The Unemployment Rate: Get Real

By Elvis Picardo, CFA AAA

The national unemployment rate is defined as the percentage of unemployed workers in the total labor force. It is widely recognized as a key indicator of labor market performance. A closely watched economic indicator, the unemployment rate attracts a great deal of media attention, especially during recessions and tough economic times.

Why Does the Unemployment Rate Matter?
As the U.S. Bureau of Labor Statistics (BLS) notes, when workers are unemployed, their families lose wages, while the nation as a whole loses its contribution to the economy in terms of the goods or services that could have been produced. Unemployed workers also lose their purchasing power, which can lead to unemployment for other workers, creating a cascading effect that ripples through the economy.

To better understand the nature of unemployment, policymakers need information on many aspects of it, including the number of unemployed people, the period of time for which they have been unemployed, their skill levels, the trend in unemployment, regional disparities in unemployment and so on. Once these statistics have been obtained and interpreted, policymakers can use them to make better-informed decisions about steering the economy and countering unemployment.

How are Labor Statistics Compiled?
One misconception about the unemployment rate is that it is derived from the number of people filing claims for unemployment insurance (UI) benefits. But the number of UI claimants does not provide accurate information on the extent of unemployment, since people may still be jobless after their benefits run out, while others may not be eligible for benefits or may not even have applied for them.

Counting each and every unemployed person on a monthly basis would also be a very expensive, time-consuming and impractical exercise. Therefore, the U.S. government conducts a monthly sample survey – known as the Current Population Survey (CPS) – to measure the extent of unemployment in the nation. The CPS has been conducted monthly in the U.S. since 1940. About 60,000 households, or approximately 110,000 individuals, are in the CPS sample survey, selected to be representative of the entire U.S. population. A typical household that is included in the sample survey is interviewed monthly for four consecutive months and then again for the same four calendar months a year later.

The survey itself is carried out by 2,200 trained and experienced Census Bureau employees. They interview persons in the 60,000 sample households for information on labor force activities or non-labor force status of their household members during the survey reference week (generally the week that includes the 12th of the month).

When a sample survey is used, rather than a survey of the entire population, there is a chance that the sample estimates may differ from the actual population values. The BLS notes that at an unemployment rate of 5.5%, the 90% confidence interval is about +/- 280,000 for the monthly change in unemployment, and is about +/- 0.19% for the unemployment rate. In other words, there is a 90% chance that the monthly unemployment estimate from the sample is within about 280,000 of the figure obtainable from a total census of the entire population.

Employment vs. Unemployment
The basic definitions used by the BLS in compiling labor statistics are quite straightforward:

  • People with jobs are employed;
  • People who are jobless, looking for jobs and available for work are unemployed; and
  • People who are neither employed nor unemployed are not in the labor force.

The Rest of the Bunch
The sum total of employed and unemployed people makes up the labor force. The remainder – those who are not in the labor force – comprises people who have no job and are not looking for one, such as students, retirees and homemakers.

Note that labor force measures, such as the unemployment rate, are based on the civilian non-institutional U.S. population that is age 16 and older. Labor force measures exclude persons who are below age 16, people confined to institutions such as nursing homes and prisons, and all personnel on active duty in the Armed Forces.

While the basic concepts that determine whether an individual is employed or unemployed are simple, given the millions of people that constitute the U.S. labor force, numerous situations can complicate matters and make it difficult to ascertain the correct category to which a person belongs.

People are considered employed if they did any work at all for pay or profit during the survey week. People are also counted as employed if they have a job at which they did not work during the survey week, for reasons such as being on vacation, falling ill, doing some personal work, etc.

People are classified as unemployed if they fulfill the following three criteria:

  • Do not have a job;
  • Have actively looked for work in the prior four weeks; and
  • Are currently available for work.

The official unemployment rate that is widely quoted in the media is based on the above definition of unemployment.

The criteria for being considered unemployed are rigorous and well-defined. For example, actively looking for work includes such measures as contacting prospective employers, attending job interviews, visiting an employment agency, sending out resumes, responding to job advertisements and so on. Therefore, this excludes passive methods of job search such as attending a training course or scanning the job advertisements in newspapers.

As such, the total unemployment figure includes people who have lost their jobs, as well as persons who have left their jobs to look for other employment, temporary workers whose jobs have ended, individuals looking for their first jobs and experienced workers returning to the labor force.

Measures of Unemployment
The official unemployment rate has often been cited as being too restrictive and not representative of the true breadth of labor market problems. Some analysts contend that the official unemployment measure is too broad, and they would like a more narrowly targeted measure. However, they are in the minority, far outnumbered by those who believe that the unemployment rate is too narrowly defined, as a result of which the full dimensions of the unemployment problem are understated.

To address these issues, the BLS – under the direction of Commissioner Julius Shiskin – in 1976 introduced a range of labor market measures entitled U-1 through U-6. In 1995, following the redesign of the Current Population Survey in the previous year, the BLS introduced a new range of alternative measures of labor underutilization titled U-1 through U-6. Regular publication of these measures commenced with the February 1996 Employment Situation report.

The measures range from U-1 – which is the most restrictive, since it only includes those people who were jobless for at least 15 weeks – to U-6, the broadest definition of labor underutilization. The U-3 measure is the official unemployment rate. U-1 and U-2 are more restrictive and therefore lower than U-3, while U-4, U-5 and U-6 are higher than U-3.

U-6: The Real Unemployment Rate
The U-6 measure provides the broadest measure of labor underutilization. It is defined as the total unemployed populace, plus all marginally attached workers, plus all persons employed part-time for economic reasons, as a percentage of the civilian labor force plus all marginally attached workers.

"Marginally attached" workers are defined as persons without jobs who are not currently looking for work (and hence not considered unemployed) but who have demonstrated some degree of labor force attachment. To be included in this category, individuals must indicate that they currently want a job, have looked for work in the last 12 months and are available for work.

One subset of the "marginally attached" group is "discouraged workers." Discouraged workers are those who are not currently looking for work because they:

  • Believe that no job is available to them in their line of work;
  • Have been unable to find work;
  • Lack the necessary schooling, skills or experience; or
  • Face some form of discrimination from employers (for example, being too young or too old).

The U-6 measure is being increasingly referred to as the real unemployment rate. Proponents of this measure contend that it represents the true nature of the unemployment problem, since it includes:

  • People without jobs;
  • Those who would like to work but have not actively sought jobs in the past four weeks due to issues such as child care, family obligations or other temporary problems;
  • Discouraged workers who have stopped looking for work because they think it is futile; and
  • Underemployed people, which includes those who are actually employed but are working fewer hours than they would like.

The Unemployment Test
Consider the following hypothetical cases as examples of how the official unemployment rate (U-3) understates the magnitude of the labor underutilization problem:

  1. A single mother who has been unemployed for three months, but is unavailable for work for the past two weeks in order to care for her sick child, would be classified as "not in the labor force." She would be excluded from the U-3 measure, but would be included in the U-6 measure.
  2. A 60-year-old former executive who lost his job in a corporate restructuring a year ago is keen to return to the workforce. However, after sending out more than 100 resumes in the first three months of unemployment, he is discouraged by the fact that he has not received a single interview call or acknowledgment letter, and has stopped his job-hunting efforts. He would be excluded from the U-3 measure, but would be included in the U-6 measure.
  3. A sales executive with a family to support and bills to pay has been unable to find full-time work after six months of unemployment. He finally takes up a three-month contract that entails only six hours of work a week. While the U-3 measure would consider him as employed, the U-6 measure would take his obvious degree of underemployment into consideration.

The Bottom Line
While the alternative measures show very similar movements over the course of the business cycle, they differ significantly in magnitude from the official unemployment rate. The strict definition of unemployment under the official U-3 measure may result in understating the magnitude of the actual unemployment situation. It is therefore advisable to look beyond the headline (U-3) unemployment number, as it may not convey the whole story. The U-6 measure, by virtue of being the least restrictive and therefore the highest unemployment rate, may provide a truer picture of the degree of labor underutilization.
 

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