- Unemployment imposes costs on the unemployed themselves, on firms, on the government, and on the wider economy.
- How large those costs are depends on how deep the unemployment is and, above all, on how long it lasts.
Key Idea
- The unemployed lose the most, but the cost spreads to firms, the government and society as a whole.
- Lost output is gone for good, so unemployment is a cost even to those still in work.
Costs for the Unemployed
- The unemployed lose income, so their spending falls and their living standards drop.
- A long spell causes deskilling, because skills and work habits erode when they are not used, so the worker becomes less productive.
- This can lead to hysteresis, where people out of work for a long time struggle to get back in even after the economy recovers.
- Unemployment is also linked to poorer physical and mental health and to social exclusion, which further lowers the chance of re-employment.
Example
- A worker made redundant loses their £2,000-a-month wage, so their spending falls and their living standards drop straight away.
- After a year out of work their skills are outdated and employers read the long gap as a negative signal, so they are offered fewer interviews and lower pay.
Costs for Firms
- Widespread unemployment leaves households with less income, so aggregate demand for firms' products is weaker.
- Lower sales reduce revenue and profit, which in turn discourages investment.
- Against this, firms face a larger pool of available labour, which eases wage pressure and lowers hiring costs.
Note
- There is a tension for firms: cheaper and more available labour, but weaker demand for what they sell.
- For most firms the loss of demand outweighs the saving on wages, so profits still fall.
Costs for the Government and Economy
- The government collects less income tax and less indirect tax, because incomes and spending have fallen.
- It pays out more in unemployment benefits, so the budget balance worsens into a larger deficit or smaller surplus.
- The economy loses the output those workers could have produced, so it operates inside its production possibility frontier.
- That lost output can never be made up later, so it is a permanent opportunity cost for society.
- Wider social costs, such as rising inequality and crime, can also follow from long-term unemployment.
Example
- Suppose 1 million extra workers are made redundant in a downturn.
- Their lost output leaves the economy producing below its potential.
- At the same time income-tax and VAT receipts fall while benefit spending rises by around £90 a week for each newly unemployed person, so the fiscal deficit widens.
Why Duration Matters
- A short spell of unemployment does only limited, temporary harm.
- This is because a worker out of work only briefly keeps their skills current and holds on to their professional contacts.
- They can usually maintain spending from savings or short-term benefits, so their income loss is small and soon recovered.
- Because they return to similar-paid work quickly, there is no lasting scar on their earnings and little output is permanently lost.
- Long-term unemployment is far more damaging, because skills erode, confidence falls and employers treat a long gap as a negative signal.
- Through hysteresis, cyclical unemployment can even turn into structural unemployment if a downturn drags on.
- So the type and length of unemployment, not just the headline rate, decide its true cost.
Exam technique
- In evaluation, argue that the cost of unemployment depends on its type, its duration and the strength of the economy.
- Separate the private cost to the jobless from the wider cost of lost national output.
Common Mistake
- Do not treat unemployment as a purely private cost to the jobless.
- The lost national output is a wider opportunity cost borne by the whole of society.
Self review
- Name two costs of unemployment for individuals.
- Explain why a short spell of unemployment does little lasting harm.
- What is hysteresis, and why does it matter?
- Through what chain does unemployment worsen the government's budget balance?
- Why is lost output a cost to society as a whole?
