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In many ways, today’s prevailing economic conditions are unusual given the signs of an economic slowdown. Interest rates are far below historical averages, real productivity growth remains strong, credit appears to be widely available – the “credit-crunch” notwithstanding, and the national unemployment rate is well below its post-WW II average. Is this low unemployment rate reading masking more serious deterioration in the labor market?

At the current 4.8 percent unemployment rate, many economists believe the economy is near “full employment” levels, or a situation where most individuals who wish to work are able to find it at prevailing wages. Much of the unemployment that remains when an economy is at full-employment is due to people changing jobs, taking a break between jobs, or newly entering the labor force.

The unemployment rate, as measured, does not necessarily capture the complete picture of what is happening in the labor market, particularly on the supply side. The 4.8 percent number reported by the Bureau of Labor Statistics is computed as the number of people who are actively looking for work (but cannot find it) divided by the total number of people in the labor force (i.e. all employed workers and those classified as unemployed).

Individuals are only classified as unemployed if they do not have a job and have actively searched for a job in the previous four weeks. The intensity of job search is not considered. When an economy weakens, some people may be so discouraged as to stop looking for work altogether. This propensity is likely largest for groups with marginal attachment to the labor force, such as some married individuals, teenagers, and those with limited skills. While this is a voluntary decision on the part of workers, the presence of these so-called “discouraged workers” in an economy may lead to the unemployment rate understating the severity of the non-employment situation.

An increase in the amount of discouraged workers will show up as a decline in the labor force participation rate (i.e. the labor force divided by the total adult, non-institutionalized population), even as the unemployment rate rises. To be in the labor force one needs to either be employed or actively looking for work. Since discouraged workers are not seeking work, they have effectively dropped out of the labor force. Are today’s unemployment numbers understating the degree of current economic weakness?

The table below displays labor market statistics from each of the previous two cycles. In March 2007, 152.9 million people were in the labor force; 146.1 million were employed; and 6.7 million were unemployed leading to an unemployment rate of 4.4 percent (6.7 unemployed divided by 152.9 in the labor force). In February 2008, 153.4 million people were in the labor force; 146.0 were employed; and 7.4 million were unemployed, leading to the above 4.8 percent unemployment rate. 


Over this time, the labor force participation rate fell from 66.2 percent to 65.9 percent – indicative of the fact that some workers have indeed become discouraged. The BLS estimates that roughly 400,000 individuals fall into this category right now. If all of these workers who dropped out of the labor force had continued to search for work and were classified as unemployed, the unemployment rate would rise to 5.1 percent, three-tenths of a percentage point higher than the stated unemployment rate.

To compare, the unemployment rate rose from 3.8 percent to 6.3 percent from April 2000 to June 2003. And during this time, the unemployment rate, including discouraged workers, was similarly three-tenths of a percentage point higher.

In short, today’s low unemployment rates are not masking substantial deterioration in labor market conditions. Including discouraged workers in today’s calculation of the unemployment rate would still leave it at levels well below historical averages – in fact, discouraged workers consistently make up a very small portion of the out-of-work population. But as the chart below shows, the unemployment rate rarely troughs without a recession to follow. If this business cycle behaves as others since the mid-1960s, the unemployment rate is likely to rise considerably since beyond its low-point in March 2007.


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