When the demand for and supply of employment are allowed to function in a free market economy and settle at equilibrium, some unemployment occurs as a normal function of the economy (Rittenberg & Tregarthen, 2011). During periods of recession, unemployment tends to increase cyclically as firms defer current demand for forms of capital, including human capital, due to low consumption. As the period of recession ends, despite a typical minor influence of frictional unemployment, unemployment usually decreases back to the natural level for that time period as firms begin increasing demand for human capital through increased hiring (Rittenberg & Tregarthen, 2011).
During the recession of 2007 – 2009, the U.S. experienced a high level of unemployment (up to 10.0% at its peak). Despite the end of the recession and three subsequent quarters of growth, the unemployment level remained high for over a year afterwards (See Appendix A, Figure 1) (Laibson, 2010). The increase in production didn’t lead to a net decrease in the unemployment rate, due its components: a cyclical component caused by the recession and a structural component caused by changes across different industries in the economy (Rittenberg & Tregarthen, 2011). Prior to the recession, most businesses in the U.S. focused on maximizing strong growth in new lines of business. Many were reticent to cut declining lines of business or switch from older technologies, even though it was the best time to do so (Seabright, 2010). As the recession started, businesses aggressively cut costs, adopted efficient new practices and technologies, and began to shutter declining lines of business. As this occurred, firms across those same industries surplused employees who were no longer needed – this was the structural contribution to unemployment. The decrease in investment in human capital caused by the recession was the cyclical component (Acemoglu, 2010).
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