Tag Archives: labor force participation

A Tale of Three Indicators: How Bad is the Labor Market Really?

It is the best of times. It is the worst of times. It it the worst of times but getting better.

It all depends on how you measure it.

There’s a lot of interest these days in alternative economic measures, particularly with regard to employment. Part of this is driven by real problems with unemployment rates. Even more is driven by a people wanting indicators to tell a different story than they do. And some is driven by a desire for measures that provide different policy incentives. The news yesterday that the unemployment rate fell from 8.1 percent to 7.8 has only exacerbated the situation.

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Probably the three most closely watched macroeconomic indicators in the U.S. are the change in real GDP, the consumer price index (CPI), and the unemployment rate.

When we say “unemployment rate”, we really mean the “U-3 unemployment rate”; there are (at least) five others we could consider. They range from the narrowest U-1 to the broadest U-6 rates.

Basically the U-3 unemployment rate is the percentage of the workforce that is actively looking for work but is not employed.It’s true that the U-3 rate doesn’t capture a lot of the economic pain out there. But it’s the standard measure that policy-makers have focused on for decades.

Politicians who want things to sound worse will throw around phrases like “15 percent underemployment”. This is valid but misleading. The U-6 unemployment rate – the broadest measure that also includes most discouraged workers and others – is at 14.7 percent these days. But the U-6 is not the standard definition. If you’re going to use it as your standard in bad times, you also need to use it in good, or else you’re talking apples and crabapples.

That said, all of the unemployment rates move very much in tandem. In fact, since 1994, the correlation between the U-3 and the U-6 rates is 0.996. They’re practically the same measure. Here’s a graph of the six unemployment measures over the past four years, courtesy of the Washington Post.

But even the broad U-6 unemployment rate doesn’t capture people who have permanently left the labor force because they feel things are hopeless. This is one reason some analysts have proposed using the Labor Force Participation Rate (LFPR) as a main indicator of labor economic health.

I addressed the problems with the LFPR in an earlier post, and there are many. Even though the LFPR does capture long-term discouraged workers, it introduces many other difficulties. The LFPR is mostly driven by long-term demographic changes. It doesn’t reflect the business cycle at all, as is clear from the graph below.

The LFPR thus is pretty much useless as a “how are we doing?” sort of measure.

If you’re really desperate for an alternative labor economics indicator that captures both the long-term unemployed as well as the business cycle, I propose yet a third measure: the Employment-Population Ratio.

The Employment-Population Ratio (EPR) is the percentage of the total (noninstitutional) population aged 16 years and over that is employed. It has the advantage of capturing both shorter-term cyclical unemployment and long-term unemployment of discouraged workers.

The EPR has problems, too, of course. There’s no perfect economic indicator (I addressed problems with GDP in an earlier post as well). Specifically, the EPR is a victim of many of the same demographic realities that the LFPR is. When you have a lot of people reaching retirement age, the EPR will fall. When you have a lot of women entering the work force, the EPR will rise.

But the EPR does capture the business cycle. And it has the added benefit – for those who want the economy to look worse – of making the economy look a little worse.

To be fair, the EPR is being pulled in different directions by different factors. Baby boomers are hitting retirement age and are leaving the labor force in increasing number for legitimate reasons. At the same time, the economy is (slowly) recovering. The net effect is that the EPR has been basically flat since late 2010.

Personally I still prefer the U-3 unemployment rate as my main measure of how the economy’s doing, though I always keep in mind that it has its flaws like any other indictor.

If I were looking for a secondary labor measure to provide supplemental information, I’d choose the Employment-Population Ratio.

But all things considered, just measuring the economy really can scare the dickens out of you.

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