Hysteresis

In economics, the term “hysteresis” refers to an economic event which continues to influence the economy even when the factors that caused it have been extracted or re-channeled. In other words, hysteresis might be described as a delayed or prolonged consequence of some economic events.

The term was derived from the Greek word with the meaning of “deficiency”, or “shortage”. It was introduced by a Scottish physicist, Sir James Alfred Ewing, in the end of the 19th century. Initially, it was related to the systems or organisms that have an ability to memorize past interactions. Subsequently, this term has been extended to other fields of science like economics. In this article, we’ll focus on the economic meaning of hysteresis.

Clarification of the term

Typically, hysteresis takes place after some intensive or critical economic events, such as an economic crash or recession. For example, the economy of a country gets stabilized after an economic crisis, however, a level of unemployment continues to grow. An unemployment rate (or unemployment level) refers to the percentage of people who are in search of work, but can’t find any. At first sight, there are no reasons for it to grow after the end of the crisis, but this unreasonable growth is explained by the impact of hysteresis. The unemployment level might grow because of a serious shortage of professional human resources that usually persists after the crisis. Therefore, this example shows that hysteresis is like a delayed effect of a critical economic event.

Another example of hysteresis is a prolonged market depression that persists even after the market’s recovery. In this case, hysteresis is caused by people’s behavior on the market, or their changed attitude toward investing. Traders’ investment strategies might change after an extreme economic event, such as a market crash. Even after the stabilization of the market, a lot of investors might stay passive and risk-averse in fear of losing more money. Some stop themselves from reinvesting. Therefore, this changed attitude continues to influence the market even after its recovery. Hysteresis is frequently caused by such behavior of the market participants.

Hysteresis in unemployment

We’ve already considered the example of hysteresis related to the unemployment rate. Hysteresis in unemployment is quite common, thus, let’s take a bit more attention to this topic, starting with the types of unemployment:

• Cyclical unemployment occurs during a country’s poor economic performance. Usually, it’s caused by an economic crisis or recession. In other words, it’s the consequence of some critical economic situations.
• Natural unemployment refers to a healthy state of the economy and demonstrates the amount of people searching for jobs or just transferring from one job to another. Generally, this group of people consists of college graduates, people who voluntarily left their previous jobs, or people who lost their jobs due to some involuntary reasons. For example, some kinds of jobs might be automatized or upgraded to the level which require more technical skills from the workers.
• Structural unemployment is a subtype of the natural unemployment rate, which includes workers who lose their jobs because of some unfortunate events, new technological advances, or lack of skills. This type of unemployment is considered to be natural, thereby taking place in a healthy state of the economy.

Ideally, when a business cycle faces an upturn after the crisis, the unemployment rate has to go down, because businesses restore their ability to offer vacant work places. However, the effect of hysteresis is different. After the end of the crisis, the level of unemployment still might go up. Possible reasons for this tendency are people’s adaptation to the previous low standard of living, fear of changes, skills shortage, or simply lack of motivation to find a job. Therefore, the situation on the labor market might stay similar to the critical one.

Another important consideration on hysteresis in unemployment is about technological progress. Nowadays, it’s a common practice to implement new technologies into business processes. It might happen even during the economic recession. Some businesses might turn to technologies in order to save money and/or increase their profits. The conditions of employment change as well as these business processes, and the workers have to adapt and master new skills. If they’re unable to do this, they might lose their jobs, thereby increasing the cyclical unemployment rate. By the time the recession is over, this cyclical unemployment will transform into the structural one, which is a part of the natural unemployment rate. Thus, hysteresis influence might be more general.

Example of Hysteresis

As a real example of hysteresis, we can take the UK recession that occurred in 1981. When the country’s economy took a downturn, the cyclical unemployment rate rose by 500 thousand people during the first year of recession. However, when it was over, the cyclical unemployment rate transformed into the structural one and rose even more significantly. By 1986 the number of unemployed people in the country was above 3 million.

Hysteresis control methods

Economies might prevent themselves from experiencing hysteresis. There are a few of methods to control hysteresis:

• Expansionary monetary policies are aimed at stimulation of the country’s economy by lowering interest rates and making loans more affordable for people.
• Job training programs are aimed at mastering workers’ skills, which might be especially important in cases of raised structural unemployment due to the technological progress.