What is Cyclical Unemployment?

Cyclical unemployment is like a system update on your computer...

Things might be running fine for a while. You plug away, doing your day-to-day tasks without interruption. But, at some point, the software you are running gets out of date. New code has been written and new processes have been added that your outdated software can’t run. The only way to get things running correctly is to shut the system down and let it reset (a recession). While it’s down, you don’t get any work done (cyclical unemployment). But, once you reboot (find a new job), things will typically run better than before.

Cyclical unemployment occurs during a recession . Therefore, the causes of cyclical unemployment are the same as the causes of recessionary periods.

Recessions typically occur when a temporary increase in economic activity is completed (like a war), or when investors or consumers lose faith in the ability for economic growth to continue.

All economies experience the business cycle to some degree. During the growth phase, the economy expands. But, if that growth is artificial or temporary, it eventually gets corrected. That correction is the contractionary phase of the business cycle, called a recession. It usually happens following a time that the country is producing at a level it cannot sustain.

As the economy reaches its limit, business owners and investors see growth start to slow down. That reduction in growth often leads to a hesitation in lending, which slows growth further.

Businesses missing growth targets begin cutting back on expansion plans, which leads to some job losses. In turn, those job losses lead other people to fear for their jobs, thus reducing household spending.

Reduced spending results in reduced sales, which causes a self-fulfilling prophecy – More jobs are lost. This vicious cycle continues, causing more and more cyclical unemployment until the economy reaches the bottom of the cycle.

Cyclical unemployment is usually temporary. Those who are cyclically unemployed tend to find jobs when the economy begins growing again.

A recession often has the effect of putting poorly run businesses and outdated business models out of business. Therefore, one effect of cyclical unemployment is to weed out weaker companies. This forces businesses to become more cost-conscious, innovative, and creative.

It also forces employees to become more skilled as jobs are harder to find. Therefore, another effect of cyclical unemployment is an increase in educational attainment and a more skilled workforce. However, this effect has become less beneficial in the modern economy.

As technology advances, the last few recessions have led to labor replacement through automation processes. Consequently, cyclical unemployment has increasingly become structural unemployment for many workers in rich countries.

There are four basic types of unemployment:

Cyclical unemployment occurs when the economy enters a recession. They are jobs that are lost as businesses lose sales or go out of business. Historically, recessions have been short-lived, and cyclical unemployment is temporary. Most cyclically unemployed persons find work again once the recession is over.

Seasonal unemployment is what happens when a job can only occur during certain parts of the year. During the off-season, the employee gets laid off and becomes seasonally unemployed. Some examples include a fishing boat crew that only works in the summer, construction workers who can’t work in the winter, and holiday workers who don’t have jobs outside of the holiday season.

Frictional unemployment refers to the time spent between jobs. It is usually short term and voluntary. People often become frictionally unemployed when they look for better opportunities to match their skills and interests. The economy always has some churn, which causes some natural rate of frictional unemployment to be ever-present.

Structural unemployment arises out of changes in the economic structure. This type of unemployment usually stems from a new technology disrupting an old process. As new technology is adopted, the old technology becomes obsolete. People working in the hand-dying industry became structurally unemployed when machines became capable of doing the work. Structural unemployment can be long-lasting, depending on the ability of the workers to obtain new skills.

Cyclical unemployment is usually bad. It almost always corresponds to a reduction in gross domestic product (the value of the things an economy creates), called a recession. These downturns typically correspond to businesses losing money, people losing jobs, and significant disruptions in people’s financial lives.

If these cyclical trends have any redeeming qualities, it is that it forces businesses to become more efficient and workers to become more skilled. Companies that lose money have to cut back on payroll and pilot projects. They tighten their belts and cut out expenditures that do not have adequate returns on investment.

As the economy recovers, the businesses that survived are often leaner and better run. Likewise, losing a job may force a worker to go back to school or to embark on a new training program. As the economy recovers, the labor force may be more skilled.

One example of cyclical unemployment is the increase in layoffs as a result of the COVID-19 pandemic. With the onset of stay-at-home orders and temporary business closures beginning in March of 2020, many companies faced decreased revenues.

With this decrease in revenue and the onset of a recession in 2020, many businesses were forced to layoff their employees across a wide variety of industries and many of those unemployed faced difficulty in finding new positions.

Between February and May 2020, for example, more than 40 million people applied for unemployment benefits in the United States. As a result of such a large number of people losing their jobs and wages, the U.S. government passed economic stimulus packages to help those affected by the pandemic pay their bills.

Another example of cyclical unemployment occurred during the Great Recession from 2007 to 2009.The housing market was booming in the years leading up to the Great Recession. Real estate agents, construction workers, architects, appraisers, loan originators, and several other professionals saw a significant jump in demand for their services in the United States. That increased demand led thousands of people into occupations related to the housing market.

Eventually, the housing bubble popped, and everything changed. Suddenly, the number of clients for realtors, loan originators, and construction workers fell. There was not enough work for the number of people in these occupations.

Consequently, construction companies and financial institutions had to lay off workers. Real estate agents had to find other things to do with their time. All of these people suffered from cyclical unemployment.

Once the economy entered its recovery phase, the work started to show up again. While not everyone who lost their job would get hired back, many of these workers were able to come out of the slump and continue their careers.

Another example is the recession that followed the end of World War II. During the war, millions of young people got thrust into military service. Those that didn’t end up in uniform ended up supporting the effort from home. Factories began manufacturing bombs, tanks, and airplanes. Mining companies were asked to generate more resources.

The increased activity surrounding the global conflict pushed the economy to create more than it otherwise would have. And it had to be done with a smaller civilian workforce. In other words, the economy was above full employment.

As the war ended, all of this production slowed down. Suddenly, the efforts on the homefront were not needed. Plus, the young men coming home from overseas didn’t have jobs waiting for them. The economic activity spurred by government spending had to return to normal levels.

Consequently, many people ended up out of work and looking for a new direction in life. Fortunately, this post-war cyclical unemployment was short lived and not as severe as people feared. It lasted from February to October of 1945, was followed closely by another downturn in 1948-1949, and then kicked-off a period of exceptional economic growth.

The government often attempts to intervene when cyclical unemployment is present. Holding down unemployment is one of the mandates of the Federal Reserve. And the federal government frequently attempts to stimulate the economy when it looks like the business cycle might falter.

The federal reserve uses monetary policy to fight off cyclical unemployment. By reducing the interest rate, it can promote more borrowing and less saving (so that people will spend more). Both of these outcomes pump more money into the economy, which in turn generates more labor demand. As businesses get busier, they hire more people, and the number of cyclically unemployed people goes down.

Congress also attempts to combat cyclical unemployment through fiscal policy. The fastest and easiest option is to increase government spending. By embarking on capital projects or by simply putting more money into people pockets, it can increase the demand for labor. As a result, the unemployment rate may fall.