Back to Basics: What Constitutes Unemployment?

• Author: Ceyda Oner
• Position: an Economist in the IMF's Asia and Pacific Department.

EARLIER this year, the International Labor Office announced that global unemployment last year reached the highest level on record. More than 200 million people, 7 percent of the global workforce, were looking for jobs in 2009.

It is not a coincidence that the global economy is experiencing the most severe case of unemployment during the worst economic crisis since the Great Depression. Unemployment is highly dependent on economic activity; in fact, growth and unemployment can be thought of as two sides of the same coin: when economic activity is high, more production happens overall, and more people are needed to produce the higher amount of goods and services. And when economic activity is low, firms cut jobs and unemployment rises. In that sense, unemployment is countercyclical, meaning that it rises when economic growth is low and vice versa.

But unemployment does not fall in lockstep with an increase in growth. It is more common for businesses to first try to recover from a downturn by having the same number of employees do more work or turn out more products—that is, to increase their productivity. Only as the recovery takes hold would businesses add workers. As a consequence, unemployment may start to come down only well after an economic recovery begins. The phenomenon works in reverse at the start of a downturn, when firms would rather reduce work hours, or impose some pay cuts before they let workers go. Unemployment starts rising only if the downturn is prolonged. Because unemployment follows growth with a delay, it is called a lagging indicator of economic activity.

How sensitive is the unemployment rate to economic growth? That depends on several factors, most notably labor market conditions and regulations. One estimate for the strength of this relationship for the U.S. economy is Okun’s Law (named after the late economist Arthur Okun), which postulates that a decline in unemployment by 1 percentage point corresponds to a 3 percent rise in output. More recent estimates find that the consequent rise in output may be lower, possibly between 2 and 3 percent.

How far does this inverse relationship between growth and unemployment go? If economies kept expanding, would one expect to see unemployment disappear? Actually this is not the case (see Chart 1); even in the 2000s when the global economy was prospering (at least until the 2008–09 crisis), global unemployment declined but never reached zero. This observation raises one basic...