When an event persists even after the factors causing it have been removed, that event is called hysteresis. More often than not, hysteresis occurs after an economic meltdown and is typically enhanced by certain factors within an economy. Keep reading to know the meaning of hysteresis and how to prevent it.
Introduction to Hysteresis
Sir James A. Ewing, Scottish engineer and physicist coined the word “hysteresis” to refer to organisms, fields and systems that have memory. One popular example that helps to define hysteresis is iron, which retains magnetization after even being exposed and removed from magnetic fields. The curiosity stirred by this hysteresis definition is justified in its Greek meaning, “a deficiency”. This attribute of ‘hysteresis effect’ is more pronounced in economics.
Hysteresis in economics is used to refer to an event in an economy that continues to exist even after the factors responsible for that event have been removed. It may be in the form of prolonged effects of unemployment whereby the unemployment rate keeps rising despite economic recovery. This unemployment rate may be due to a general lack of relevant skills required by industries after an economy has recovered.
A good example of hysteresis is when the UK faced recession in 1981, with unemployment rising from 1.5 million to 2 million within 1980 and 1981. Unemployment then rose to over 3 million after the recession, a hysteresis enhanced by a general mismatch of available skills and new industry requirements.
Hysteresis in economics may also be in form of a market malaise persisting even where the trigger event is no more. A good example is investor’s reluctance to reinvest after a market crash that led to losses. This leads to a market crash, a hysteresis this time enabled by depressed stock prices.
Types of Hysteresis
Hysteresis can be observed in the following events;
Unemployment exists in three forms: cyclical, natural and structural. Unemployment is cyclical where caused by poor economy and natural where caused by natural flow of workers from one job to another. It is structural where the nature of work changes in a way that available skills don’t match industry requirements. A distinction of these three helps to determine how hysteresis works.
That said, expansionary policies can stop cyclical employment as money is pumped into the economy and people generally find it easier to hire workers. However, in the case of natural and structural unemployment, economic expansion doesn’t do much, hence the hysteresis. This is because as increase in unemployment rate causes people to adjust to lower living standards, they become less motivated to pursue higher standards of living. This explains why some unemployed people get disinterested in returning to work even after the labour market normalises.
What’s more, because of the pain experienced during the meltdown, employers will be more sceptical about hiring more workers, while demanding more from current workers.
Hysteresis caused by technology
In this case, businesses automate their operations during a market crash, and after the crash is over, only tech-savvy workers will be employable. This leaves out an unemployable majority, migrating from cyclical unemployment to structural unemployment. This creates a hysteresis of unemployment.
Two Ways to Prevent Hysteresis
Economic stimulus is useful in combating cyclical unemployment where it is a hysteresis effect of natural unemployment. This may be through expansionary monetary policies, increase in government spending in most affected areas and reduction of interest rates to cheapen loans.
Hysteresis typically persists after cyclical unemployment due to lack of requisite skills. So, economic stimulus will be inadequate. Job training and skill acquisition programmes will therefore be a worthy solution.
Hysteresis offers an insight into why markets don’t function optimally even after efforts to revive them. Similarly, identifying hysteresis or its patterns can help to tackle it.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.