Define hysteresis

In economics, hysteresis refers to an event that continues to exist even after the factors causing the event have been removed. This phenomenon often takes place due to a prolonged event or events, such as depression, recession or economic meltdown.

The meaning of hysteresis can also be explained in scientific terms. Scottish physicist and engineer Sir James Alfred Ewing coined the term. According to Ewing, hysteresis can be used to refer to any organisms, fields and systems that have memory. The word translates as  ‘deficiency’ in Greek, meaning that some events have consequences even after the factor has been removed, with a certain time lag or delay.

For example, iron possesses magnetisation even after it has been removed from a magnetic field. The most common trend in hysteresis can be the rise of the unemployment rate even after the recession period is over and the economy is growing at a fairly optimum pace. 

Types of hysteresis

When the course of the economy is impacted by a single disturbance, hysteresis occurs. Though there are no specific reasons for hysteresis, it may vary depending on the event. On several occasions, the market’s unhappiness after an event has affected the attitudes of market participants. Often after a market crash, investors are jittery and reluctant to reinvest. This causes a hysteresis in which there is a period when stock prices are depressed due to investors’ attitudes.

There are primarily two types of hysteresis in economics:  

Hysteresis in unemployment rates – Before we dive into answering why hysteresis occurs in unemployment, we need to understand the forms of the unemployment rate. An unemployment rate exists in three forms: cyclical, natural and structural. 

When a recession occurs, cyclical unemployment rises due to the economy experiencing negative growth rates. When the economy regains traction, the unemployment rate falls. Natural unemployment, which is not the result of a recession, is caused by the natural flow of workers from one job to another. 

Structural unemployment exists due to changes, like factories relocating and technology replacement. 

In an ideal scenario, when cyclical unemployment takes place businesses conduct layoffs. However, when the economy begins an expansionary phase, businesses are expected to hire the unemployed till a normal unemployment rate is reached. However, unemployment increases as more people adjust to a lower standard of living and are unmotivated to achieve the previously desired higher living standard. They are not willing to return to work, and those who are willing to do so demand more money.

Hysteresis caused due to technology – Business automation during a period of the downturn can be a major cause of hysteresis in unemployment. During the pandemic, several companies have opted for digitisation and automation. Hence, workers without skills in newly installed technology will be unable to find themselves a job. From a business point of view, the adoption of automation reduces any reliance on the labour force.

Example of hysteresis

One of the best examples of hysteresis is the rise in the unemployment rate in the UK after the recession in 1980 to 1981. During the recession period unemployment rose sharply from 1.5 million to 2 million, but even after the recession was technically over, the unemployment rate kept moving up to more than 3 million between 1984 and 1986. This trend was in large part due to structural unemployment. Hysteresis was enhanced by a gap in the availability of skills among employees and new industry requirements.