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Why the level of unemployment matters nothing for real economic growth

Unemployment is a painful economic phenomenon which drives many social and political processes. For example, the Federal Reserve System has a dual mandate aimed at balancing of inflation and unemployment. (In macroeconomic, there is no empirically derived link between these variables, however.) By definition, unemployment is treated as a crucial parameter which theoretically responsible for the level of real economic performance. When unemployment is high, real economic growth is considered as a suppressed one, and thus, below its potential value with some “natural” rate of unemployment. In reality, economic recessions are usually accompanied by tangible increase in the rate of unemployment. Economic logic is often faulty and says “in sync means interlinked”. This is not the case for the relation between unemployment and real growth. Fluctuations in real growth are caused by external forces and result in the change of unemployment. This does not mean that one can decrease unemployment and thus drive economic growth.

The reason of the independence of real economic growth on unemployment is simple. The portion of unemployed, in the total working age population, UE/POP, is too small compared to the portion of people out of labor force, NLF/POP. Figure 1 displays both ratios. The portion of unemployed fluctuates near 4% (mean value 3.8%) of the total population with amplitude of 2%. Currently, the portion of unemployed is around 6%. At the same time, the portion of people out of labor force has dropped from 42% in 1983 to 33% in 1999. Effectively, the economy included 10% more population in 2000 than in 1963. This is a much bigger change than the observed variation in the portion of unemployed. All unemployed in 2000 would be out of labor force in 1963, i.e. irrelevant to real economic growth according to the mainstream macroeconomic paradigm.

Figure 1. Comparison of the portion of unemployed, UE/POP, and the portion of people out of labor force, NLF/POP, in the total working age population, POP.
Now, it is instructive to evaluate the influence of the increasing portion of employed people, E/POP, on the rate of real economic growth. Figure 2 compares E/POP (reduced by 0.55) and the rate of GDP per capita growth, dGDP/GDP, where the overall real GDP is divided by the working age population, POP. One can see that the rate of growth has a negative trend since 1960. During this period the E/POP has increased from 55% to 63% and then dropped to59%. From Figure 2, it is possible to conclude that the increasing proportion of employed population suppresses the rate of economic growth.

Figure 2. The portion of employed in the working age population, E/POP, compared to the rate of GDP per capita growth, dGDP/GDP.

Finally, we can answer the question why the level of unemployment means nothing for real economic growth. The fluctuations in UE are too small and their effect is opposite to the growth in the level of employment, which reduces the rate of real economic growth. In this regard, an increasing rate of unemployment is a positive phenomenon in the long run.