Are You Getting Fooled By The Unemployment Rate Illusion?

February 12, 2021

Are You Getting Fooled By The Unemployment Rate Illusion?

An acceptable level of unemployment means that the government economist to whom it is acceptable still has a job the labor market is in bad shape

Post Covid, the US unemployment rate has fallen from a high of 14.8% to 6.3%.That’s a good thing right?

More people employed is after all an indication of, if not economic strength, then at the very least, some economic growth. And who doesn’t like economic growth?

But…what if a fall in the unemployment rate doesn’t actually mean that there are more people who are employed?

Let’s begin by understanding what the unemployment rate actually represents.

The number is calculated as: Unemployed People / Labor Force. While these terms seem straightforward enough at first glance, they actually aren’t straightforward at all.

“Unemployed People” isn’t simply a tally of everyone who is unemployed, it is the tally of people who are unemployed and looking for a job.

In other words, if someone is not looking for a job, they are not considered to be unemployed.

Also, “Labor Force” isn’t simply the total number of people who are of working age. In order to be counted as part of the Labor Force, one has to either be working or actively seeking work.

Why do these definitions matter? Because understanding them allows one to realize that the unemployment rate is not simply a measure of how many unemployed people there are in a country.

Instead, to be considered as unemployed, one must be unemployed and looking for a job.

This necessarily means that individuals who are unemployed and not looking for a job are not considered in the government’s calculation of the unemployment rate. How is this important?

Because now we know that what matters isn’t just the number of unemployed persons, but also what’s happening in the Labor Force.

Enter the labor force participation rate. This is simply the Labor Force as a percentage of the population aged 16 and up (excluding people in prison). It is the percentage of the US population that is working, or actively looking to work.

Take a look at how it relates to the unemployment rate:

Labor force participation shows that unemployment rate is low because people are giving up looking for work not because the job market is strong

It is quite clear that even though the unemployment rate has fallen sharply since the beginning of the pandemic, the labor force participation rate has not shown anywhere near the same level of improvement.

This means that the sharp drop in the unemployment rate is not a function of employers rushing to hire previously laid off workers. Instead, it is a result of fewer people participating in the labor force.

In other words, Americans are dropping out of the labor force and not going back. If that sounds bleak, it’s because it is – a good chunk of unemployed Americans are so discouraged about future job prospects that they have simply given up looking for work.

Other data points corroborate that the American labor market is in distress, including weekly initial jobless claims numbers and JOLTs data… Who would have thought this was the case just by looking at the unemployment rate?