered to be in a state of full employment in the 1970s.

So the policy requirement of a country was confined to removing frictional employment by correcting market imperfections, reducing monopoly powers of labor unions and business corporations, and by providing market information and job training.

2.   Structural unemployment

The structural unemployment arises due to structural change in a dynamic economy making some workers go out of job.

Structural changes include change in structure or sectoral composition of the economy and change in technology.

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The downfall or decay of some kinds of industries throws people of specific skill out of job. They remain unemployed till they find new jobs.

Some skills become obsolete and some less efficient. In a dynamic society, structural change is a continuous process. In this process, some persons find it difficult to get a new job requiring a new kind of job skill.

The important thing in the structural unemployment is that there are vacancies and there are job-seekers and yet there is unemployment because of mismatch between the demand and supply pattern of the labor market.

In spite of a great deal of similarity, the structural unemployment is different from the frictional unemployment.

Under frictional unemployment, an unemployed person gets a job after a short period of unemployment, whereas under structural unemployment, a person either goes out of job or remains unemployed for a prolonged period of time till he acquires new skills.

In simple words, frictional unemployment appears to disappear, whereas structural unemployment appears to stay, even if they arise for the same reasons.

3.   The Natural of Rate of Unemployment

The term “natural rate of unemployment” was coined and used by Milton Friedman.

Friedman has defined the natural rate of unemployment as the rate of unemployment “which has the property that it is consistent with equilibrium in the structure of real wage rate”.

Friedman’s concept of natural rate of unemployment is similar to the concept of structural unemployment.

Structural unemployment, as mentioned above, becomes a regular feature in a dynamic society. As a result, a certain rate of unemployment is always there even when market is cleared and the economy is in the state of full employment equilibrium.

At this rate of unemployment, the forces of demand-pull and cost-pull inflation are in balance and the rate of inflation is stable. Friedman calls this rate of unemployment as “the natural rate of unemployment.” Therefore, at the natural rate of unemployment, the economy is said to be at full employment. The theory of the natural rate of unemployment is discussed here at length.

4.    Cyclical Unemployment: Okun’s Law

Arthur Okun, Chief economist of President Kennedy’s Council of Economic Advisors in the United States, was the first to bring out the relationship between output and unemployment Opens in new window.

Okun used output and employment data of 1950s and early 1960s to study the relationship between output and employment. His study revealed that every one percentage point increase in unemployment rate results in a 2.5 percent reduction in real GNP below the natural output.

This relationship between unemployment and output is known as Okun’s law Opens in new window. The number 2.5 is called Okun coeffiecient. It implies that a one percentage point decline in real GDP causes a 0.4 percentage point in the unemployment rate.

Different versions of Okun’s law Opens in new window are available in the literature. One of the widely quoted versions is expressed as

100 (YNY )/YN = LC (u – uN)

where Y = real actual GNP; YN = natural output; LC = Okun’s law coefficient; u = unemployment and uN = natural unemployment.

The Okun’s law does not stand the empirical test in exact quantitative terms. But inverse of this law does indicate an irrefutable fact that recession causes fall in output and fall in out causes unemployment.

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What Rate of Unemployment Is the Natural Rate of Unemployment?

The concept and the theory of the natural rate of unemployment have been discussed above. However, an empirical question that remains to be answered is:

What rate of unemployment should be treated as the natural rate of unemployment?

The answer to this question is “elusive”—it is illusive because the very concept of the natural rate of unemployment is elusive.

The empirical studies on the issue reveal that the natural rate of unemployment varies from country to country, from time to time in the same country and from condition to condition at the same point of time in the same country.

The first attempt to answer this question was made for the US economy during the President John F. Kennedy regime and a 4 percent unemployment rate was considered to be the tolerable natural rate of unemployment.

It meant that with a 4 percent unemployment, the economy was to be taken to be at full employment. During the late 1970s, however, the US economists debated again on the question “how much unemployment is full employment.”

According to Robert J. Gordon, an expert on the subject, the natural rate of unemployment was about 6 percent during the 1980s. In fact, by the early 1980s many economists came to believe that full employment meant an unemployment rate close to 6 percent.

However, the available evidence shows that the natural rate of unemployment has been increasing in the US—from 4 percent in the early 1960s to 5 percent in the early 1970s and then to 6 percent during the 1980s.

The rise in the natural rate of unemployment in the US is attributed to these factors:
  • change in the demographic structure of the labor force due to a larger participation of teenagers and women;
  • unemployment insurance (for 23 weeks) which discouraged temporarily unemployed persons to find job and to accept a low-paid job; and
  • an increase in the structural unemployment due to ups and down in the industrial sector.

As regards the natural rate of unemployment in other countries, it was found to be between 1 percent and 2 percent in France, Germany and the UK during the early 1960s. In later years, however, the natural rate of unemployment in these countries rose to a range between 6 percent and 12 percent.

The variability of the natural rate of unemployment makes many economists doubt even the validity of the concept. The concept of the natural rate of unemployment continues to remain a controversial issue.

Nevertheless, the fact remains that some unemployment is always there in all the countries for the reasons cited by Friedman and other economists. The rate of this unemployment is called the natural rate of unemployment.

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