As workers return to the office after an extended Labor Day weekend, labor and employment are naturally front of mind. This is even more true for Jerome Powell and the members of the Federal Reserve Board of Governors. As the Fed’s battle against inflation appears to be drawing down, the body now turns its focus stabilizing labor markets and combating threats of rising unemployment.

Our goal each month is to share insight from “under the hood” of our investment program in a manner that is both interesting and relevant to your daily life. Given the renewed headline appeal of labor and employment topics, we wanted to take some time and touch on the topic of unemployment, specifically, the various types of unemployment and why a modest amount of unemployment is ultimately a healthy phenomenon for an economy.

In somewhat of a surprising twist, the Olympics serve as a useful metaphor for labor markets. If we are being honest, at some point during the Olympics last month, you probably found yourself watching one of the slower paced sports and soon after, a thought crossed your mind:

“Well, I could have competed in this event!”

If only you had known 30 years ago that event would exist in the modern Olympic games, and if only someone had encouraged you to devote countless hours over many decades perfecting your craft, you too could have been an Olympic skeet shooter or breakdancer from Australia. 

This thought, though humorous, touches on something deeply human—a desire to measure oneself against the best, even in arenas where the chances of success are infinitesimal. We all harbor these fleeting moments of fantasy, despite knowing the absurdity of believing we could match the caliber of an Olympic cyclist, rower, or even a breakdancer like the charismatic Rachael “B-girl Raygun” Gunn, who, in her exuberant performance, embodied the spirit of “giving it a shot.”

We enjoyed watching the Olympic Games and the events made for great water cooler talk around the office. But as investment professionals, we could not simply enjoy watching the Olympics without recognizing them for what they truly are: a fantastic metaphor for employment and labor markets.

When it comes to Olympic and labor market analogs, four sports vault to the lead. Specifically, gymnastics, cycling, baseball, and breakdancing serve as useful vessels for exploring the different types of unemployment occurring within an economy: frictional unemployment, cyclical unemployment, and structural unemployment.

Frictional Unemployment and “the Twisties”

Women’s gymnastics is one of the most demanding Olympic disciplines, requiring unparalleled levels of physical and mental precision. Few athletes exemplify this more than Simone Biles, whose extraordinary talent has redefined the sport. However, even the greatest champions are not immune to setbacks. During the 2020 Tokyo Olympics, Biles encountered a sudden and disorienting condition known as “the twisties,” which forced her to withdraw from several events. This episode was a stark reminder that even the most finely tuned athletes can face unexpected challenges that require time to recover and realign.

Biles’ journey is reflective of the downsides of frictional unemployment, where highly skilled workers find themselves temporarily between jobs due to unforeseen short-term events. Like Biles, who regrouped and returned triumphantly to win gold in Paris, frictionally unemployed workers are not without prospects; rather, they are in transition, finding the right opportunity and timing to match their skills and aspirations.

A similar story of transition and triumph was seen in Kristen Faulkner, who only took up cycling as a hobby after graduating college. What began as a casual interest evolved into a passionate pursuit, leading Faulkner to compete at the highest levels of the sport. In Paris, she defied expectations and won gold, proving that sometimes, what appears to be a detour can become a defining moment.

In a healthy economy, frictional unemployment reflects the natural movement of talent, where short-term transitions lead to new opportunities. Like Biles and Faulkner’s journeys to Olympic gold, these challenges are essential for matching skills with the right roles and driving innovation.

Cyclical Unemployment: Baseball’s On-and-Off Olympic Status

Baseball’s inclusion in the Olympics has always been a point of contention. Its intermittent presence in the Games—dependent on factors like the host country’s preferences and the sport’s global popularity—mirrors the nature of cyclical unemployment. Cyclical unemployment arises when economic downturns lead to temporary job losses, much like how baseball players may find themselves on the sidelines when their sport is excluded from the Olympics.

Just as baseball’s Olympic status fluctuates, cyclical unemployment is influenced by the broader economic climate. When the economy is strong, jobs abound, and workers find opportunities plentiful. However, when the economy contracts, jobs disappear, leaving workers in a temporary state of unemployment until conditions improve. The ebb and flow of cyclical unemployment are natural parts of economic cycles, but they can be deeply unsettling for those caught in the downturn.

Breakdancing: The Unexpected Face of Structural Unemployment

Perhaps the most surprising addition to the Paris Olympics was breakdancing, where dancers like B-girl Raygun brought a fresh, “street-savvy” energy to the Games. Yet, despite its moment in the spotlight, breakdancing’s Olympic journey appears to be short-lived, with the sport already excluded from the 2028 Los Angeles Games. This sudden shift highlights structural unemployment, where economic changes gradually render certain skills or industries obsolete—though usually not as swiftly as breakdancing’s brief Olympic appearance.

Structural unemployment occurs when there’s a fundamental mismatch between the skills workers possess and the needs of the job market. Just as breakdancers may find themselves without a stage in Los Angeles, workers whose skills are no longer in demand due to technological advances or market shifts can find themselves structurally unemployed. This type of unemployment is often the most challenging to address, as it requires retraining and adaptation to new economic realities.

The Broader Implications: Understanding Unemployment in Today’s Economy

Together, frictional, cyclical, and structural unemployment lead to the total unemployment rate. In all its forms, unemployment is a complex and multifaceted metric. While the word itself naturally conjures negative connotations, a moderate level of unemployment is beneficial and necessary for economic growth.

The natural rate of unemployment is a statistical concept representing a healthy labor balance in which the economy is neither overheating nor stagnating. It allows for the necessary movement of workers between jobs and industries, fostering innovation and economic dynamism.

Since 1963, frictional unemployment has accounted for about 70 to 90% of total unemployment. As of the end of Q2 2024, frictional unemployment accounted for 79% 3.4%) of the current unemployment rate (4.3%), which is consistent with the long-term average of 81.5%.

Today, concerns about rising unemployment are making headlines, with the recent surge in unemployment to 4.3% sparking debates about the health of the economy. However, it’s important to understand that not all unemployment is created equal. Moderated frictional unemployment, which typically accounts for the majority of joblessness, can be a sign of a well-functioning labor market.

The more concerning forms of unemployment are cyclical and structural. Cyclical unemployment, which fluctuates with the business cycle, can lead to short-term economic pain but often resolves as the economy recovers. Structural unemployment, on the other hand, can be a byproduct of progress, but can also pose longer-term challenges.

A recent example of structural unemployment is evident in the tech industry’s shift towards AI, which has left many workers, particularly in sales and software development roles, without a position. This reorganization reflects a broader trend where companies are restructuring to meet new technological demands. For those affected, the challenge lies in adapting to this changing landscape, often requiring new skills or a shift in career focus.

Looking Ahead: Navigating the Future with Caution and Confidence

Cyclical unemployment fluctuates with the economy, rising during downturns and falling when conditions improve. It revolves around the natural rate of unemployment, reflecting the balance between actual economic productivity and potential activity. When the economy is strong, more jobs are created, lowering total unemployment. However, this can also spur innovation, leading to structural unemployment as new technologies outpace current skills.

Conversely, during economic declines, cyclical unemployment increases, and total unemployment rises as companies focus on survival rather than innovation. In these periods, mass layoffs are more common, but the gap between labor skills and employer needs may temporarily narrow, reducing structural unemployment.

When evaluating today’s headlines about jobs reports, it’s essential to consider whether the news originates from cyclical or structural forces. While cyclical unemployment can result from sudden economic shocks, such as the COVID-19 pandemic, recent corporate layoffs appear more related to structural changes driven by growth and innovation, at least for the time being.

There certainly is an opportunity for these trends to reverse should consumer spending and corporate earnings weaken, however, in the aggregate unemployment remains relatively low and current measures of real Gross Domestic Product exceed current estimates for potential GPD—a normalized measure of current long-term US economic potential. This should continue to support cyclical employment which supports wages and consumption and further economic growth in the near-term.

As we approach our annual capital market forecasting process for 2025, we remain vigilant, assessing the evolving economic landscape and its implications for our clients. In the meantime, we encourage you to regroup with your fiduciary investment advisor to discuss any concerns or questions you may have about your investment portfolio or financial plans. Whether in the world of Olympic dreams or economic realities, preparation and adaptability are the keys to success.