Root Causes of Unemployment: An In-depth Analysis

Unemployment is one of the most persistent and complex challenges facing developing nations. While a job seeker in a developed country might face a temporary layoff or a skills mismatch, in countries like India the problem runs much deeper – rooted in structural imbalances that have built up over decades. India’s unemployment is largely structural in nature, meaning it stems not from short-term economic fluctuations but from fundamental gaps between the economy’s productive capacity and the size of its labour force. Understanding these root causes is essential to grasping why unemployment persists – and what it will really take to address it.

Why unemployment in developing countries is different 🔗

It is tempting to apply the same frameworks used to understand unemployment in rich countries to nations like India. But the two situations are fundamentally different. In developed economies, unemployment is predominantly cyclical or frictional – workers between jobs or affected by downturns in demand. In developing countries, unemployment exists mainly due to a lack of capital. Capital deficiency prevents economic sectors from expanding and generating enough jobs to absorb the growing labour force. This creates what Marxist economists called a “reserve army of labour” – a pool of workers who cannot be employed simply because there is not enough productive capacity to put them to work.

Rapid population growth and a swelling labour force 🔗

At the heart of India’s unemployment problem is a straightforward demographic reality: the population has grown far faster than the economy’s ability to create jobs. Between 1951 and 2011, India’s population grew at roughly 2.1% per year, rapidly swelling the number of people entering the labour market – while employment opportunities did not keep pace due to slow economic growth. This is not merely a historical problem. India’s large and young population means millions of new entrants join the workforce every year, placing enormous pressure on an already strained job market. When the economy cannot generate enough new positions to absorb these entrants, unemployment accumulates from one generation to the next.

The demographic challenge is compounded by labour immobility – the inability or unwillingness of workers to move to where jobs exist. Cultural attachment to family and community, as well as barriers of language, religion, and climate, mean that many workers who could be productive elsewhere remain in areas with few job opportunities. This low mobility of labour magnifies unemployment, particularly in regions that lack industrial or service sector development.

Low capital formation: the fundamental bottleneck 🔗

The major cause of unemployment and underemployment in developing countries like India is the deficiency of physical capital relative to the needs of the growing labour force. Capital formation – the process of building up the stock of factories, machines, infrastructure, and tools – is what enables workers to be productively employed. Without it, even willing and able workers have nothing to work with.

In agriculture, a farmer needs land, ploughs, seeds, and irrigation. In industry, workers need factories and machinery. When investment remains inadequate – whether due to low savings rates, insufficient foreign investment, or misallocation of public resources – the economy simply cannot generate enough productive employment. According to this view, a “wage-goods gap” exists in labour-surplus developing countries, where the total supply of goods needed to sustain additional employed workers falls short of what would be required to bring all the unemployed into work. This gap is a fundamental structural barrier to full employment.

Slow industrial growth and neglect of labour-intensive sectors 🔗

Industrialisation has historically been the most reliable route out of mass unemployment. Manufacturing draws surplus agricultural labour into more productive, better-paid work – a process that underpinned the economic rise of East Asia. India’s industrial trajectory, however, has been uneven. Limited investment in industries leads directly to fewer job opportunities, making slow industrial growth a key driver of unemployment.

Neglect of small-scale and cottage industries 🔗

Small-scale and cottage industries are by nature labour-intensive – they absorb a large number of workers per unit of capital invested. Yet these industries have struggled to survive against competition from larger, capital-intensive enterprises. Five-year plans in India laid greater stress on capital-intensive industries, while small-scale industries faced problems of technological upgradation and marketing, preventing them from developing appreciably. As industrialisation advanced, demand shifted toward cheap, mass-produced goods, making handcraft and artisan production economically unviable. The result was a loss of livelihoods for millions of workers in the small-scale sector.

Neglect of agriculture 🔗

Despite the majority of India’s workforce being employed in agriculture, the sector has historically received insufficient attention in development planning. The share of agriculture in India’s plan outlay has varied between 18 and 25 percent – much smaller than agriculture’s share in national income and employment. Underinvestment in the sector has led to low productivity, persistent seasonal unemployment, and a growing pool of landless agricultural labourers who lack stable work throughout the year.

Rigid labour legislation and its unintended effects 🔗

India has about 250 labour regulations at the central and state levels, which global manufacturing companies find excessively complex and restrictive. While these laws were designed to protect workers, their rigidity has had an unintended consequence: employers, particularly in the organised sector, are reluctant to hire permanent workers when letting them go is legally difficult. Labour legislation makes it very difficult to retrench a worker employed for 240 days, and even closing down a business unit is procedurally onerous – leading private employers to favour maximum use of capital over labour. The result is that formal sector employment grows more slowly than it otherwise would.

The growth of the informal sector: a buffer with limits 🔗

When formal employment falls short, workers do not simply sit idle – they migrate into the informal economy. Street vending, casual construction labour, domestic work, small-scale trade: these activities absorb the surplus workforce that the formal economy cannot accommodate. According to the International Labour Organization, over 2 billion people globally work informally, with 93% of all informal employment concentrated in emerging and developing countries.

In India, informal employment amounted to 88.6% of total employment in 2018 – one of the highest rates in the world. The informal sector acts as a crucial buffer, preventing open unemployment from reaching even higher levels. But it is not a solution to unemployment in any meaningful sense. Informal jobs typically lack contracts, social security, stable income, and legal protections. A person working as a street vendor for 12 hours daily but barely earning subsistence wages would not be counted as unemployed in official statistics, despite their deeply precarious economic situation. This is why standard unemployment figures significantly understate the true scale of labour market distress in developing countries.

The dominance of the informal sector also creates a vicious cycle. Informal workers earn low wages, have limited purchasing power, and contribute little to tax revenues – which in turn constrains the government’s ability to invest in the infrastructure and education needed to create formal employment. High unemployment was a feature of the Indian labour market even before the COVID-19 pandemic, and the pandemic caused sharp increases in unemployment, especially among young workers in low-income urban areas.

Inequitable land distribution and agricultural unemployment 🔗

In predominantly agrarian economies, land is as critical a form of capital as factories or machinery. Unequal land distribution means that many agricultural households lack adequate access to land – a key asset for farming-based employment. Sub-division of land holdings under the pressure of rapid population growth has further reduced access for several households, turning previously self-employed farmers into landless agricultural labourers who suffer from acute unemployment and underemployment.

This fragmentation of landholdings is directly connected to the phenomenon of disguised unemployment – a situation where more people are working on a piece of land than are actually needed for productive output. In such cases, a worker’s marginal contribution to output is effectively zero. Removing them from the farm would not reduce production at all. This form of hidden unemployment is widespread in rural India and represents a massive underutilisation of human potential that conventional unemployment statistics do not capture.

The skills mismatch: education without employability 🔗

Rapid expansion in education has not automatically translated into employment. India’s educational system has long struggled to align its outputs with the demands of the labour market. There is a persistent mismatch between the skills possessed by the workforce and the skills demanded by industries, resulting in high unemployment rates, particularly among the youth. As industries evolve and adopt new technologies, the gap widens further.

Urban youth unemployment in India remained elevated at 17 percent in early FY24/25, even as overall economic indicators showed improvement – a telling sign that growth alone is not sufficient if it fails to generate employment accessible to young, educated job-seekers. The combination of a degree without job-relevant skills, on one side, and employers unable to find qualified workers, on the other, represents one of the most urgent dimensions of India’s unemployment crisis.

A self-reinforcing cycle 🔗

What makes unemployment in developing countries so stubborn is that its causes are deeply interconnected. Population growth outpaces capital formation; insufficient industrial development keeps the formal sector small; a weak formal sector pushes workers into informality; informal workers lack the stability and income to drive consumption that could fuel further industrial growth. Research shows that a substantial fraction of self-employment in developing countries stems from poor labour market prospects rather than genuine entrepreneurial opportunity – meaning that many people are self-employed not by choice but by necessity. Breaking this cycle demands not just economic growth, but growth of a particular kind: labour-intensive, geographically distributed, and supported by investment in both physical capital and human capital.

The Indian government has taken steps in this direction – from the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), which guarantees 100 days of wage employment to rural households, to skill development schemes and support for micro and small enterprises. But the scale of the challenge – millions of new job seekers entering the labour market every year, alongside a vast pool of underemployed workers already in it – means that policymakers must continue to address not just the symptoms of unemployment, but its structural roots.

What do you think? Given that both rapid population growth and insufficient capital formation are identified as root causes of unemployment in developing countries, which of the two do you think is more difficult to address through policy – and why? And with such a large share of India’s workforce trapped in the informal economy, what would a meaningful transition to formal employment actually require?

References

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