Why you shouldn’t just read the headlines on US unemployment

Everyone is familiar with the deterioration in US labour market. Figures out today show that the unemployment rate has more than doubled to 9.1% from its pre-crisis low of 4.4% in 2007. The question is how accurately does the unemployment number reflect the true state of the US labour market? To understand this, we need to grasp how the unemployment numbers are compiled.

The Bureau of Labor Statistics (BLS) is responsible for conducting the surveys that inform economists, press, politicians and citizens as to the strength or weakness of the labour market. To do this, the BLS conducts the Current Population Survey (CPS), known as the Household Survey. The CPS has been conducted in the United States every month since 1940.

The BLS calls up around 60,000 households – covering around 110,000 people – every month to find out who is and who isn’t working. To get an even spread of responses, the US is split into 2,025 geographic areas. From the 2,025 areas, 824 are selected every month to take part in the survey. The sample is designed to reflect urban and rural areas and different types of employment. Persons are classified as unemployed if they do not have a job, have actively looked for work in the prior four weeks, and are currently available for work.

There are around 115,000,000 households in America, meaning that there is a 0.05% chance that the BLS will call any individual household. Obviously, the majority of households will never be called. If you are lucky enough to be called up, the BLS will ask you a number of questions including:

1. Does anyone in this household have a business or a farm?
2. Last week, did you do any work for (either) pay (or profit)?
3. Last week, did you have a job, either full or part time? Include any job from which you were temporarily absent.
4. Have you been doing anything to find work during the last four weeks?
5. Last week, could you have started a job if one had been offered?

If there is no reason, except temporary illness, that the person could not take a job, he or she is considered to be not only looking but also available for work and is counted as unemployed.

The labour force is made up of the employed and the unemployed. Excluded are persons under 16 years of age, all persons confined to institutions such as nursing homes and prisons, and persons on active duty in the Armed Forces. Everyone else is defined as “not in the labour force”. If you are not in the labour force, the BLS will ask you:

1. Do you currently want a job, either full or part time?
2. What is the main reason you were not looking for work during the last four weeks?
3. Did you look for work at any time during the last 12 months?
4. Last week, could you have started a job if one had been offered?

From responses to these questions, the BLS will determine whether or not a person is “marginally attached to the labour force”. To be counted as marginally attached to the labour force, individuals must show some degree of labour force attachment by looking and being available for work. “Discouraged workers” are those who are not looking for work because they don’t believe there are any jobs, were previously unable to find work, lack the necessary skills or experience to do a job, or face some form of discrimination from employers such as being too young or too old.

If you are “marginally attached to the labour force” or a “discouraged worker”, you’re out. You are not included in the labour force. When it comes to calculating the unemployment rate, you’ve disappeared. You are not counted in the official unemployment rate, the rate that everyone uses to understand how well the Fed is doing at achieving its dual mandate of stable prices and full employment. This official unemployment rate, which equals the total number of unemployed as a percent of the labour force, is known to economists as U-3. On this measure, it appears the unemployment rate is now trending lower.

For those who think the U-3 calculation is too stringent (like us) to get the full picture of what is going on in the labour market, the BLS produces a broader measure of unemployment known as “U-6”. It basically includes marginally attached and discouraged workers in the unemployment calculation. It also includes those people that are working part-time but would rather be full-time. On this measure, the US labour market appears to be deteriorating once more, and the unemployment rate as calculated by this measure is 16.5%. This suggests around 11.4 million Americans are marginally attached or discouraged workers (from 2001-2008, the number of marginally attached or discouraged workers was on average 5.8m people). According to the BLS, 11.4m Americans do not have an income, do not pay income tax, and do not contribute producing goods and services. Indeed, almost 15% of Americans (45.8m) are now on food stamps. This is a substantial drag on economic growth. In writing this blog, we’ve had an eyebrow-raising moment. According to the BLS, the American workforce (employed plus unemployed people) has actually shrunk since October 2008. It doesn’t seem to make sense, given most estimates tend to suggest the US population is growing at 1.0% per year, in part due to immigration. We would expect labour force growth to slow due to the retiring cohort of baby boomers and peak in the participation of women in the labour force. But it shouldn’t be negative.

The reason it is negative is because the BLS doesn’t count those who are marginally attached or discouraged from entering the labour force (as shown above, around 11.4m people). This has the result of reducing the size of the labour force, resulting in a lower unemployment rate percentage. This is why the official unemployment rate is much lower than the broader U-6 measure and has actually been falling. More and more people are becoming so disenchanted with their job prospects that they have simply stopped looking for a job.

Despite the idiosyncrasies in calculating the unemployment numbers, they are the best we’ve got. If the Fed is really serious about targeting the unemployment rate – as Chicago Fed President Charles Evans has suggested – then it should have a good hard look at including those people who are underemployed, discouraged or marginally attached to the labour force. The official headline rate – which gets the most coverage amongst the financial community – overstates the current health of the US labour market.