Interpreting the Unemployment Rate (Michael Pakko Commentary)

The most commonly cited measure of labor market conditions is the unemployment rate, defined as the ratio of number of employed to number of labor force participants.

But the unemployment rate expresses itself as a fraction of the labor force, it provides an incomplete picture, and it can give misleading signals. During the recent recession and recovery, for example, labor force participation has fallen sharply — and unlike unemployment rates, participation rates have shown little sign of recovery.

For example, when labor market conditions are weak and jobs are scarce, job seekers sometimes become discouraged and stop seeking employment altogether. When this happens, they are considered to have left the labor force and the unemployment rate might fall — even though the discouraged workers might more appropriately be classified as unemployed. There is evidence this has happened during the current slow recovery.

From the recession’s start to peak unemployment in October 2009, the participation rate declined by one full percentage point (66 to 65 percent). During the same period, the participation rate in Arkansas declined by two percentage points (62.8 to 60.8 percent). Since then, participation rates have fallen even further. By December 2013 the participation rate for the U.S. had fallen below 63 percent; for Arkansas it was 58 percent. These rates represent cumulative declines of 3.2 and 4.8 percentage points, respectively.

Suppose that 100 percent of the decline in labor force participation was due to discouraged workers leaving the workforce. If all of those individuals were counted as unemployed, the current unemployment rate for the nation would be more than 11 percent. In Arkansas, the unemployment rate would be well more than 14 percent. These numbers are alarming, but they also overstate the economic impact of lower labor force participation rates.

First, participation rates were trending downward in recent years and would have continued to decline even in the absence of the recession. For decades, increasing participation rates by women had been offsetting a long-term decline in participation rates for men. But the increasing trend for women had leveled off during the past decade, leaving an overall downward trend.

The aging of the U.S. population has also been a contributing factor. As baby boomers reach traditional retirement age, the participation rate for that population is falling. Even though labor force participation rates among those 65 and older have been increasing in recent years, they are still far below the rates for prime working-age cohorts: In 2012, the U.S. participation rate in the 65-plus age bracket was a record high 18.5 percent. But the participation rate for 55- to 64-year-olds was 64.5 percent, and the rate for those aged 45 to 54 was 80.2 percent.

So the aging of the baby boomer generation lowers the overall average participation rate. The aging-population effect is also one reason that participation rates in Arkansas are lower and falling faster than the national average. The proportion of Arkansans aged 65 and over was 18.6 percent in 2012, compared with just 17.2 percent nationwide.

Another age demographic with a declining participation rate has been those at the younger end of the scale: 16- to 24-year-olds. One explanation for this trend is that an increasing number of younger workers are taking the time to attend college or other postsecondary training. With training and skills more highly valued in today’s workforce than ever before, this is not surprising. Labor force participation rates for 16- to 24-year-olds are slightly higher than the national average in Arkansas, but in recent years we have seen declining trends for both the state and the nation.

Although existing trends and demographic changes would have caused participation rates to decline regardless of the recession, the economic downturn clearly had an impact. Both the data and anecdotal evidence suggest that many workers who were at or near retirement age have chosen to take early retirement rather than to continue in the labor force. Many of those will not be back and would have exited in the near future anyway. But there is also a contingent of discouraged workers who may return to the labor force when conditions improve. The dynamics of these developments will be important for interpreting movements in the unemployment rate as the economic recovery continues.

Michael Pakko is the state economic forecaster and an adjunct professor at the University of Arkansas at Little Rock’s College of Business.