What is hysteresis?
Economic hysteresis refers to an event in the economy that persists in the future, even after the factors that led to that event have been eliminated. Hysteresis can occur following a recession when the unemployment rate continues to rise despite the growth of the economy.
Hysteresis was a term coined by Sir James Alfred Ewing, Scottish physicist and engineer (1855-1935), to refer to systems, organisms and fields that have memory. In other words, the consequences of an entry are felt with some delay or delay. An example is seen with iron: iron retains a certain magnetization after being exposed and removed from a magnetic field. Hysteresis is derived from the Greek term which means “short to come, a deficiency”.
Hysteresis in economics occurs when a single disturbance affects the course of the economy. An example of hysteresis is the delayed effects of unemployment, whereby the unemployment rate can continue to rise even after the economy has started to recover. The current unemployment rate is a percentage of the number of people in an economy who seek work but cannot find it. In order to understand hysteresis, we must first explore the types of unemployment. In a recession, which represents two consecutive quarters of contraction in growth, unemployment rises.
When a recession occurs, cyclical unemployment increases while the economy experiences negative growth rates. Cyclical unemployment increases when the economy is performing poorly and decreases when the economy is expanding.
Natural unemployment is not the result of a recession but rather the result of a natural flow of workers to and from jobs. Natural unemployment explains why the unemployed exist in a growing and expanding economy. Also called the natural unemployment rate, it represents people, including college graduates or those dismissed due to technological advances. The constant and always present movement of labor entering and leaving employment constitutes natural unemployment. However, natural unemployment can be due to voluntary and involuntary factors.
When workers are laid off due to a factory relocation or when technology replaces their jobs, structural unemployment exists. Structural unemployment, which is a part of natural unemployment, occurs even when the economy is healthy and growing. This may be due to a changing business environment or economic landscape and last for many years. Structural unemployment is generally due to trade changes such as factories moving abroad, technological changes and the lack of skills for new jobs.
Key points to remember
- Hysteresis in economics refers to an event in the economy that persists in the future, even after the elimination of the factors that led to that event.
- Hysteresis can include the delayed effects of unemployment, so that the unemployment rate continues to rise even after the economy recovers.
- Hysteresis may indicate a permanent change in the workforce from the loss of job skills making workers less employable even after the end of a recession.
How hysteresis occurs
As mentioned above, cyclical unemployment is caused by a slowdown in the economic cycle. Workers lose their jobs when businesses lay off workers during a period of low demand and declining business earnings. When the economy enters a boom again, businesses should start rehiring the unemployed and the economy’s unemployment rate should start to decline to its normal or natural unemployment rate until unemployment cyclic becomes zero. It’s the ideal scenario, of course, but hysteresis tells a different story.
Hysteresis says that as unemployment increases, more and more people adjust to a lower standard of living. As they get used to the lower standard of living, people may not be as motivated to achieve the higher standard of living previously desired. In addition, as more and more people become unemployed, it becomes more socially acceptable to be or remain unemployed. After the labor market returns to normal, some unemployed workers may no longer want to return to the labor market.
Hysteresis due to technology
Unemployment hysteresis can also be seen when companies switch to automation during a market downturn. Workers without the skills to operate these machines or the newly installed technology will find themselves unemployable when the economy begins to recover. In addition to hiring only technophile workers, these companies will only have to hire fewer employees than before the recession phase. Indeed, the loss of professional skills will cause workers to move from the cyclical unemployment stage to the structural unemployment group. An increase in structural unemployment will lead to an increase in the natural unemployment rate.
Hysteresis may indicate a permanent change in the workforce from the loss of job skills making workers less employable even after the end of a recession.
Example of hysteresis
The recession that the UK experienced in 1981 is a good illustration of the effects of hysteresis. During the country’s recession, unemployment increased sharply, from 1.5 million in 1980 to 2 million in 1981. After the recession, unemployment rose to more than 3 million between 1984 and 1986. The unrest recessions have created structural unemployment which has persisted during the recovery and has become difficult to manage.
Economies experiencing a recession and hysteresis in which the natural unemployment rate is rising generally use economic incentives to fight the resulting cyclical unemployment. The expansionary monetary policies of central banks like the Federal Reserve may include lowering interest rates, making loans cheaper to stimulate the economy. An expansionary fiscal policy could include an increase in public spending in the regions or sectors most affected by unemployment.
However, hysteresis is more than cyclical unemployment and can persist long after the economy recovers. For long-term problems such as the lack of skills due to workers displaced by technological advances, vocational training programs could be useful in combating hysteresis.