Friday, September 7, 2012

Unemployment Rate 101

Today's jobs report showed that the unemployment rate dropped from 8.3% to 8.1% This is good news for Americans, right? Wrong.
I personally believe that there are problems with the way we currently calculate the unemployment rate, and that we should consider reporting a different statistic as the main indicator of the jobs market. The number is not as telling as it should be. Furthermore, it's somewhat confusing (especially for those without an economics class), making it too easy to spin politically. So how is the unemployment rate calculated? Let me explain:

This is the formula for calculating the unemployment rate:

In the above equation, unemployed persons are defined as,"All persons who: 1) had no employment during the reference week; 2) were available for work, except for temporary illness; and 3) had made specific efforts, such as contacting employers, to find employment sometime during the 4-week period ending with the reference week" (source: The labor force is defined as unemployed persons + employed persons (the definition of employed persons is fairly straight forward compared to the definition of unemployed persons).

So every month, the Bureau of Labor Statistics performs a survey of approximately 60,000 households and inquires whether or not a person is employed or unemployed. Then, they use the equation above to calculate the unemployment rate. But, you will notice from the definitions above, that their definition of what it means to be "unemployed" is rather narrow. For example, if an individual has been out of work for 6+ months, and in hopelessness and despair, has decided that they are too discouraged to "make specific efforts ... to find employment," this person is not considered unemployed. This results in a reduction of one person in both the numerator and the denominator. However, the proportional decrease in the numerator is greater than the proportional decrease in the denominator, resulting in a overall lower ratio.

Let me illustrate with a simple example.

Let's say in our little economy, there are eight people currently in the labor force. Of those eight, let's assume that two are unemployed. Our unemployment rate is currently 25% (2/8). Now let's assume that one of the two currently unemployed people stops looking for work. Now, there are seven people in our labor force, and only one is unemployed. Now, our unemployment rate has fallen to 14.29% (1/7).

You see the problem? The way we calculate the unemployment rate does not include people who are chronically unemployed, something not uncommon during periods of extended, high unemployment. So when today's jobs report showed a decrease in the unemployment rate, it didn't show more people getting new jobs, it showed that 368,000 people stopped looking for work.

The most informative statistic about our anemic jobs market is this: Just 63.5% of the working-age population is either employed or actively looking for work. That's a 30-year low (Source: So politicians might try spin the drop in the unemployment rate as favorably as they may like. But in reality, today's job report is nothing to be proud of.