Friday, September 7, 2012

What's the REAL unemployment rate?

Source: Wikimedia Commons

Today the jobs numbers for the month of August are being released. Inevitably, I will see people claiming that the headline unemployment number "is not the real unemployment rate." The real rate, according to them, is much higher; and they often suggest that authorities are intentionally feeding us a misleading number for political reasons. Are these skeptics right?

More precisely, what is the "real unemployment rate"? I'm going to suggest that there is no such thing, and I'm going to explain a few of the ways we measure labor market conditions. Each has benefits and limitations which are relevant to the discussion about the state of the economy. This will be a short guide for non-economists.

A lot hinges on how we want to define "unemployed." To different people and at different times, that word might refer to anyone without a job (in which case, happily retired people and stay-at-home spouses would be "unemployed"), anyone without a job who is actively seeking work, or anyone without a job who wants one. Perhaps it should include those who have part-time jobs but desire full-time work. It might even refer only to people who have been searching unsuccessfully for work for at least some amount of time or people who were fired or laid off from their job (i.e., they didn't leave voluntarily). Since there is no common definition of "unemployed" that satisfies everyone's needs, the Bureau of Labor Statistics (BLS) attempts to measure several versions of unemployment.

Each of these indicators is derived from a random sampling of about 60,000 households, conducted by the BLS and the Census Bureau, called the Current Population Survey (CPS). The CPS and its products are subject to response error, sampling error, and seasonal adjustment error (topics for another post, perhaps); so it's probably foolish to get excited about small movements in any of the unemployment rates I describe below as they may just be statistical noise.

Headline/official unemployment (U3)

The unemployment rate most often cited in the media is called the "civilian unemployment rate." It is defined as the number of people in the "labor force" who do not have work, expressed as a percentage of the total number of people in the labor force. The key restriction that bothers many people is that "labor force" is defined somewhat narrowly as civilian adults (16+) who are available for work and are either employed or have actively searched for a job within the past four weeks. People who have been temporarily laid off are also included. People who don't have jobs and are not looking for work are not included in this definition of "labor force," and this is why some people claim that the "real" unemployment rate is much higher.

But this number doesn't just exist to give politicians cover. It serves a useful purpose for those who are trying to diagnose problems in labor markets. Discouraged workers who have given up the job search aren't actually in the labor market, so if we want to know something about whether the labor market is clearing--whether it is efficiently matching job seekers with employers--then we need an unemployment measurement that is limited to people who are actually participating in the labor market. In fact, this is a decent way to sum up the headline unemployment rate: it attempts to measure how well the labor market is clearing.

There are additional reasons for caring about the headline unemployment rate. Unlike some other popular measures, we have been collecting the standard unemployment statistic in a reasonably consistent way since 1948. It's immensely helpful to be able to compare labor market clearing conditions across time. Finally, because of its usefulness for measuring labor market clearing, the standard unemployment rate has long been used by economists for finding helpful economic relationships which can inform policy.

The use of this rate in headlines and policy discussions is not new or unique to the political leadership of a certain party. This is the number we've used for decades--and it's compliant with international standards.

So when people complain that this is not the "real" unemployment rate, they're really just saying that they don't care about what this number measures. Often, these critics care less about labor market function than they do about broader economic misery.

Unemployed, marginally attached, and part time for economic reasons (U6)

This measure is the one that journalists, thinking they're very clever, like to discuss when asserting that the headline number is a smoke screen. But it's not a secret; it gets released by the BLS along with the headline number, and you can find time series data for U6 from a variety of websites (like FRED).

U6 is the broadest measure of employment problems in that it counts the most categories of people; to qualify as "unemployed" (more precisely, underutilized), a person must be unemployed (as defined in the headline rate), underemployed, or marginally attached. Underemployed people are those who have work but do not work as many hours as they would like. Marginally attached workers are those who want a job and have searched within the past year but have given up (and have not searched for work within the last month).

This number helps us get an idea of how much labor the US economy could supply in better economic conditions; it also gives us an idea of how many people are hurting economically because of bad labor market conditions. So it is useful for knowing just how far we are from satisfactory economic outcomes. In that respect, it is an important number.

However, like any statistic, U6 has its drawbacks. It is too broad to tell us much about immediate labor market clearing. It is also a new number--the BLS began collecting U6 in 1994--so we lack long time series for comparing business cycles over time. Finally, by using such a broad measure of underutilization, we lack the ability to pin down the different issues plaguing labor markets.

So the U6 measure does not fully satisfy our need for a good description of labor market conditions; but for those who want a single estimate of how many people are unsatisfied with the labor markets, this one might work.

More restrictive measures (U1 and U2)

There are two unemployment indicators that give rates lower than the headline number. U1 counts as underutilized only those who have been unemployed (by the headline definition) for at least 15 weeks. U2 counts as underutilized only those who are unemployed (by the headline definition) due to involuntary separation from their last job (i.e., those who quit their last job do not count). Since even booming economic times are characterized by a constant flow of people between jobs, these measures are useful for distinguishing between those who have good labor market prospects but are just between jobs temporarily (or voluntarily) and those who are actually in trouble.

Other broad measures (U4 and U5)

Finally, U4 and U5 bridge the gap between the headline number and the extremely broad U6 measure. U4 includes those who are unemployed by the standard definition along with discouraged workers--those who searched for work within the last year but gave up because they believe no jobs exist for them. U5 includes the standard unemployment definition and all marginally attached workers--those who have become discouraged for any reason. Again, these measures have useful purposes, helping researchers, policymakers, and commentators distinguish between reasons for job-search discouragement.

Six unemployment rates, seasonally adjusted (click for larger image)
"UNRATE" is the headline number (U3)

Final thoughts

There is no way to perfectly measure the state of the economy, and there is certainly no way to summarize it in one number. The BLS attempts to provide a broad and deep picture of the employment situation that allows us to drill down on the nature of labor market problems (and we can supplement these statistics with a variety of other data releases to get a clearer picture). The US statistical agencies are well respected worldwide for good reason. They exercise political independence and seek to approach data collection and summarization using best practice from statistical science. That's true even if some data releases contradict your ideological priors or local anecdotal evidence.

There is no "real" unemployment rate, nor are any of the indicators we have useless; what matters is choosing the right number for the right purpose.