Types and theories of unemployment

Types and theories of unemployment

Unemployment is a situation in which an individual who is actively looking for employment is unable to secure one. The unemployment rate represents the number of these unemployed individuals in the workforce. Nonetheless, the prevalence of joblessness is one of the indicators of economic performance.

But what causes unemployment? What are the factors leading to high unemployment rates? Note that there are several categories or types of unemployment. Also, there are also different theories explaining the factors of or reasons behind the prevalence of unemployment within a given economy. Understanding these types and theories provide several explanations of the causes of unemployment.

Causes Based on the Categories and Types of Unemployment

The two broad categories of unemployment are voluntary unemployment and involuntary unemployment. Unemployment is voluntary when an individual willingly left his or her job in search of a new one. There are specific and more personal causes of voluntary unemployment including a desire to look for a higher salary, professional development, migration or relocation, and conflicts with the employer or colleagues, among others.

On the other hand, unemployment is involuntary when an individual has been laid off and has no other choice but to look for another job or when he or she is willing to work at the prevailing wage but remains jobless. A high rate of involuntary unemployment within an economy indicates a surplus of labor.

There are more specific types of unemployment apart from the aforementioned categories. These are structural unemployment, frictional unemployment, and cyclical unemployment. They provide a partial explanation of the causes of unemployment. Take note of the following:

• Structural Unemployment: Structural unemployment arises from the inability of the labor market to provide jobs for every member of the workforce because of a mismatch between the skills of the unemployed individuals and the skills requirements of specific jobs, or because of technological advances in which people are replaced by machines or their skills become outdated because of inability to keep up with latest trends.

• Frictional Unemployment: Frictional unemployment occurs when an individual is in between jobs. It corresponds to the time when this individual has to find another job after leaving his or her employer or when he or she is transitioning from one job to another. Note that this type of unemployment has some overlaps with structural unemployment. However, its defining characteristic is that it is usually short-lived.

• Cyclical Unemployment: Cyclical unemployment represents the offshoots of the business cycle and the boom-and-bust cycle of the economy. Keynesian economics explains that the frequent shifts in the business cycle and severe economic downturns, such as in the case of the Great Depression, lead to a shortage in aggregate demand that is not enough to provide employment for everyone who wants to work.

Major Theories Explaining the Causes of Unemployment

There are several theories of unemployment. Each theory provides an explanation of the factors and causes of unemployment.

1. Classical Unemployment Theory

Several schools of thought in economics such as classical economics and the Austrian School of economics argue that unemployment increases with government regulation or intervention. Their arguments collectively form the classical unemployment theory.

There are different ways regulations and interventions contribute to unemployment. For example, raising the minimum wage increases the labor costs more than the economic value of the actual labor, especially the value of jobs that merely require low competencies. Businesses respond to these minimum wage laws by refusing to hire more laborers to reduce their costs and optimize their operations.

Labor laws that restrict layoffs or downsizing, promote the security of tenure, and mandate the provision of benefits beyond wages are another example. Some businesses are less likely to hire or expand their workforce because of the legal and financial risks stemming from stringent labor laws.

Note that there are other theories related to the classical unemployment theory. These are implicit contract theory and efficiency wage theory.

2. Implicit Contract Theory

Greek macroeconomist Costas Azariadis and American economist Joseph Stiglitz introduced the implicit contract theory of unemployment in 1983. They developed this theory to explain why there are quantity adjustments or layoffs instead of price adjustments or wage adjustments in the labor market, especially during economic downturns. In other words, this theory tries to explain the primary cause of unemployment during a recession.

The implicit contract theory specifically claims that labor contracts and labor laws make it difficult for employers to cut the wage of their existing laborers. Hence, during a recession in which businesses need to save costs and optimize their operations, they usually choose to layoff their laborers or downsize their workforce instead of implementing wage reductions.

3. Efficiency Wage Theory

Renowned economist Alfred Marshall introduced the term “efficiency-wages” in his 1890 book “Principles of Economics” to indicate the equivalent wage per efficiency unity of labor. Proponents of this preliminary concept argued that employers should pay their workers differently based on their efficiency. In other words, a more efficient worker should have a higher wage than a less efficient worker.

The Marshallian concept evolved until it became the efficiency wage theory. It argues that businesses can operate more efficiently and become more productive if they provide wages above the equilibrium level. To be specific, increasing wages beyond the current labor benchmark could lead to better efforts from the employees, decrease employee turnover, attract highly competent employees, and promote the wellbeing of employees.

However, there is a downside to paying high wages beyond the equilibrium level. A high-paying employer will naturally attract more employees. Other employers might also offer higher payouts to keep up with the competition in the labor market. Unemployment might transpire if this practice becomes widespread because it not only makes labor costlier, thus compelling employers not to expand their workforce, but also creates unrealistic expectations in the labor market in which employees would not dare offer to work for lower wage and employers would rather stay away from hiring individuals offering work for a lesser payout because such might be an indicator of incompetence.

4. Keynesian Theory of Unemployment

Keynesian economics provides an alternative theory of unemployment. John Maynard Keynes and adherents of the Keynesian school of thought have explained that unemployment occurs when there is not enough aggregate demand in the economy. After all, if demands for goods and services decrease, then there is a lesser need for production and consequently, lesser needs for workers.

Take note that Keynesian economics also argues that market economies or capitalist economic systems naturally undergo a boom-and-bust cycle. Low aggregate demand and unemployment characterize the bust phase of the economy. Employment rate will normalize if the economy manages to reenter the boom phase. Hence, the Keynesian theory of unemployment serves as the basis for explaining cyclical unemployment because it describes the effects of frequent shifts in business and economic cycle on the labor market.

Because of the cyclical nature of unemployment and based on one of the primary tenets of Keynesian economics about the importance of government interventions, the Keynesian theory of unemployment recommends government-driven aggregate demand to reduce unemployment, promote consumer confidence, and revitalize production during economic recessions. Government intervention was demonstrated during the Great Depression and the 2008 Financial Crisis.

5. Marxian Theory of Unemployment

Somehow similar to the Keynesian theory, the Marxian theory of unemployment also believes that there is a relationship between economic demand and employment rate. In his manuscript “Theories of Surplus Value,” German philosopher and economist Karl Marx argued that unemployment is not only inherent in a capitalist system but also necessary.

Marx specifically argued that the purpose of the proletariat or the class of wage earners in a capitalist system is to provide a “reserve army of labor” necessary to create downward pressure on wages. He divided further this class into two subgroups: the surplus labor or the employed individuals and the under-employment or the unemployed individuals.

Nevertheless, members of this reserve army of labor compete for scarce jobs while driving wages lower and lower. The capitalist system allows capitalists or the owners of the means of production to manipulate the labor market by perpetuating unemployment and thus, limit the capacity of laborers to demand higher and fairer wages. The situation also demonstrates the theory of alienation of Marx in which workers are alienated from other workers, as well as from their species-essence.


  • Azariadis, C. and Stiglitz, J. 1983. “Implicit Contracts and Fixed Price Equilibria.” Quarterly Journal of Economics. 98. DOI: 10.7916/D83R13GF
  • Keynes, J. M. 1936. The General Theory of Employment, Interest, and Money. Britain: Palgrave MacMillan. ISBN: 978-0-230-00476-4
  • Marshall, A. 1890. Principles of Economics. London: MacMillan
  • Marx, K. 1859. “Theories of Surplus Value.” A Contribution to the Critique of Political Economy. Germany