Recession and unemployment seem to go hand-in-hand. For many individuals, unemployment describes their primary experience of a recession, as they are laid off or unable to find work. The two concepts are so closely linked in people’s minds, that many people feel some confusion about the relationship between them. Does a recession cause unemployment? Or does widespread unemployment cause a recession? Or are the two actually not correlated except in the imagination?
The simplest answer is that recessions cause unemployment. At the same time, once people become unemployed, they have less money to spend on goods and services. So, a recession in a certain sector of the economy can cause unemployment, and that unemployment can cause a recession in a different part of the economy. While the simple answer may be that recessions cause unemployment, the relationship between recessions and unemployment is complex.
Let’s take a deeper look at just how the relationship between economic recession and unemployment works.
Are Unemployment & Recession Related?
Let’s first review a simple definition of what an economic recession is. The National Bureau of Economic Research, which is a non-profit, non-partisan research organization, defines a recession as: “A significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.” As economic activity of all kinds declines, businesses lose revenue, which forces them to lay off workers. This is how a recession leads to an increase in the unemployment rate.
As hinted at earlier, there are some ways in which the recession-causes-unemployment relationship is more complicated. For one thing, a rise in unemployment can itself trigger a downward spiral that deepens and prolongs a recession. Higher unemployment leads to a drop in consumer spending. This leads to further slowing of economic activity and growth, which in turn leads to more layoffs and the creation of fewer jobs.
Going beyond issues of causality, it’s important to recognize that the economy proceeds in cycles, meaning that investment/growth, unemployment, and inflation all go up and down in relation to one another. We can understand this cycle to have four phases.
- Business activity is at its maximum, which involves a minimum of unemployment and high inflation.
- A recession begins, with a decline in total output, a rise in unemployment, and a drop in inflation.
- The recession hits its bottom, the unemployment rate rises to a maximum, and inflation is at a low point.
- The economic recovery begins, unemployment begins to fall, and inflation once again begins to rise.
The Great Recession Unemployment Rate
While unemployment typically doesn’t cause recessions, it’s still one of the ways we comprehend the depth of a recession’s effects on people. Our sense of the severity of the Great Recession—triggered by the 2008 global financial crisis—has a lot to do with the unemployment rate. At its peak, the Great Recession unemployment rate rose to 10.0% in October 2009. In other words, the highest unemployment rate during the Great Recession was the highest unemployment rate since the Great Depression.
There has been a great deal of study devoted to understanding which groups of people were hit hardest by the Great Recession. A seminal paper published in 2015, written by economists Marianne Bitler and Hilary Hoynes, analyzes the effects of the Great Recession and other recessions. They find that, generally speaking, people at the bottom of the income ladder are most severely impacted by recessions. These people are typically the first to be laid off. In addition, these workers tend to be lower-skilled, which often makes it very difficult for them to find other employment.
Cyclical Versus Structural Unemployment
Following the worst of the Great Recession, the economy expanded for over a decade. Still, it wasn’t until September of 2017 that the unemployment rate fell to pre-Great Recession levels. However, even this likely understates the true impacts of the Great Recession, especially for people at the low end of income distribution. The decrease in the unemployment rate did not factor in those who had been unemployed for over 15 weeks or those who had given up looking for full-time employment.
Most of the fluctuation in unemployment rates refers to cyclical unemployment. This is unemployment that goes up and down in relation to the economy. Typically, if a worker loses their job in a recession, they will regain it once the recession ends. However, jobs lost due to structural unemployment are never regained.
Many factors contribute to structural unemployment. One is an increase in automation and production technology that eliminates the need for employees. The outsourcing of jobs to foreign labor markets—as well as competition from foreign companies—can also lead to rises in structural unemployment. The Great Recession hit certain local economies so hard that they suffered a permanent contraction, with jobs leaving that never returned. Further, many workers who regain employment are still significantly worse off than before losing their jobs. They may have taken on debt, delayed or abandoned education paths for family members, and ultimately settled for a lower-paying job just for the sake of finding employment.
In 2011, the IMF studied and published a paper on structural unemployment. They concluded that structural unemployment in the US increased by 1.75 percentage points after the start of the Great Recession. This further illustrates the long lasting impact recessions can have on an economy.
How Should Businesses Prepare for the Coming Recession?
Starting in the fall of 2019, many investors and economic analysts began adjusting their economic forecasts, predicting a recession was coming. The coronavirus has taken the likelihood of a recession from a debatable probability to a virtual certainty. The only question is how deep the recession will hit and how long it will last. Regardless, businesses need to immediately start doing everything they can to prepare. Likewise, consultants need to be ready to offer businesses their services. Businesses will need advice for how to keep from going under in the months—and maybe years—ahead.
The first thing businesses need to do is to begin accumulating and saving as much cash as possible. The ensuing liquidity crisis is going to make credit increasingly difficult for struggling businesses to access. If businesses do not enter the recession with as much cash as possible, they may be forced to declare bankruptcy.
Businesses should do everything possible to increase revenues, accelerate payment schedules, and minimize costs wherever possible. All possible expenses should be cut. This includes unprofitable assets and unnecessary travel. If any assets can be sold in order to bring in money in the short-term, this is worth considering. Companies may want to explore options for adapting to new markets if some of their traditional revenue streams are down. This is where it would be beneficial to bring on a creative consulting team experienced in strategizing during economic downturns.
Lay-Offs and PPP Program
We know that one of the most important things on the minds of business owners right now is trying to avoid layoffs. Laying off workers in a recession is one of the hardest things for most owners to do. One short-term step to avoid layoffs may be looking into reducing hours or even reducing wages. However, most companies are going to have to explore outside funding in order to keep all their employees on payroll. Luckily, the US government has recently launched $350 billion in funding via the Paycheck Protection Program. Low-interest loans are widely available, and a great deal of the funding is forgivable when 75% of it is applied to payroll. In other words, the government may pay your employees’ salaries for you, for free.
Recessions, by definition, put a significant strain on almost all businesses. This in turn puts a terrible strain on individuals. The unforeseen disaster of the coronavirus has many experts predicting that unemployment rates will exceed the highest rates seen during the Great Recession, and possibly even the Great Depression. Most American businesses are facing a challenge unlike any they have faced before. If small businesses want to stay afloat, they are going to have to explore every possible option to stay afloat. This starts by prioritizing the preservation of liquidity above all else.