Does the Recent Decline in the Unemployment Rate Reflect An Improving Labor Market?

by Paul Kasriel, The Econtrarian

Two weeks ago the BLS reported that the national unemployment rate declined by two-tenths of a percentage point in July vs. June. On the surface, that would seem to be good news for the labor market, right? Not according to the knee-jerk analysis by a lot of jerks on cable financial news. You see, to these jerks, if the unemployment rate declines at the same time that the labor force and/or the participation rate declines, the decline in the unemployment rate probably is the result of people exiting the labor force because they have given up hope of finding gainful employment. Sometimes the jerks are correct. Of late, however, they have been wrong.

Not everyone that drops out of the labor force has given up hope of finding a job. People exit the labor force for a variety of other reasons. Some people actually retire voluntarily. Following the birth of a child, some dads (or on occasion, even some moms) choose to exit the labor force in order to nurture the newborn. Some people become disabled.

In the Household Survey, from which the unemployment rate is calculated, those respondents who say they are out of the labor market are asked if they currently want a job. Chart 1 shows the year-over-year change in both the total number of the civilian non-institutional population not in the labor force and the number of these who indicate that they do want a job. In July 2013, the number of people of the non-institutional population who were not in the labor force had increased by 1,732 thousand. At the same time, of this 1,732 increase in people not in the labor force, there was an increase of only 25 thousand people (nearly invisible in the chart) who wanted a job. So, in the past 12 months, only 1.4% of the increase in people not in the labor force indicated that they wanted a job. In other words, the bulk of people dropping out of the labor force in the past 12 months did not drop out in despair over poor job prospects.

Chart 1

With these data, we can calculate an “expanded” unemployment rate that incorporates the people who have exited the labor market out of despair over their poor employment prospects but who have indicated that they really do want a job. To calculate this “expanded” unemployment rate, we have to add the number of these people back into both the labor market and unemployed totals. For July 2013, this “expanded” unemployment rate was 11.55% vs. 7.69% for the official unemployment rate, both unadjusted for seasonal variation. As shown in Chart 2, the year-over-year decline in the official unemployment rate (unadjusted for seasonal variation) in July 2013 was 0.87 percentage points. The “expanded” unemployment rate (unadjusted for seasonal variation) declined by slightly less, 0.84 percentage points.

Click to enlarge

If the primary factor accounting for the downward trend in the official unemployment rate in the past 12 months had been people dropping out of the labor force due to despair over their poor employment prospects, then the “expanded” unemployment rate either would not have declined or it would have declined significantly less than did the official unemployment rate. The fact that both the official and the “expanded” unemployment rates fell by almost the same percentage point amounts in this time period implies that labor market conditions have indeed improved. Investing on the basis of knee-jerk analysis provided by the jerks on cable financial news can be hazardous to your wealth.

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