Unemployment data is a frequently used measure to indicate the health of an economy. The general rule of thumb is that in a fast-growing economy, the unemployment rates decrease steadily. On the other hand, when an economy enters a recession, the unemployment rate increases drastically. Besides, indicating the performance of the economy, unemployment rates are also used to gauge consumer confidence levels and investor sentiment.

While generally, governments aim to reduce unemployment rates, too low unemployment rates also lead to some surprising negative consequences for businesses. Here, in this guide, we shine the spotlight on the effects of low unemployment rates on businesses, especially small businesses. 

Before, we begin, let’s get the definitions right: 

Unemployed Person: 

According to the ISCO (International Standard Classification of Occupations), an unemployed person is an adult who is not engaged in a paid job or self-employed but is currently seeking active employment opportunities. 

Unemployment Rate: 

It's the number of unemployed people divided by the total labour force expressed as a percentage. The labour force is the total of both employed and unemployed people in a country.  

The Relation between Unemployment and the Market 

The ups and downs of unemployment are directly related to the ups and downs of a business. It's a cycle.

Let's illustrate this point in simpler terms. As the economy slows down, the demand for products and services declines. As a result, businesses look to lay off employees. Workers who have been laid off do not have enough money to spend on essentials, which in turn, further reduces the revenue for businesses.

Reduced revenues force businesses to reduce costs by laying off other employees. It’s a cycle that is difficult to break out of. The unemployment rate is a lagging indicator, which means it takes a while for unemployment rates to start rising as the economy improves. Simply put, it takes some time for the unemployment rate to fall when the economy improves, and it takes some time for it to rise in a slowing economy.

Now, coming to the big question – why does a low unemployment rate negatively impact businesses? When more people have jobs, isn't it good for the economy?

Here are some of the Negative Effects of Low Unemployment Rates on Businesses 

  • Inflation of Wages

When unemployment rates are too low, businesses have a hard time filling vacant positions. There are no takers for open positions. It leads to wage inflation. Wage inflation occurs when there is an increased demand for labour as the number of people available to take work is too low. As a result, employers have to increase their wages to attract the right talent and retain existing employees. It affects the bottom line of the business.

  • Dip in Productivity 

What happens when employers are unable to find the right workers for vacant positions? In such instances, organizations that are unable to afford the high wages, settle for less-talented workers. It again reduces productivity, which, in turn, impacts the growth of the business.

Economists state that when unemployment rates fall below 5%, the economy has reached full capacity or is nearing it. Does that mean employers should not fill open positions when unemployment rates are too low? No. On the other hand, employers should put extra effort into recruiting and training the hired talent, so that the company can maintain (or even increase) existing productivity levels.

Tips for Employers to Retain Employees when Unemployment Rates are Too Low 

Retaining existing employees when jobs are abundant is a significant challenge. With plenty of jobs, employees are likely to consider switching to another position, thinking that the grass is greener on the other side.

Here are some tips for retaining employees when jobs are abundant:

  • Strive for good leadership in the workplace

You would have heard the saying, “people do not quit jobs, but they quit managers.” By providing employees with the right workplace managers, they are likely to continue in their current job. Good managers are those who help employees grow. They provide employees with career guidance and find opportunities for them to grow in the organization. 

  • Invest in employees

Employees are the biggest asset of any organisation. It would be best if you mentored your employees, helping them grow and advance in their careers. When employees feel that their managers care for them professionally and personally, they are likely to continue in their current job.

  • Build a positive work environment 

All employees strive for a positive work environment. By providing your employees with a positive and happy workplace, you can motivate them to stick around. 

Additional Reading: How Do I Apply For Unemployed Loans


The Ideal Unemployment Rates – Not Too High nor Too Low 

When it comes to unemployment rates, it’s a Goldilocks syndrome. Too high or too low is not the right sweet spot. Unemployment rates should lie in the “sweet spot” for economic, financial, and social benefits. There should be enough competition for existing jobs, as well as enough jobs to help unemployed people find the right position.