Skip to main content

Four percent unemployment is not full employment. Here’s why

Written By | May 4, 2018

WASHINGTON: Historically if the unemployment rate dropped below 6 percent, economists considered the economy at full employment. Today the unemployment rate is 4.1 percent, but economists do not consider that a full employment level. The reason is that things are much different today.

Why doesn’t the unemployment rate fall to zero?

Even if the economy is growing at a rapid rate, there will always be some unemployment. There are three reasons for this. In spite of the robust growth, there will always be some frictional, structural and cyclical unemployment. But due to changes, mostly in technology, the amount of each type is lower today.

Cyclical unemployment occurs when some industries’ business activities run counter to the business cycle. That means when there is high growth and most businesses are growing, some businesses do poorly and lay off workers.

For instance, if there are two companies in the construction industry. One company builds new homes while the other renovates existing homes. When the economy is growing rapidly, more new homes are built, so the new home builder is doing well and not laying off any workers.




On the other hand, when the economy is strong, homeowners do seek to buy new homes rather than renovate existing homes. So during the high growth periods, the home renovator may lose business and must lay off workers. His business runs counter to the business cycle.

Because of the widespread use of the internet providing information, companies that are not doing well can more easily find new opportunities, so cyclical unemployment tends to be lower.

Structural unemployment is also lower.

Structural unemployment means that there is a mismatch between the skills of the unemployed and the skills required to fill the open positions. In other words, there are plenty of unemployed manufacturing workers. There are also plenty of open positions in the computer software industry.

The skills of the manufacturing worker are different than the skills needed to be a computer coder. Since industries mature and new industries are created, the economy will always have some structural unemployment.

The way to reduce this is to retrain workers. While it is difficult to retrain a manufacturing worker to be a coder, retraining can occur. Because so many accredited degrees and certification programs are available online, retraining is much easier today.

As a result, the structural component of unemployment is lower today.

How about “frictional unemployment”?

Frictional unemployment measures the number of workers between jobs as well as new entrants into the job market. It takes time for these people to find jobs. Historically, if a worker loses his or her job, it took, on average four to six months to find a new position.

Today, that time period has been greatly reduced. Depending on the skill set, some displaced workers can start new positions in a matter of weeks. That’s because there is no longer the need to prepare and print resumes and cover letters to be sent to job openings. And they no longer have to be sent by regular mail.



Today job openings are posted instantly online. Job seekers can instantly apply for jobs and can instantly send a resume and cover letter. Often workers with much-needed skills can find a new position within weeks of losing their previous job.

 

Similarly, first-time job seekers need months to find their first position. When using online job boards, that communication time is reduced. Instead of taking months for a new job seeker to find a position, the time could be reduced to a matter of weeks.

With all three components of unemployment being reduced, full employment is now considered to be far lower than the traditional 6 percent.

What is a full employment level, really?

The Federal Reserve (Fed) bases some of their monetary policy on reaching the goal of full employment. Their definition has changed over time. Historically, if unemployment reached under 6 percent, the economy was at full employment.  In 2015, the FED lowered the number to about 5.1 percent.

Since the unemployment rate has been below 5.1 percent for many months, the Fed says it is not quite sure what the number should be.

A new employment consensus

The consensus view today seems to be that the full employment rate should be when unemployment falls to 3.7 percent. If unemployment drops below that there is a fear that inflation will rise.

With the new technologies available in this information age, 3.7 percent may be high. It is likely that the economy will continue to add an average of more than 200,000 jobs per month into the foreseeable future.  However, the unemployment rate will not fall to a 3.7 percent level for some time.

The reason is simple.

Because the U.S. economy has been stuck with a 2 percent growth rate for the last 12 years, there are as many as 6 million discouraged workers. These are workers that could not find a job because of the lack of opportunity, so they became discouraged. They became so discouraged that they stopped looking for a job. These workers are currently not counted as unemployed.

As the economy improves they will be drawn back into the labor market to fill the newly created jobs. This will hold the unemployment rate fairly constant.

All this means there is plenty of available labor that can more quickly find jobs. There should be little fear that a tight labor market will lead to more inflation today. That’s why the Fed recently decided not to raise interest rates this month, although rate hikes are likely later this year.

We still have some time until we reach full employment.

 

Michael Busler

Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years.