It seems as though there usually is a “but” when the unemployment rate falls by more than expected by the cognoscenti. The consensus estimate for the June unemployment rate was 5.4%, down from May’s 5.5%. Instead, the BLS reported that the June unemployment rate fell to 5.3%, its lowest reading since April 2008. Might this be cause for celebration if one were not an economic masochist? Au contraire, according to the mainstream media talking heads. After reporting the larger-than-expected decline in the June unemployment rate, the talking heads quickly inserted the “but” – but the labor force participation rate fell three-tenths of a point to 62.6%, its lowest since October 1977. The simultaneous decline in the unemployment rate and the labor force participation rate is consistent with the notion that the unemployment fell because people dropped out of the labor force due to discouragement over poor job prospects. So, recork the champagne, right? Wrong.
Before getting too deep into this, let’s define some terms. The “headline” or U-3 unemployment rate is the ratio of the number of people who are unemployed to the civilian labor force. Of course these numbers are estimates “blown up” from responses solicited from a relatively small sample of households. To be considered unemployed, one has to have been available to work if the opportunity to do so had arisen and have actively sought employment. The labor force is defined as the sum of people 16 years old or older who are employed or are unemployed (unemployed, i.e., according to the definition given above).
Let’s run through a couple of numerical examples of how the unemployment rate might fall. Let’s assume that the total number of “officially” unemployed is 5 million and the labor force is 100 million. In this case the unemployment rate would be 5% (5/100 x 100). Now let’s assume that the number of unemployed falls by 1 million to a total of 4 million and the labor force increases by 1 million to a total of 101 million. In this case, the unemployment rate falls to 4%, rounded. Alternatively, suppose that the number of unemployed again declines by 1 million to a total of 4 million and the labor force also declines by 1 million to a total of 99 million. Lo and behold, the unemployment rate again falls to 4%, rounded. By the laws of arithmetic, if both the number of unemployed and the number of the civilian labor force decline, the unemployment rate also will decline if the percentage decline in the number of unemployed is greater than the percentage decline in the number of the civilian labor force. And, arithmetically speaking, this is what occurred in June. The number of unemployed fell by 375 thousand or by 4.3% as the civilian labor force fell by 432 thousand or by 0.3%, resulting in a decline in the unemployment rate of two-tenths of a percent.
The question arises as to whether the drop in the number of unemployed was related to the drop in the labor force. For example, did 375 thousand people who in May were classified as unemployed become discouraged with their job prospects and throw in the towel with respect to seeking employment. If so, these people would no longer be categorized as unemployed if they had stopped looking for a job. And if these 375 thousand people were no longer looking for a job, they would no longer be counted in the civilian labor force. Thus, the labor force number would drop, too. This decline in the June number of unemployed and the labor force being due to discouragement of job prospects is just an hypothesis. We cannot make this determination simply by observing the simultaneous declines in both the number of unemployed and the labor force.
When a decline in the unemployment rate is accompanied by a decline in both the number of unemployed and the labor force, media talking heads look to the participation rate for clarification as to why the unemployment rate fell. For the life of me, I do not know why they look to the participation rate for clarification, but they do. The labor force participation rate is defined as the number of people in the civilian labor force (i.e., the sum of the number of employed and unemployed) as a percent of the population 16 years old and older, or the “potential” labor force. All else the same, then, a decline in the labor force would result in a decline in the labor force participation rate. As I noted above, in June, the labor force participation rate declined by three-tenths of a percent to decades low of 62.6%. But this does not tell us why the labor force dipped in June. Perhaps people became discouraged with their job prospects and dropped out of the labor force. Perhaps not. Perhaps people dropped out of the labor force because they retired. Perhaps they went back to school. Perhaps they dropped out of the “official” labor force to perform the most important of jobs, rearing a newborn child. So, the behavior of the labor force participation rate does not provide us with much “color” regarding the behavior of the headline unemployment rate. A decline in the unemployment rate and a decline in the labor participation rate are necessary conditions for an explanation of the decline in the unemployment rate being related to people dropping out of the labor force because of discouragement due to poor job prospects. But they are not sufficient conditions. In other words, more information is required to make such a judgment.
The critical information regarding the sufficient conditions is contained in Table A-1, “Employment Status of the Civilian Population by Sex and Age”, of the Household Survey section of the Monthly Employment Situation. Line item 8 in this table is [number of people] “Not in labor force”. Line item 9 in this table is [number of] “Persons who currently want a job”. If the principal reason people are dropping out of the labor force is discouragement over job prospects, then we ought to see approximately equal increases in the number of people not in the labor force and the number of those people not in the labor force expressing an interest in obtaining employment. Chart 1 shows the month-to-month changes in the number of people not in the labor force and the number of these people desiring a job.
In June, the number of people not in the labor force increased by 640 thousand. Of that 640 thousand, there was only an increase of 18 thousand that desired a job now. This does not comport with the hypothesis that the decline in the June unemployment rate was the result of people dropping out of the labor force because of discouragement over job prospects.
But wait. There’s more. There’s Table A-15, “Alternative Measures of Labor Underutilization”, in the Household Survey section of the Monthly Employment Situation. One of the measures of labor underutilization is the U-5 unemployment rate which takes into consideration not only the “officially” unemployed but those unemployed categorized as “marginally attached” to the labor force. Persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12
months. Discouraged workers are included in this category of marginally attached workers. If the headline unemployment rate (the U-3 measure of labor underutilization) and the participation rate were falling primarily because people were dropping out of the labor force out of discouragement, then the U-5 measure of labor underutilization, which takes into consideration discouraged workers and others who are only marginally attached to the labor force, would not decline and might even increase. Chart 2 shows the month-to-month changes in both the U-3 (headline) and U-5 measures of the unemployment rate. In June, both the U-3 and U-5 measures declined by two-tenths of a percentage point, suggesting that job discouragement did not account for the decline in the headline unemployment rate.
I don’t know why the media talking heads do not look at line items 8 & 9 in Table A-1 and at Table A-15 in the Monthly Employment Situation report. Perhaps it is because they look only at the BLS press release, which does not include these items. I place little weight on the Monthly Employment Situation in assessing the current state of the U.S. economy. The data are based on samples, not universes. The data get revised many times over. But the media talking heads ought not to compound errors by ignoring relevant information in the report bearing on their hypotheses.
(c) The Econtrarian