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What are the Impacts of Unemployment?
Impacts of Unemployment on Individuals
Loss of Earnings: Involuntary unemployment can result in significant consequences for individuals. Firstly, the loss of employment means the loss of wages. A reduction in earnings could mean a reduction in disposable income, and a lower ability to consume goods.
This is likely to cause a decrease in individuals’ consumption and investment in the economy as they simply cannot afford it. However, prolonged unemployment can result in the inability to afford basic necessities. In the United Kingdom however, we do have governmental support in the form of benefits such as universal credit, to support those who are unemployed.
Future Employment Prospects: People can often spend significant portions of time out of employment, which can in turn harm future employment prospects and elongate high unemployment rates. Economists refer to this as the hysteresis effect. If individuals are removed from employment, they may miss training and growth opportunities and become demotivated. Employers are often hesitant to hire individuals who have been out of employment for prolonged periods, which makes it more difficult to find new employment.
The following graph shows that economic inactivity (people not participating in the labour force) in the UK has risen since January 2019. Further inspection displays that inactivity has risen partially due to the rising number of people inactive due to long-term ill health since the Covid-19 pandemic. However, the number of students (counted as inactive) has also risen.
The Fraser of Allander Institute regularly publish commentaries surrounding labour market trends and discussions surrounding possible inactivity. If you wish to learn more about labour market activity, and the potential reasons for inactivity:
To quickly summarise the key labour market issues in Scotland:
- Following the Covid-19 pandemic, economic inactivity increased
- Over 29% of economic inactivity in Scotland can be explained by long-term illness, this has increased significantly following the Covid-19 pandemic
- Economic inactivity has however partially increased due to a recent increase in the percentage of students in Scotland (we classify students as economically inactive!). The country witnessed a student increase due to the Covid-19 pandemic encouraging people to reconsider career plans
Impacts of Unemployment on Firms
Large Labour Pool: Despite the obvious negative economic implications of rising unemployment, firms can witness positive effects. As unemployment grows, the size of the labour pool grows and firms will have a larger choice of workers. Furthermore, as the supply of workers is high then they may be able to offer lower wages while still attracting staff.
Decreased Consumer Demand: Rising unemployment also presents significant challenges for businesses. As unemployment decreases earnings and disposable income, we can expect that overall consumer demand will also decrease. As consumer demand decreases, we can anticipate that a decrease in demand for goods and services may harm company performance.
Decreasing Investment: A reduction in income and performance for both individuals and firms is ultimately expected to cause a decrease in investment in the economy. As individuals have lower disposable income, they are likely to decrease investment levels.
Elasticity: During high unemployment, not all goods and services will bear the same effect. Demand for basic goods such as bread and toilet roll is likely to remain the same. On the other hand, demand for luxury goods and services (restaurants, flights) is likely to suffer due to decreasing demand. This introduces the economic concept of elasticity.
Overall Economic Impact of Unemployment
Decreased Consumer Spending: We have identified that both earnings and consumer demand decrease, decreasing spending and harming the performance in the economy. On the whole, money flow and economic performance will decrease which leads to the risk of further rises in unemployment.
Reduced Tax Revenue: In the tax section, you will recall we identified that in the UK, employees pay direct tax in the form of income tax on earnings. Resultantly, if the level of employment in the economy decreases then we would expect that the level of income tax paid will decrease accordingly. In short, a rise in unemployment causes a decrease in income tax paid and decrease government revenues. This ultimately can cause the government deficit to rise and potentially create the need for austerity measures.
The below graph displays the revenue generated in the UK to fund government spending. We can see that income tax (purple) is the largest source of revenue for UK spending, indicating that an increase in unemployment would have significant negative consequences for the government.
Covid-19 and Unemployment
In March 2020, the outbreak of the Covid-19 pandemic led to the unprecedented introduction of lockdowns in the United Kingdom and worldwide. The increased financial uncertainty and significantly reduced ability to attend non-essential businesses and travel led to a significant decrease in consumer demand. While often an economic downturn is associated with a steep rise in unemployment, such an increase was not seen in the UK. The below chart demonstrates visually that the UK witnessed a smaller increase in unemployment than one might expect, whereas the United States experienced a significant rise.
Why did the UK achieve a lower rate of unemployment? The UK implemented the Job Retention Scheme (Furlough Scheme) which provided financial assistance to employers to retain their employees and fulfil 80% of their salaries even if they were unable to work. As such, the government had the ability to cover a significant portion of employees wages and maintain lower unemployment rates. If someone earned £20,000 p/year, the government paid £16,000 of this salary (excluding tax), allowing workers to maintain a stable income.
On the other hand, the USA opted not to implement an official employment protection scheme. Instead, the government expanded unemployment benefits to those who lost their jobs during the pandemic in the form of regular payments. This partially explains why the USA unemployment rate rose significantly higher than in the UK.
If you wish to find out more about the Coronavirus Job Retention Scheme and the impact it had in the United Kingdom:
