Types and Causes of Long-Run Unemployment
Over the long run, unemployment doesn't just rise and fall with the business cycle. Certain types of unemployment persist even when the economy is healthy, and understanding what drives them is central to this unit.
Frictional vs. structural unemployment
Frictional unemployment happens when workers are between jobs or searching for new ones. This is a normal, even healthy, part of any labor market. People quit to find better positions, recent graduates enter the workforce for the first time, or workers relocate to a new city. The key feature is that suitable jobs do exist for these workers; it just takes time to find and fill them.
Structural unemployment is more stubborn. It occurs when there's a mismatch between the skills workers have and the skills employers need. This mismatch comes from fundamental shifts in the economy:
- Technological change: Factory workers displaced by automation may lack the technical skills new jobs require.
- Industry decline: Coal miners lose jobs as the energy sector shifts toward renewables, and their specialized skills don't transfer easily.
- Globalization: When manufacturing relocates overseas, domestic workers in those industries face long-term displacement.
The distinction matters because frictional unemployment is short-term and largely unavoidable, while structural unemployment can leave workers jobless for months or years and typically requires active policy intervention.
Natural Rate of Unemployment and Economic Performance
Natural unemployment and potential GDP
The natural rate of unemployment is the unemployment rate that persists when the economy is operating at full capacity. It combines frictional and structural unemployment but excludes cyclical unemployment (the kind caused by recessions).
Think of it this way: even in a perfectly functioning economy, some people will always be between jobs (frictional) and some will have the wrong skills for available positions (structural). That baseline level is the natural rate.
This rate is directly tied to potential GDP, which is the maximum output the economy can sustain without generating accelerating inflation. When unemployment sits at the natural rate, the economy is producing at or near potential GDP. A higher natural rate means more workers are persistently idle, which reduces the economy's productive capacity.
The labor force participation rate also plays a role here. If fewer people are participating in the labor force (not working and not looking for work), the pool of available workers shrinks, which can shift the natural rate.
Trends in the natural rate
The natural rate isn't fixed. It shifts over time in response to structural changes in the economy:
- Demographics: An aging population tends to lower the natural rate because older workers who retire exit the labor force entirely (they're no longer counted as unemployed).
- Education levels: Rising educational attainment gives workers more adaptable skills, reducing structural mismatches.
- Job search technology: Online job boards and recruiting platforms have made matching workers to openings faster, reducing frictional unemployment.
In the U.S., the natural rate has generally declined since the 1980s, partly due to these factors. However, estimating the natural rate is tricky because you can't observe it directly. Economists rely on models and historical data to approximate it, and estimates can differ.
Policy Approaches to Reduce Long-Term Unemployment
Policymakers can't eliminate the natural rate of unemployment, but they can try to lower it by addressing the root causes of frictional and structural unemployment.
Education and training programs
These aim to close the skills gap that drives structural unemployment:
- Vocational training and apprenticeships give workers hands-on skills aligned with current employer needs, helping displaced workers transition into growing industries.
- Higher education subsidies (such as Pell Grants in the U.S.) make it more affordable for workers to gain new qualifications, broadening the range of jobs they can fill.
Labor market reforms
Reforms that make the labor market more flexible can reduce both frictional and structural unemployment:
- Lowering barriers to hiring and firing encourages employers to take on new workers, since the risk of a bad hire is smaller.
- Reforming unemployment insurance can balance providing a safety net with maintaining incentives to search for work actively.
- Promoting geographic mobility (through relocation assistance, for example) helps workers move to where the jobs are.
Targeted employment subsidies
Governments can offer tax credits or direct subsidies to firms that hire the long-term unemployed. These incentives offset the perceived risk of hiring someone who has been out of work for an extended period, helping workers who face the steepest structural barriers.
Infrastructure investment and industrial policy
Public spending on infrastructure (roads, bridges, broadband) creates jobs directly and can absorb displaced workers. Supporting growth industries like renewable energy or technology through industrial policy generates new employment opportunities that can replace jobs lost in declining sectors.
Economic Growth and Unemployment
The relationship between growth and unemployment over the long run has several important dimensions.
Growth and job creation: Sustained economic growth tends to create new jobs and pull unemployment down. But the type of growth matters. Growth driven by capital investment and automation can initially reduce labor demand in certain sectors, even as it raises overall productivity and expands the economy over time.
Wage rigidity can slow the adjustment process. If wages don't fall when labor demand drops (due to minimum wage laws, union contracts, or employer norms), employers may cut jobs instead of lowering pay. This can prolong unemployment during periods of economic transition.
Hysteresis is a particularly important concept. It suggests that long spells of high unemployment can permanently raise the natural rate. Workers who stay unemployed for extended periods may see their skills deteriorate, lose professional networks, or face employer stigma. Even after the economy recovers, these workers struggle to find jobs, and what started as cyclical unemployment becomes structural.
Demographic shifts also shape long-run trends. An aging population reduces the share of working-age adults, which affects labor supply, the types of jobs available, and the overall unemployment rate. These shifts unfold slowly but have lasting effects on the labor market.