Monday, November 11, 2013

Is the unemployment rate a good measure of job market strength?

Mark Thoma argues it is not, because the official unemployment rate changes with both the number of unemployed AND the number of discouraged workers.
The problem with using changes in the unemployment rate as the most important measure of the job picture is that it can fall even when labor market conditions get worse. When the unemployment rate declines because more jobless people find work, that reduction reflects a positive development in the labor market. But the unemployment rate also falls when people get discouraged about their prospects for finding a job and drop out of the labor force.

Thus, to properly interpret a change in the unemployment rate, it's important to know whether the change is due to a change in the proportion of people finding jobs or from a change in the labor force participation rate.

This is especially important recently because there has been a large change in labor force participation, meaning the number of working-age people who are employed or who are looking for work. The civilian labor force participation rate has fallen from 66 percent at the start of the recession in December 2007 to 62.8 percent in October of this year.

According to the Bureau of Labor Statistics, there are 2.3 million people among those who have dropped out of the labor force who wanted and are available for work. These individuals are not counted as unemployed because they have not searched for work in the previous four weeks. If all of these workers had been counted as part of the labor force, the unemployment rate in October would have been 8.6 percent instead of 7.2 percent, a major difference.

One big unknown for the future is how many of these workers will return to the labor force once labor market conditions improve. If they return in substantial numbers, it would make it harder for the unemployment rate to fall.
Thoma goes on to suggest that the employment-to-population ratio be given more attention. He also notes, "Of course, no single measure of labor market conditions is perfect, so it's best to look at the full range of indicators rather than focusing on any one measure."

Possible discussion questions:
- Why do the rates of employment and unemployment sometimes tell conflicting stories?
- What other issues should be considered when interpreting changes in the unemployment rate?