A common mistake, when thinking about what a good unemployment rate is, is to jump to the obvious conclusion that the closer the rate is to zero the better it is. This is a fallacy, because there is a level below which the economy will overheat resulting in a boom-bust recession.
While a low unemployment rate is generally seen as a positive sign for the economy, as it indicates a high level of job creation and a robust labor market, lower is not always better. A sustainably low unemployment rate is what we are looking for, as that can have several benefits, both at the individual and societal levels.
At the individual level, a low unemployment rate means more job opportunities and a higher likelihood of finding employment. It can lead to increased job security, higher wages, and improved overall financial well-being. Additionally, a low unemployment rate can reduce income inequality and provide individuals with a sense of stability and confidence in the economy.
At the societal level, a low unemployment rate can have a positive impact on government finances. When more individuals are employed, tax revenues tend to increase, providing governments with more resources to invest in public services and infrastructure. A low unemployment rate can also contribute to social cohesion, as individuals are more likely to feel engaged and included in society when they have access to employment opportunities.
The best estimate of a good rate of unemployment is offered by the ‘natural rate’ that emerges over long time periods. This rate irons out the ups and downs of the business cycle and allows us to estimate the long-run sustainable rate. As a rule of thumb, in developed economies this rate tends to be about 5%, as explained in my article about the Natural Rate of Unemployment.
In recent decades, the natural rate has fluctuated within a range of about 3.5% to 7.0%, but there is nothing special about this range. If, in the years ahead, western economies were to go through severe structural changes to our industries that render many of our workers’ skills obsolete, then we may face prolonged periods of higher unemployment as redundant workers are forced into training to acquire new skills.
Even more worryingly in such circumstances, a large proportion of workers who experience this sort of ‘structural unemployment’ tend to quickly become discouraged, and stop seeking work altogether. Whole sections of society can then fall into decay, as has already happened with much of the deindustrialized ‘rust-belt’ communities of former manufacturing towns and cities throughout the western world.
Several factors influence the unemployment rate, and understanding these factors is crucial to interpreting the rate accurately. It may seem that a lower unemployment rate is better, but a lot depends on who is included in the rate and why.
A significant factor is the labor force participation rate, which refers to the percentage of the working-age population that is either employed or actively seeking employment. This does not include those people of working age who, for whatever reason, are neither working nor actively seeking work.
An increase in labor force participation rate can lead to a beneficial higher unemployment rate, as more individuals enter the job market. On the other hand, a decrease in the labor force participation rate can artificially lower the unemployment rate, as individuals who have given up looking for work i.e., discouraged workers, are not counted as unemployed.
Wage growth is an important factor to consider when analyzing the unemployment rate. When wages are stagnant or declining, individuals may be discouraged from seeking employment or staying in the workforce. Conversely, when wages are rising, individuals are more likely to enter or re-enter the job market, potentially increasing the unemployment rate.
Another limitation is that the unemployment rate does not provide insights into the quality of employment. It does not differentiate between full-time and part-time employment, nor does it consider the skills or qualifications of individuals in the labor force. Therefore, a low unemployment rate does not necessarily indicate a high level of job satisfaction or stable employment opportunities.
With all this said, when the unemployment rate is high, people will tend to face financial hardships and experience a decline in their overall quality of life. High unemployment rates can contribute to social unrest and economic inequality, as individuals and communities may feel marginalized and excluded from the benefits of economic growth. I have described these issues in my article about the effects of unemployment.
An unemployment rate that is considered good in one country can be considered bad in another country due to differences in economic structures, government policies, and social factors. For example, countries with overly generous welfare benefits may have higher unemployment rates than countries with less generous benefits. The ‘welfare trap’ can discourage work if the remuneration available fails to significantly raise living standards.
Additionally, cultural and demographic factors can also influence unemployment rates, such as the prevalence of informal employment or the participation of women in the labor force.
Additionally, differences in data collection methods and definitions of unemployment can further complicate international comparisons. Nevertheless, comparisons of global unemployment rates can offer a worthwhile benchmark with which to assess what a good unemployment rate is.
Understanding the components that make up a good unemployment rate is crucial for policymakers to navigate the economic landscape. A low unemployment rate is generally seen as a positive sign for the economy, as it indicates a high level of job creation and a robust labor market. However, it is essential to consider factors such as labor force participation rates, wage growth, and the types of unemployment to interpret the rate accurately.
As a general rule of thumb, the natural rate of unemployment has tended to average around 5% in normal times, and this is a reasonable estimate of what a good unemployment rate is. However, the natural rate will vary over time depending on structural changes in the economy.
The unemployment rate is not without its limitations and criticisms, and policymakers must employ a range of strategies to address unemployment and promote job creation. By analyzing historical trends, global comparisons, and the relationship between the unemployment rate and the economy, we can gain valuable insights into the challenges and opportunities faced by individuals and societies.