Cross Arrows
By - Joseph Perrotta

The Truth About The Unemployment Rate

Last week, the Government released employment data for March. According to the report, we added 120,000 jobs in the month of March, and the unemployment rate edged down from 8.3% to 8.2%, the lowest rate in three years.

That’s great, right?


While no one would argue that adding jobs is bad, the measure of the actual employment rate is flawed, and ignores/misinterprets several key pieces of information.

The actual calculation used to measure the unemployment rate is as follows:

Total number of unemployed persons / Total labor Force * 100

Simple enough, right?

All you need to do is reduce the number of unemployed persons, and the unemployment rate drops. That’s how it works, isn’t it?

Well, you’re half right.

The second variable in the equation is the Total Labor Force, and this number is behind much of the decrease in the unemployment rate we have seen over the past several years.

The total labor force is defined as those who are actively seeking full-time employment.

This number does not account for those who have dropped out of the labor force through discouragement in attempting to find a job.

This means if you have stopped looking for work, and chose to stay home with your child, go back to school, or sit home and play video games all day, you are not consider part of the labor force.

If the number of unemployed workers remains the same, but the number looking for work decreases, the unemployment rate will drop, even thought not a single job has been created.

Since December of 2007, the labor force participation rate, a measure of the total labor force relative to the overall population, has dropped from 66% to 63.8%.

According to a recent report by ZeroHedge, as of December 2011, the real jobless rate, after accounting for the drop in the labor force participation rate, sat at 11.4%, versus the reported employment rate of 8.5%.

That is a 2.9% difference!

Note: There is debate as to how much of the drop in the labor force participation ratio is due to structural changes, such as people retiring, and how much is out of discouragement. While this debate is well beyond the scope of this article, it is safe to say that both sides have a valid argument.

While this certainly does not account for the entire drop in the unemployment rate, it is a significant factor that needs to be accounted for.

Fortunately, there are several other measures of unemployment that account for these variables.

    The U-6 Measure of Unemployment

    The U-6 measure of unemployment calculates the unemployment rate as follows:

    Total number of unemployed individuals
    Total Labor Force + Discouraged workers who have dropped out of the labor force + part-time workers who would prefer full-time employment

    This measure of unemployment takes into account those who have voluntarily removed themselves from the labor force, as well as those who are underemployed, defined as those working part-time who would prefer or are qualified for full-time employment elsewhere.

    The U-6 measure of unemployment currently sits at 14.5%.

    That’s a pretty big difference.

    That means for every 100 individuals, there are 8 people reported by the unemployment rate to be unemployed, and an additional 6 people who are looking for more or better employment, but are not reported as being unemployed.

    Long-Term Unemployed

    Another metric often ignored is the long-term unemployment rate.

    This is defined as the percentage of unemployed who have been unemployed for a period of 27 weeks or longer.

    Historically, this rate has averaged between 15%-20%.

    Today, that rate sits at 42.5%.

    That means that nearly half of all unemployed people have been unemployed for six months or longer.

    That is shocking.

    Not only does that statistic shed light on a fault of reporting the pure unemployment rate, it also points to larger structural headwinds facing our economy.

    Besides the fact that the longer you are unemployed, the more difficult it becomes to find a job, will there even be jobs for these individuals once the economy recovers?

    A large part of the problem is that there are structural factors facing our economy that cannot be easily fixed.

    For example, if a computer manufacturer got laid off during the recession, will he/she be able to find a job once the economy recovers, if that position has been outsourced to another country?

    Maybe, but it may require additional training or geographic relocation.

While the unemployment rate certainly has its purposes, it by no means paints a clear picture of our economic situation.

The next time you see the employment rate tick up or down on the TV, do yourself a favor and go to portal seven to find out what the U-6 rate did to gain a better understanding of the true unemployment situation.