Different Measures of Unemployment and Implication for Labour Markets

It is nothing new: the official unemployment rate of 8.5% does not catch the extent of the current job crisis as discouraged unemployed individuals (who stopped looking for work and consequently been officially dropped out of the labour force) are no longer part of the unemployed statistics. Similarly, people who settled for a part time job but who would prefer to be employed in a full time job are not considered unemployed or partially unemployed. If one included these people in the unemployment statistics, we would get closer to a 16% unemployment rate (15.6% actually). As I said, we already know this by now.

But the situation is even worse than this statistic suggests. These “revised” statistics do not include the mass of people who are employed full time but, for lack of better options, had to settle for a job that is less than optimal given their qualifications and skills. These people are partially unemployed as well. After all, they most likely had to accept a lower salary than they would otherwise get in their “optimal job”.

It might be good for America's competiveness to have overqualified workers in certain jobs but this is only true in the short-run. In the long run these people are not developing their skills as much as they would as they are not being challenged to the maximum of their capacity. Moreover, when labour markets start to improve, these workers might not be able to move back up on the job ladder as their skills might have deteriorated; or, at least, there is a good chance that the perception of employers will be that the skills of such workers have deteriorated even if they have not.

This is because employers mostly value and rely on a worker’s recent experience to make hiring decision. Older experience might no longer be relevant and older skills might have been lost. The longer the situation will persist, the worse will be the phenomenon.

But even has it stands now, it is most likely that, once the crisis is over, the U.S. economy will have sustained a permanent loss of skills. For workers, it will mean a permanent loss of future income as it will become harder and harder for many of them to get reinserted in the labour markets at their former skill level and wages. The possibilities of getting a promotion that would have allowed such workers to catch up (i.e. getting a job that they would otherwise have, had they not been forced to accept an interim in a lower skilled job) are even slimmer.

But the question is also whether the job market is eventually going to recover. In other words, once this crisis is over, will the U.S. economy be ever the same? In the short run, the problem seems to be of lack of demand. But in the longer term, it is a question of supply and demand of available skills at prevailing wages. Given that there is an excess demand for skills by businesses and a shortage of skilled labour available, isn’t it an enigma that many high skill workers have to settle on lower skills jobs?

I suspect that there are many reasons for this situation. For instance, labour market rigidities due to regulations and the situation on the housing markets which is making it more difficult for people to sell their house and move where good jobs are available may play a bigger role than in the past. This is being disputed by some economists. These argue that since many unemployed workers have underwater homes, it is as easy for them to just walk away from them as it would be to sell them in healthy housing market.

There are, however, other reasons to explain why labour mobility is lower today than it has been in the past. Over the last few decades, the entry of women in the labour force gradually reduced labour mobility as there are less compelling reasons for an unemployed individual to move to another city to get a job if it means that her/his spouse is going to have to resign from her/his current job and look for a job in that other city.

But more importantly the problem seems to be that workers who were considered skilled yesterday may no longer have the skills needed to perform the tasks required on the jobs that are available today. Finally, competition may force many of us to take a pay cut as skills that were considered in high demand yesterday have found new sources of supply putting pressure on the wages of these workers.

As globalisation extends its reach, expect this phenomenon to gather steam. The longer the unemployed remained unemployed and the sub-optimally employed remained in their sub-optimal jobs, the worse the skill mismatched will become but the trend was already there. The boom before the crisis was only hiding it from plain view. Now that we are deep into the crisis, it is easier to observe but we are still in denial. By thinking that all will come back to normal once the crisis is over, we fail to accept that the world has changed forever but the crisis, while temporary, is making both the situation worse and the eventually recovery more difficult.

This means that pretty soon firms will not be leaving this country chiefly because unskilled workers are much cheaper abroad but mainly because they won’t even be able to find the skilled labour that they need to grow. Isn't it surprising then that businesses do not spend more on training workers to ensure that they have access to this skilled labour force? Maybe. But they don’t see it as their responsibility. The way I see it, firms are under so much competitive pressure in the current context that they prefer stealing skilled workers from one another than to train their own workers and risk seeing the competition steal them away.

In other words, we are confronted with a classical free-rider problem which affects the supply of skills, a public good. To make an analogy, we could compare the situation to that of a country which does not have efficient roads to facilitate trade and the conduct of business. Who will or should provide the road? While the roads could be built and eventually be paid by the private sector, the question is more who should finance and coordinate their construction?

What are the solutions in the case of skills? I am not sure but certainly, they pass by ensuring that people have the incentives and the proper environment to acquire the skills that are needed to guarantee our prosperity.

In Tracking the Unreported (15.6%) Unemployed, written by Aparna Mathur and Matt Jensen and published in Real Clear Markets recently, the authors explain how the gap between the official unemployment rate is higher than it has ever been and that this gap has been stagnating at this level for a few years now. This is suggesting to me that there is something more fundamental (other than just the normal business cycle) percolating under the labour market to explain the situation in which we are today and which is likely to persist beyond the end of the current crisis. In other words, a structural shift in our economy is taking place and we better start ackowledging it if we are to find solutions.

Here is their piece:

President Barack Obama took office in January 2009 after having campaigned on the broad promise of "hope" and "change." However, to stay in office, there is one thing President Obama should hope for: an improvement in the employment picture before the 2012 elections.

The last three years have seen some of the highest unemployment rates reported since the Great Depression. The official rate moved from 5 percent in January 2008 to a high of 10.1 percent in October 2009, and a current rate of 8.6 percent. It rests 3 points above the 1948-2007 average of 5.6 percent. Unfortunately, the reality is even worse than these numbers suggest.

This is because of the way the Bureau of Labor Statistics calculates the official unemployment rate. Conceptually the unemployment rate seems simple - it is just the number of unemployed divided by the number of people in the labor force. However, deciding whom to include in the labor force is a complicated task. In the official unemployment rate, the Bureau of Labor Statistics measures the labor force as those who are employed or who have actively looked for work within the last four weeks. As a consequence, the official rate excludes workers who have decided to drop out of the labor market altogether because economic conditions have discouraged them, or for other reasons. The official rate also ignores those who settle for part-time work since they are unable to find a full-time job.

So, the way in which we calculate unemployment might mask the actual weakness of our economy. Paradoxically, if pessimism about the economy drives workers to stop looking for work or to settle for a part time job, it could actually cause the official unemployment rate to fall because of a bad outlook.

To compensate for this problem, the Bureau of Labor Statistics has published an alternative measure of the unemployment rate based on an analysis of the Current Population Survey, a household survey. This measure, referred to as the "U-6 rate", includes those that would still like a job and have looked for work in the last twelve months, not just the last four weeks. It also includes people who opted to work part-time even though they would like full-time jobs. Unfortunately, this measure is not cited nearly enough.

The U-6 rate offers a clearer picture of how precarious a situation we are in. It has moved from 8.8 percent in December 2007 to 17.4 percent in October 2009 and 15.6 percent in November 2011. Today the gap between the U-6 rate and the official rate is 7 percentage points, meaning that the number damaged by the weak job market is almost twice what the official number would suggest. At the start of the recession, there was only a 3.8 percentage point difference. By comparison, during the 2001 recession, which lasted only a few months, the difference grew by a meager 0.9 points from 3 percent to 3.9 percent.

For a historical perspective, we obtained data on these two measures going back to 1994. The evidence reveals the gap between the official rate and the U-6 rate has averaged less than 4 percentage points, and has not exceeded 5 percentage points except for the first month in 1994. October 2008 is the first time that the difference exceeded 5 points, and since then has averaged around 7 points.

Currently more than 5.7 million Americans have been unemployed for more than 27 weeks, or an astounding 43 percent of all unemployed. The tremendous increase in long-term unemployment is one factor driving the unprecedented disparity between the official measure of unemployment and the alternative measure. Long-term unemployment has a damaging psychological impact on workers' willingness to keep searching for work and motivates them to accept part-time work.

More importantly, however, long-term unemployment has a real impact on their ability to find a job because skills erode and employers tend to recoil from large gaps on a resume.

The silver lining of this bleak jobs outlook might be that more workers are settling for part-time work rather than dropping out of the labor force completely. When individuals opt for and are able to obtain part-time work, it enables them to retain their skills and, at least partly, finance their household expenses and needs. In December 2007, only 0.2 percent of the labor force was discouraged from looking for work for economic reasons. Today, the number is 0.7 percent. The percent of the labor force that is willing to settle for part-time work has grown much more, from 3 percent to 5.4 percent.

The frailty of the labor market may be a symptom of broader issues facing the economy. Trillions of dollars of spending portend an unsustainable fiscal future, and regulatory uncertainty is high. The reasonable response of businesses to higher expected tax rates and the possibility of new regulations may be to offer part-time and temporary jobs instead of hiring full-time workers. As bad policy forces businesses to seek flexibility, the chasm between the U-6 and official unemployment rates may become a permanent fixture of the economic landscape.

The main challenge facing the Obama administration is to improve the employment situation. An easy way to start is by restoring faith in the economy and providing certainty about the future in the minds of consumers and businesses. To do this, President Obama needs Benjamin Franklin's kind of "change." A penny saved is a penny earned, and today, it may also be a job saved.