Does the Unemployment Rate Matter Anymore?

The first Friday of every month at 8:30 AM (EST) is a very important time for those of us who follow news about the economy. That is when the U.S. Bureau of Labor Statistics (BLS) releases its monthly report entitled “The Employment Situation.” The headline figures of new jobs created and the unemployment rate are featured in all the major news outlets. The investment community analyzes the details of the BLS report, which includes twenty-five tables of statistics. The stock market reacts almost immediately in pre-market trading and throughout the trading day after the bell rings an hour later. Politicians on both sides of the political spectrum (unfortunately we only have the two) receive new talking points from their advisors to buttress their political arguments one way or the other. To paraphrase the old real estate adage, there are only three critical issues in American politics—jobs, jobs, and jobs.

The number of net new jobs (i.e., the change in total nonfarm payroll employment) is based on a monthly survey of approximately 144,000 businesses and government agencies (called the establishment survey). Although seasonally adjusted, increases in total employment are variable month to month and may not be indicative of the overall trend. The unemployment rate is the figure that stays in our collective memory, and it is more important for two reasons. First, the percentage of prospective workers who are unable to find a job reflects the human toll of an underperforming economy. Second, the percentage of unemployed is the prime measure of how far the economy is from its maximum level of production—and arguably the best indicator of the potential for inflation to rear its ugly head. Unfortunately, the methodology for determining the unemployment rate is seriously flawed, rendering it practically meaningless in today’s economy.

The unemployment rate is derived from a different survey than the establishment survey’s new jobs data. In order to calculate the unemployment rate, the Current Population Survey (CPS) collects information from about 60,000 households every month. Assuming for the moment that the CPS actually collects accurate data depicting the workforce (a dubious assumption), the official unemployment rate is still not reflective of the jobs economy. The two numbers that are used to calculate the rate are completely pliable and unreliable. The “civilian labor force” (the denominator in the all-important unemployment equation) counts only those persons at least sixteen years old who are actively looking for work, as evidenced by a specific set of job search activities undertaken during the previous four weeks. If someone failed to perform any of these activities during the prior month, even if ready, willing, and able to work, that person does not officially count as part of the labor force.

Even in a good economy the “civilian labor force” would be understated because of these criteria. In an economy that has been in a deep recession and slow recovery for five years, the volume of ready, willing, and able workers who have tired of sending out resumes is substantial. This large number of potential workers are not counted in the official labor force and are not considered by the government to be unemployed. Of course they are unemployed, are part of the labor force, and should be counted in the unemployment rate. If they were properly counted, the unemployment rate would be about 12 percent instead of the official 6.3 percent announced in the BLS report for April 2014. The government counted 9.7 million Americans as being unemployed, but the real number of unemployed is closer to 20 million. There are more than twice as many unemployed Americans as the Bureau of Labor Statistics acknowledges.

This huge discrepancy can be validated simply by looking at historical comparisons. There are a definitive number of Americans who are 16 years of age and older and who are not in the military or institutionalized. This “civilian noninstitutional population” is the starting point for employment statistics. Many of them are either unable or unwilling to work due to old age or other circumstances. The remainder of the civilian noninstitutional population, those who are working or would work if jobs were available to them, is the “civilian labor force”. The percentage of the civilian noninstitutional population that are in the labor force is called the participation rate. From the 1960s to the late 1990s the participation rate gradually increased from under 60 percent to 67 percent, as more women joined the labor force and the growing service economy allowed more people to work later in life.

The participation rate remained above 67 percent from 1997 through 2000, and then declined slightly through 2008. Since 2008, the rate has plummeted from 66 percent to 62.8 percent, the lowest level in 37 years. There is no reason for such a dramatic decline in the percentage of people interested in working. In fact, one would expect that a higher portion of the eligible population would want to work when times are tough. The only explanation is that the faulty survey methodology is drastically undercounting the number of “unemployed”. If the percentage of the eligible population who are interested in working (the real participation rate) has remained at 67 percent, which is probably understated, that equates to 20 million unemployed and a 12 percent unemployment rate. That is the real state of the U.S. economy!

Since 2008 the civilian noninstitutional population has grown by 5.8 percent, but the civilian labor force has barely increased by 0.7 percent, according to the BLS. This aberration cannot be explained by anything other than the flawed methodology used to collect and report the data. In reality, the unemployment rate has not dropped from almost 10 percent down to 6.3 percent as government reports contend—it has hardly moved, from 12.7 to 12.1 percent according to the methodology used here. There were slightly over 20 million Americans unemployed during the recession and there are still around 20 million unemployed today. A conspiracy theorist might see a connection between politics and the official reports of improving rates of unemployment. But I am more inclined to chalk it up to good old bureaucratic inertia and incompetence. Despite an obvious need to change the way unemployment is defined, politicians and bureaucrats cling to an old, unreliable, and outdated method that denies the reality of millions of unemployed Americans.