Cyclical Unemployment – Definition, Causes and Cure

In the previous two articles, we studied about frictional and structural unemployment. They can be considered to be the mild and moderate form of unemployment respectively that can be suffered by an economy. They are not usually the ones being referred to when common people talk about unemployment.

The most dreaded form of unemployment is called cyclical unemployment. This is the form that plagued the world during the Great Depression of 1929 and after the subprime mortgage crisis in 2008 and many more times. This is the type which brings horrific images to people’s minds and overthrows governments in the blink of an eye. In this article we will study the concept of cyclical unemployment in detail.

Definition of Cyclical Unemployment

Investopedia defines cyclical unemployment as follows:

A factor of overall unemployment that relates to the cyclical trends in growth and production that occur within the business cycle. When business cycles are at their peak, cyclical unemployment will be low because total economic output is being maximized. When economic output falls, as measured by the gross domestic product (GDP), the business cycle is low and cyclical unemployment will rise.

Examples of Cyclical Unemployment

Cyclical unemployment cannot be explained with the help of personal examples. Rather the examples here refer to huge events which are known to pretty much everybody.

• The Great Depression is one of the biggest examples of cyclical unemployment. Estimates of the magnitude of the problem vary. However, some estimates have pegged the unemployment rate to be as high as 40%.

  Considering the fact that official figures tend to understate the true impact of the problem, this situation was indeed alarming. Also, it must be noted that the Great Depression in 1929 happened immediately after a period of immense economic growth i.e. the roaring 1920’s

• The more recent subprime mortgage crisis is also an apt example of cyclical unemployment. During the early 2000’s the demand for housing exploded as a result of low interest rates and cheap availability of money. As a result, houses were being constructed at a breakneck speed providing employment to a lot of people in the process. When the housing market collapsed in 2008, it had ripple effects causing losses, foreclosures and unemployment at a catastrophic scale.

Economic history is rife with examples of cyclical unemployment. Earlier, these incidents were isolated to a particular industry or to an economy. However, of late, the financial markets of the world have become increasingly integrated and the rise of cyclical unemployment in one part of the world, particularly the developed markets, quickly escalates into a spiral and spreads to other economies as well.

Duration of Cyclical Unemployment

Cyclical unemployment is of long term duration. It is this kind of unemployment that escalates into a self destructive economic spiral whose cause and consequence are both unemployment. This type of unemployment can take decades to resolve if left on its own. The most famous example being the Great Depression wherein the situation did not get resolved until US joined World War -2 i.e. in 1944 i.e. after 15 long years.

Causes of Cyclical Unemployment

Cyclical unemployment is caused by a fundamental imbalance within the economy. In this case, the number of people in the economy looking for jobs is greater than the number of jobs in the economy. Hence if all the jobs in the economy are filled simultaneously, there will still be someone who will be unemployed.

This kind of unemployment happens when the economy as a whole goes down. This means that the GDP of the country reduces. Hence, since less and less goods are being consumed by consumers, fewer people are required to manufacture them. Since fewer people are required, manufacturers begin to lay off excess employees. This causes even more panic causing even lesser consumption and the self destructive cycle goes on. The only way to stop this downward spiral is to uplift the entire economy by increasing the GDP i.e. coming out of a recession into a boom phase. This, as we all know, is not at all an easy task. Hence cyclical unemployment is considered to be a cause of concern. Economies that are plagued by it have a hard time recovering from it.

Cure of Cyclical Unemployment

Cyclical unemployment can be cured by increasing the GDP of the country. In most countries today, this job is done by the governments. They cannot single handedly end the recession. However, the government can accumulate money in the form of debt and end the negative cycle by creating more jobs which can later be paid off by taxes received.

The idea behind government spending is to give a forward thrust to the economy. This forward thrust creates a momentum which can then be sustained by private firms. More government jobs will create more spending which will then also create more private jobs.

Government spending as a means to end unemployment has been a widely debated topic in the past. There are both advantages and disadvantages to this approach. In fact, this topic is so wide that it is beyond the scope of this article and we will discuss it in the next article.

For now, it is enough to understand that cyclical unemployment is the most severe form of unemployment that there is and massive programs have to be created to help economies recover from them.