Unemployment Rate Falls, But Prospects Are Dimmer

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The March job report was deceiving.  While the unemployment rate fell from 7.7% to 7.6%, there was only modest job growth and a contracting labor force.  Even though job growth was 88,000, it was far less than projections ranging from 125,000 to 160,000 and just a little more than a third from last month’s rate of new jobs.  In fact, the only reason why the unemployment rate did not rise was due to people dropping out of the labor force.

There are a few ways to quantify the extent of the shrinking labor force.  The traditional measures include the labor force participation rate and the employment-population ratio.  The labor force participation rate answers what portion of the non-institutionalized adult population is either working or actively seeking work.  Even though it would not count individuals who are incarcerated or institutionalized with mental illness, it would include those who are happy to not be working, such as a homemaker or retiree.  The employment-population ratio is similar, but only focuses on those working in relation to the non-institutionalized adult population.

There are somewhat mixed signals with the labor force participation rate falling, but the employment-population ratio remaining stagnant.  Over the last year, the labor force participation rate has fallen from 63.6% to 63.3% over the last 12 months, but the employment-population ratio was the same at 58.5% after adjusting for seasonal factors.  However, a closer look shows that the labor force participation rate trend more accurately reflects the labor market.  From the Bureau of Labor Statistics, Table A-16, they show that of the 90,483,000 people not in the labor force, 6,399,000 million want a job.  That is an increase of 358,000 from last March.

If enough people are dropping out of the labor force, then a falling unemployment rate can be misleading.  Here is a quick example to demonstrate why.  Assume that there are 10 people in the labor force with 8 working and 2 not working. Since the unemployment rate is the number of unemployed workers divided by the sum of workers and unemployed workers (labor force), we would show an unemployment rate of 20% (2 divided by 10).  Now let’s assume that one of the unemployed workers dropped out of the labor force due to diminished job prospects.  Then that will change both the number of unemployed workers and the labor force.  The new unemployment rate would be 11.1% (1 divided by 9). Even though the unemployment rate fell, it was due to a worsening job market not a better one.

Ironically, a falling unemployment rate shows a picture dimming, rather than brightening.


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