The consequences of unemployment

As Eurozone unemployment sits at a huge 12.1 %, and UK unemployment remains above 8 %, I thought it may be an appropriate time to discuss the Economic consequences of unemployment :

Labour is one of the four factors of production, the other three being Land, Capital and Entrepreneurship. As such, unemployment represents Labour not operating at it’s full capacity, and has many important consequences for the rest of the economy and the people living within it.

One of the most important consequences of unemployment is Lost Output. As Labour is one of the factors of production, a decrease in employment means that less goods and services will be produced within the economy. It is, however, important to note that the potential Aggregate Supply is not dependent on the amount of people unemployed, for the quantity and quality of labour is not affected by the amount of people unemployed. As such, not only will less goods and services be produced during high unemployment, but people will have less disposable income with which to spend on these aforementioned goods and services, hence meaning that supply and demand both lower to reach a new equilibrium meaning reduced output. This lower output means a reduced material standard of living, due to the reduced real GDP and reduced amount of expendable money for many people to spend.

          Another important consequence of unemployment is reduced tax revenues, both from direct and indirect sources. People will have less money to spend due to the increased unemployment, and whilst the average propensity to consume will increase due to the lower income, overall consumer spending will be lower, meaning less revenue from VAT. Furthermore, this lower income will result in lower income tax receipts for the government, hence meaning reduced tax income for the government. As such, the government can either raise tax rates to recoup the losses, which will mean that people and businesses have less money to spend and invest, resulting in reduced aggregate demand. Alternatively, the government could keep taxes constant and reduce spending in order to maintain a balanced budget, meaning reduced government  spending, one of the components of aggregate demand, and hence reduced AD. Keeping government spending constant or raised despite the lower tax receipts for the government will result in an imbalanced budget, meaning that the government will need to borrow, increasing long-term interest and, in the long-run, reducing spending power of the government and eventually reducing aggregate demand.

          Similarly, the problems caused by the likelihood of increased government spending are accentuated by the increased government spending on unemployment benefits. This increases spending on the welfare sector in turn means that less money can be spent on other areas such as education ; Less education in turn means that workers are less well-trained and hence the quality of labour may well be diminished. Therefore, greater unemployment means an opportunity cost as amounts of other public goods will be reduced,  which in turn may have negative externalities on society, as aforementioned.

         Not only does the increased spending on unemployment benefits have negative effects on the public sector via the increased proportion of unemployment benefit expenditure, but increased unemployment results in pressure on other aspects of government expenditure, as unemployed people face great deals of stress, due to the pressure of financial difficulties. This stress manifests itself in increased illness, both physical and mental, and increased amounts of crime. In turn, government expenditure on these public goods is likely to increase, and as aforementioned, government expenditure may well decrease due to the reduced government tax receipts. As such, a select few public goods may receive a disproportionate amount of the (potentially reduced) government expenditure within the economy.  Other sectors of government expenditure will then struggle to maintain efficiency with their disproportionately low funding, exacerbated by the aforementioned possibility of lower government spending as a whole.

          It is important, however, that we do not forget that there are obvious effects to the unemployed themselves. The aforementioned stress not only contributes to increased illness, but also increases the probability of marital break-up and may decrease people’s feelings of social status or their own self-worth.

         As such, another consequence of unemployment, hysteresis, may take effect in the long term. As people become unemployed for longer periods, their skills and hence efficiency and productivity may be diminished, meaning that employers will be reluctant to employ these workers, causing a continued, vicious cycle of unemployment, in which some may become discouraged to apply for jobs and may become used to the life afforded to them by state benefits.

        These seven different consequences of unemployment are all inexorably linked and hence it is possible that different economists will have opposing views on their respective importance. However, in my opinion, many of the consequences stem back to the Lost output caused by unemployment. This lost output manifests itself as reduced standards of living and is ultimately the most pertinent consequence of unemployment to the entire public, whether they be unemployed or not. The only real way that the problems caused by the lost output can be mitigated is to increase employment, which is why I believe that the human consequences of unemployment : Increased Stress and Hysteresis. It is these human factors which make the labour force less efficient and hence reduce the quality of labour, reducing Aggregate Supply and hence interfering greatly with the entire economy.

As such, in my opinion, the final three consequences of unemployment, namely Lost Tax revenue, government spending on unemployment benefits, and pressure on other forms of government spending, whilst still important, are the three less important of the consequences of unemployment.  In my opinion, the Lost Tax revenue is more important than either the Pressure on other forms of government spending, or the increased gov.spending on unemployment benefits, for the Lost Tax revenue has an immediate effect on government spending, which accounts for 47 % of our GDP. Furthermore, the Lost Tax revenue may result in higher tax rates to increase tax revenue, which will have another knock-on effect to all people and businesses, making the Lost Tax revenue a more expansive and hence important consequence of unemployment than  either the increased government spending on unemployment benefits or pressure on other forms of government spending, which are the two least important effects of unemployment.

          To conclude, unemployment affects nearly all aspects of the economy, having many knock-on effects on the general public. Whilst it is debatable which of these effects or consequences is the most adverse or important, in my opinion Lost Output is the most important, followed by Costs to the Unemployed and Hysteresis, followed by Lost tax revenue, government spending on unemployment benefits and pressure on other forms of government spending.