What is the Real Unemployment Rate, and How Could We Tell?

Ezra Klein flags an article written by Edward Luce in the Financial Times, where Luce notes: “According to government statistics, if the same number of people were seeking work today as in 2007, the jobless rate would be 11 percent.”  Heidi Shierholz of EPI has more details here, including a great list of alternative measures of weak labor market performance.  But to expand on Luce’s point, depending on how you measure it, this rate could be more like 11.4%, with no improvement over the past two years.

The normal mechanism for understanding the percentage of workers who want to work but can’t find work – the unemployment rate – is telling us less and less each month.  Quick recap – here is what the labor economy looks like from a high view:

By definition, you can be one of three, mutually exclusive types – employed, unemployed or not in the labor force – and you can transfer between these types.  The labor force is the sum of employed people and unemployed people.  December 2007 is when the Great Recession started, so we include that as a baseline in each circle.

There are two facts to deal with in this Great Recession.  The labor force hasn’t grown since December 2007 when the recession started, even though we are a much bigger country.  The “Not in Labor Force” has increased in response.  This must mean that the labor-force participation rate has declined.  Let’s graph each normalized to December 2007:

The second, as Arjun Jayadev and I explained back when, is that this is the first time period we have data for where it is more likely an unemployed person will drop out of the labor force rather than find a job.  A lot of the increase in the number of those outside the labor force is the unemployed giving up on work.  Both of these tell us that there is something fishy going on with traditional unemployment figures that just count the unemployed.

Let’s take a look at three ways of counting unemployment.

1.  The official unemployment rate.  Called “U-3”, it is the total unemployed divided by the labor force.   Unemployed are defined as: “Persons are classified as unemployed if they do not have a job, have actively looked for work in the prior 4 weeks, and are currently available for work.”  If a person stops looking for work but are available for work, they end up in the “Not in Labor Force” category.  How to keep track of those who have given up looking for work?

2.  The marginally-attached unemployment rate.  This refers to “U-5” unemployment.  Marginally-attached workers are those that “indicate that they currently want a job, have looked for work in the last 12 months (or since they last worked if they worked within the last 12 months), and are available for work.”  To get this rate, the BLS adds marginally-attached workers to the labor force as unemployed and recalculate the unemployment rate.

Even this alternative mechanisms of determining unemployment isn’t necessarily working.  If it has been thirteen months since you’ve last looked for work, you are no longer counted as marginally attached.  Given how long this recession has been going, it is likely some people have fallen out of this measure.  We’ll need to come up with something else.

3.  A consistent labor-force participation rate.  Many people have posted graphs on how the employment-to-population ratio has declined.  How can we use that to help give us a clearer picture on the labor market?

A different way to go about it is to look at the labor-force participation rate, which is down to 64% from 66% in December 2007.  How many people would have to enter the labor force to get that percentage up to where it was before the recession?  I subtract these two numbers and calculate the number of people who would need to enter the labor force to keep that rate consistent, and add them to the labor force as unemployed.  I’m taking the the December 2007 labor force participation rate of 66% for this exercise.

What do the unemployment numbers tell us?  Here’s a graph of each during the recession:

The current labor force participation adjusted unemployment rate is 11.4%.

Even though the official unemployment rate peaked in November 2009 and has declined slowly since then, the number adjusted for labor force participation rate hasn’t declined but instead floated in that range.   We can see the marginally-attached rate decline with time, though the labor-force adjusted participation rate stays constant.  That’s bad news.

This is very sensitive to what you consider to be the baseline labor force participation rate – and the assumption that it shouldn’t change.  James Pethokoukis of AEI benchmarks it to the beginning of 2009 and finds “if the labor force participation rate were back at its January 2009 level, the U-3 rate would be 11.0 percent” – contrasted to the beginning of the recession in December 2007, which finds 11.4%.

What would the labor-force participation rate look like with a healthy economy?  I can imagine there will be some big debates in 2012, especially if unemployment decreases and the employment-to-population/labor force participation rate stays the same, about the changes in the economy.  Is this driven by increases in education attainment or retirement decisions?

Interestingly, Larry Mishel finds that the decrease is stronger for those with higher educations over 25.  Labor force participation is down across the board, including people 25-54.  The Federal Reserve Bank of San Francisco found that “trends in retirement and health benefits will probably remain in place and the recession’s severe shock to wealth will likely compel even greater numbers of retirement-age workers to stay in the labor force.” Since it is up across the board I don’t think non-cyclical factors are driving it, but it will be important to watch what people are saying and how they approach these important questions – especially for those who want to wish away the problems in the economy.