I’ve written pretty copiously of late on how the current unemployment rate is unusually uninformative about the current weakness of the job market. Due to many potential job seekers leaving the labor market—and the fact that you’re only counted in the jobless rate if you’re looking for work—it’s biased down. In my estimation, the bias right now amounts to a couple of percentage points, which is historically large.
But these writings have triggered a very good question from many readers: why is unemployment defined this way? Shouldn’t it be designed to capture those who’ve left the labor force due to discouragement about their job seeking prospects?
The obvious answer is yes, and, in fact, there’s another, more inclusive measure of labor market slack that kind of gets at that issue—it includes “discouraged” former job seekers. With its clever title of “U-6” this broader measure of labor utilization includes not only discourage job seekers but the partially employed as well, i.e., part-timers who would rather have full-time jobs. U-6, plotted below along with the official rate, was 13.1% last month, almost twice the 6.7% of the official rate.
OFFICIAL UNEMPLOYMENT RATE AND U-6
FTR, U-6 has fallen even faster than the official rate (4 ppts vs 3.7 ppts compared to their peaks), as both the numbers of involuntary part-timers and discouraged workers have diminished of late. But is this type of more inclusive measure really better?
I’m not sure. The official measure has the advantaged of simplicity: you’re unemployed if you’re unsuccessfully seeking work. Boom. That’s it. Everything else involves some degree of psychology. You say you’re discouraged because there aren’t enough jobs, but how do you know if you’re not looking? Would the involuntary part-timers really kick up their hours if they could?
Now, these variables–discouraged workers, involuntary pt’ers–are quite cyclical, so I suspect that they’re generally good, reliable measures of slack, that we—and by “we” I mean the Federal Reserve in contemplating whether to keep up their stimulus and the Congress in contemplating the UI extension—should carefully track these days. The flat EMployment rate is also an important indicator right now.
But here’s the thing: because the labor force has typically held up more than in recent years, we didn’t so much need these other measures. The good old, very simple unemployment rate was telling us what we needed to know and it was strongly correlated with these other measures such that we wouldn’t have learned much more from them as we did from the official rate.
The problem we face right now is thus less that the unemployment rate is poorly conceived, and more that an unusually large share of the adult population has left the labor force. The graph below just plots unemployment along with the labor force participation rate with recession shading. Two points jump out at you. First, unemployment is much more cyclical than the LFPR, and second, the LFPR is falling faster than it has in its lifetime.
I can make this point about relative cyclical differences between these two variables even more dramatically. Since a time series can be decomposed into trend, cycle, seasonal, and leftovers (random noise, if you’ve got the rest of it right), I can extract the cyclical component from both series, as I do in the next graph.
The cyclical part of unemployment is in red, and it jumps up and down pretty visibly. Meanwhile, the cyclical part of the LFPR looks a bit like the EKG of an almost dead person.
THE CYCLICAL COMPONENTS OF UNEMPLOYMENT AND THE LFPR
In other words, and to both cut to the chase and put this more plainly, the unemployment rate has historically done a good job of reflecting the slack in the labor market because when people lost their jobs, they didn’t give and stop looking, as many have of late. A big part of that is, of course, the historically very high rate of long-term unemployment, as people just give up after a while.
It also true that some of this labor force decline is older people who would have left soon anyway—this isn’t all about weak demand; there’s a demographic component too. But besides the immediate policy issues that I’ve been stressing, and stressing out over, like the UI extension, what’s particularly worrisome here is the extent to which persistently weak demand is turning a cyclical problem—weak job growth leading to labor force exit—into a structural one—a permanently smaller labor force and lower potential growth.
This, in turn, means that the cost of bad growth policy, like austerity measures, is even greater than we thought.