Unemployment impact

How much will a high rate of unemployment impact the overall economy? The answer to that depends on two factors. First, assuming that the unemployed will have some sort of income, whether from Government, benefits, retirement funds or perhaps "off the books" work, that will offset the loss of employment income to some degree. Of course, the amount of Government aid they get impacts taxes. The second factor is the ability of businesses to be profitable if you subtract the loss in disposable income, the first factor, from the economy.

I haven't seen very much information on the actual reduction in income suffered by an unemployed individual, and anything I come up with here is clearly speculative, but lets assume they lose 2/3rds of their income. I actually think that between retirement funds, Government aid, part time work both on and off the books, they will actually do better than this but I need to use some number. Well, if we were to have a long term unemployment rate of 10%, and nothing else was to change, we would see a 6.6% decrease in disposable income from unemployment. Now of course, you have to subtract the unemployment rate that we had prior to the downturn and lets use 4%. So instead of 6.6% we have a net decrease of 4%. Clearly, a factor and there are other factors that may very well mitigate that impact but lets use that.

So if high unemployment led to a reduction in consumer spending of 4% what does that mean for the economy? I guess it depends on you view of what a recovery is going to look like. Considering other factors in the economy, such as loss in housing and equity wealth and increase in savings it would potentially lead to a smaller economy of about 15%.

Now if the economy was about to contract by 15%, this would be quite scary. However, the economy has already contracted by more than that and is now in fact starting to recover a bit. What we are seeing is company after company reporting earnings that support a contraction to a lower need for revenue in order to maintain profitability.

A number of analysts or bloggers seem to think that cost reduction is a one time event and try to discount it. However, when a company reduces cost by laying off workers or closing plants, this is an ongoing reduction. The savings keep on helping profitability. So if a company has adjusted its operations to be profitable at a certain reduction in revenue and revenue then grows, the improved profitability actually may lead to greatly increased profits.

So, as we watch what may very well be, at least initially, a jobless recovery, how bad is it for the economy? On an ongoing basis, I think it will lead to about a 4% reduction in economic activity and consumer spending. Without ignoring the individual devastation that losing a job can cause, from a purely economic impact it becomes a fairly minor overall factor in economic recovery.