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Persistent unemployment

History warns us that unemployment could stay high for years
Persistent unemployment

Unemployment is rising. Figures next Tuesday could show that the official jobless rate has risen to 5 per cent, its highest for almost five years. And with redundancies near a record high, all economists expect the rate to climb further. Worse still, this problem could stay with us for years.

For example, after the 1980-81 recession unemployment did not return to its 1979 low-point until 2000 – 21 years later. After the 1990 recession unemployment did not fall back to its pre-recession level until 1997 – four years after its peak. And after the 2008-09 recession the jobless rate didn’t return to its 2008 low-point until 2015 – again, four years after its recessionary peak.

History, therefore, warns us that when unemployment rises, it stays high for a long time. We should therefore expect it to stay above its pre-pandemic low until at least 2025.

But why is it so slow to fall after recessions?

In part, it has been because overly tight macroeconomic policy depressed job creation – such as high real interest rates in the 1980s or fiscal austerity in the 2010s. But this is not the whole story. After the early 1990s recession monetary and fiscal policy both loosened significantly and yet joblessness was still slow to fall.

Instead there are other reasons why joblessness stays high.

One is that unemployment leaves permanent scars. Workers who suffer long spells of unemployment tend to become less employable, as their skills and work habits deteriorate – if indeed they ever had these in the first place. This is especially true of younger people: David Bell and David Blanchflower have pointed out that those who experience joblessness when young are more likely to be unemployed or have low wages even years later.

Employers too can be scarred, though. Memories of recession and falling profits can dampen their reluctance to expand for a long time: once bitten, twice shy. This is especially the case for those companies who take on higher debt to see them through the recession: for these, weaker balance sheets also inhibit expansion.

And then there are mismatches and search frictions. A job is like a marriage; it requires two sides to make a good match. After recessions, though, such matches are harder to find as the unemployed might not have the skills that employers want, or the jobs might be in different areas from the unemployed. The jobs that are created in an upturn can be very different from those destroyed in the downturn.

All this means that unemployment is prone to hysteresis: it can stay high even after its initial cause has disappeared. “All types of recessions, on average, lead to permanent output losses,” conclude Valerie Cerra and Sweta Saxena, two IMF economists.

This should worry investors on two counts. One is simply that high unemployment can weaken demand and economic activity. The other is that it can cause political instability. As Harvard University’s Ben Friedman showed in 2006 – and subsequent events have vindicated – economic stagnation fuels intolerance and hostility to democracy. Which is why we need policies – both micro and macro – to get unemployment down quickly.