The Cost of Unemployment to the Economy

It’s not just the price of paying out benefits

While economists and academics make convincing arguments that a certain natural level of unemployment cannot be erased, elevated unemployment imposes high costs on the individual, society, and the country.

Worse yet, most of the costs are of the dead loss variety, where there are no offsetting gains to the costs that everyone must bear. Depending on how it’s measured, the unemployment rate is open to interpretation. In addition, underemployment can be extremely detrimental to the economy of society as well. Unemployment numbers include people who are working at low-paying or low-skill jobs that do not provide enough full-time hours for benefits or enough to earn a living wage.

Global and national emergencies can trigger both unemployment and underemployment. For example, when the COVID-19 pandemic hit, it left more than 10 million Americans jobless in its first two weeks. The situation was so serious that the Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded unemployment benefits to self-employed and part-time workers through Pandemic Emergency Unemployment Assistance and provided up to 39 weeks of benefits beginning on or after Jan. 27, 2020, and ending on or before Dec. 31, 2020.

Key Takeaways

  • Unemployment has costs to a society that are more than just financial.
  • Unemployed individuals not only lose income but also face challenges to their physical and mental health.
  • There are societal costs of high unemployment.
  • Governmental costs go beyond the payment of benefits to the loss of the production of workers, which reduces the gross domestic product (GDP).
  • Unemployment affects not on the individual but also their spouses, partners, and children.

Costs to the Individual

The costs of unemployment to the individual are not hard to imagine. When a person loses their job, there is often an immediate impact on their standard of living. Before the Great Recession, the average savings rate in the U.S. had been drifting down toward zero (and sometimes below). There are anecdotal reports that the average person is only a few weeks away from serious financial trouble without a paying job.

Even those eligible for unemployment benefits and other forms of government assistance find it is not enough as these benefits often only replace 50% or less of their regular income. That means these people are consuming far less than usual. However, the economic consequences can go beyond just less consumption. Many people will turn to retirement savings in a pinch, and draining these savings has long-term ramifications.

Prolonged unemployment may lead to an erosion of skills, basically robbing the economy of otherwise useful talents. At the same time, the experience of unemployment (either direct or indirect) may alter how workers plan for their futures—prolonged unemployment can lead to greater skepticism and pessimism. On a similar note, the absence of income created by unemployment can force families to deny educational opportunities to their children and deprive the economy of those future skills.

Last but not least, there are other costs to the individual. Studies have shown that prolonged unemployment harms workers' mental health and can worsen physical health, and shorten lifespans.

Costs to Society

The social costs of unemployment are difficult to calculate but no less real. When unemployment becomes a pervasive problem, there are often increased calls for protectionism and severe restrictions on immigration.

Protectionism can not only lead to destructive tit-for-tat retaliation among countries but reductions in trade harm the economic well-being of all trading partners.

Other social costs include how people interact with each other. Studies have shown that times of elevated unemployment may correlate both with less volunteerism and higher crime.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act expanded unemployment benefits to self-employed and part-time workers and helped keep individuals and families solvent during a global pandemic.

Costs to the Country

The economic costs of unemployment are probably more obvious when viewed through the lens of the national checkbook. Unemployment may lead to higher payments from state and federal governments for unemployment benefits, food assistance, and Medicaid.

Unemployment is also a dangerous state for the U.S. economy. Almost 70% of what the U.S. economy produces goes to personal consumption and unemployed workers.

Even those receiving government support cannot spend at prior levels. The production of those workers leaves the economy, which reduces the gross domestic product (GDP) and moves the country away from the efficient allocation of its resources. For those who subscribe to Jean-Baptiste Say’s theory that the production of goods creates its own demand, that is a serious issue.

It is also worth noting that companies pay a price for high unemployment as well. Unemployment benefits are financed largely by taxes assessed on businesses.

How Does a High Unemployment Rate Affect the Economy?

A high unemployment rate affects the economy in many ways. Unemployed people tend to spend less, may accrue more debt, and unemployment may lead to higher payments from state and federal governments for things like food stamps.

How Do I Get Unemployment Benefits?

You have to apply for unemployment benefits through your state. You can find your state's guidelines via the U.S. Department of Labor website, CareerOneStop. Some states will allow you to file a claim over the phone or online, other states make you file a claim in person. Make sure to have your contact information, like your social security number and information about your former employer on hand.

Should I Use My Retirement Savings if I Am Unemployed?

If you find your unemployment benefits running out or your benefits don't stretch enough to pay the bills, you could be tempted to pull money out of a retirement account. However, it isn't always the best idea. If you withdraw early, you will be hit with a 10% percent penalty tax, plus state and federal taxes, unless you meet certain eligibility requirements to waive the penalty tax. You could consider a loan from your retirement account, which does not incur penalities.

The Bottom Line

Governments worry about the consequences of inflation, but unemployment is likewise a serious issue. Apart from the social unrest and disgruntlement that unemployment can produce in the electorate, high unemployment can have a self-perpetuating negative impact on businesses and the country's economic health.

Worse still, some of the more pernicious effects of unemployment are subtle and long-lasting. Consumer and business confidence are key to economic recoveries, and workers must feel confident in their future to invest in developing the skills—and building the savings—that the economy needs to grow in the future. The unemployment costs go far beyond the accumulated sums handed out as unemployment insurance benefits.

Article Sources
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  2. U.S. Bureau of Labor Statistics. "Monthly Labor Review: Unemployment rises in 2020, as the Country Battles the COVID-19 Pandemic."

  3. U.S. Department of Labor. "Advisory: Unemployment Insurance Program Letter NO. 14-20," Page 3.

  4. U.S. Bureau of Labor Statistics. "Monthly Labor Review: Great Recession, Great Recovery? Trends from the Current Population Survey."

  5. Federal Reserve Bank of St Louis, FRED. "Personal Saving Rate."

  6. American Psychological Association (APA). "The Toll of Job Loss."

  7. US National Library of Medicine. "Effects of unemployment on mental and physical health."

  8. American Immigration Council. "The Economic Blame Game: Immigration and Unemployment."

  9. Urban Institute. "Consequences of Long-Term Unemployment," Pages 4 and 5.

  10. U.S. Department of Labor. "Unemployment Insurance Relief During COVID-19 Outbreak."

  11. Bureau of Economic Analysis. “National Income and Product Accounts Tables: Table 1.1.6. Real GDP,” Select “Modify,” Select “First Year 2019,” Select “Series Annual,” Select “Refresh Table.”

  12. Mises Institute. "Say's Law in Context."

  13. Internal Revenue Service. "Understanding Employment Taxes," Page 7.

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