What Is Underemployment Equilibrium?

Underemployment equilibrium is a condition where underemployment in an economy is persistently above the norm and has entered an equilibrium state. This, in turn, is a result of the unemployment rate being consistently above the natural rate of unemployment or non-accelerating inflation rate of unemployment (NAIRU) due to sustained economic weakness.

Key Takeaways

  • Underemployment equilibrium describes a state in an economy where underemployment is persistently higher than usual.
  • In turn, the unemployment rate will be greater than the NAIRU rate of unemployment, often due to economic weakness.
  • In the U.S., underemployment arose following the 2008 financial crisis as many people dropped out of the workforce.

Understanding Underemployment Equilibrium

Underemployment in an economy implies that workers have to settle for jobs that require less skill than they possess, or that offer lower wages or fewer hours than they would like. The degree of underemployment is dictated by the strength (or lack thereof) of the job market, and tends to rise when the economy and employment are weak. Advocates of Keynesian economics suggest that a solution to an underemployment equilibrium state is through deficit spending and monetary policy to stimulate the economy.

An economy in long-run equilibrium is one that is said to be experiencing full employment. When an economy is not in full employment, it cannot produce what it would have were it in full employment. That output gap is caused in part by the employment shortfall. When an economy is currently below its long-run real GDP level, there will be economic unemployment of resources, which will lead to an economic recession. The long-run real GDP level represents what an economy can produce had it been under full employment.

How to bring underemployed workers more fully into the economy is a challenge that has vexed policymakers for years. It's not clear whether stagnant wages are behind this or whether there are other reasons why so many people drop down or out of the labor force following a deep recession.

Underemployment Conditions

Although by 2018 the economy had fully recovered from the Great Recession of a decade earlier and unemployment has fallen from over 10% to under 5%, the notion of underemployment remained. According to the Federal Reserve, "the fraction of Americans working part time for economic reasons (PTER) remains relatively elevated. Measurement of underemployment, i.e., working fewer hours than one is willing to, has important implications for understanding labor market conditions and the strength in the broader economy."

PTER substantially underestimates underemployment along the dimension of hours people are actually working--relative to the numbers they would prefer to work at current wages, the Fed reported.

"Textbook economic theory suggests that an individual will work until his or her marginal utility of leisure is equal to his marginal utility of consumption multiplied by his or her wage. That is, the individual should be indifferent, at equilibrium, between working an additional hour and earning extra wages compared with spending an hour on leisure activities.

By this logic, underemployment occurs when some workers cannot work enough hours to satisfy this indifference condition. Indeed, people who have a full-time job, and thus are not included in the PTER statistics, may desire to work even more hours at their current wage level but are not able to for similar economic reasons that keep other people working only part time even though they would prefer full-time work."