It is joked that the acceptable level of unemployment is the rate at which the economist who finds the level to be acceptable still has a job. While the joke clearly intends to make light of a general sentiment that academics and politicians do not have a firm grasp on the plight of the public, it also speaks to a second truism when it comes to measuring the health of the job market.
People’s perceptions of the job market are generally biased towards what they can observe in their local environment. Computer science majors in Denver Colorado view the job market very differently than energy workers in West Virginia. Compound this relativity with a plethora of different unemployment statistics, and you get a voter base that is likely to accept whatever line of political rhetoric that best fits what they can observe in their community. This leaves politicians with a fair amount of room to cherry pick and overemphasize the unemployment metrics that put their policies in the best light.
This election season has been no exception. Republican politicians argue that the falling unemployment numbers are the direct result of recent policy measures. Meanwhile, democrats point to nonexistent wage growth and growing disparities between blue and white collar jobs as indications of growing inequality. Outside of the political sphere, economists remain puzzled by the contradicting signals being sent by wage growth and the U3, U6, and labor participation rates. (There will be more on different employment metrics later).
So, are we in one of the greatest labor markets of all time? Are policies achieving their intended purpose and putting the United States on a more prosperous path?
To give the ultimate economist answer: It depends. It depends on the type of American worker you’re looking at. It depends on how you define prosperity. And it depends on future policy measures and macroeconomic conditions.
To attempt to dive a little deeper than “it depends,” this paper will take a step back and discuss fundamental concepts and trends that will help paint a clearer picture, by hitting on the below points:
- Jobs Report — How is it calculated and what does it say?
- U3, U6, and Labor Force Participation Rates — What are they and how are they trending?
- Wage Growth — Why is wage growth low and why does it matter?
- The Bottom Line — Are Americans better off?
Before diving into the different measures of unemployment and what they mean, it is important to first understand how unemployment data is gathered and reported. The primary source of unemployment data comes from the Bureau of Labor Statistics (BLS) in a monthly report published during the first week of the month. Of the data contained in the report, headlines are typically driven by the number of new jobs and any movement in the U3 unemployment rate.
Every month the BLS selects a statistically representative sample of households and businesses and issues surveys written to gather employment data. Statisticians then extrapolate results to estimate the national unemployment rate and number of new jobs created during the month. After publication, the number is typically revised once or twice during the month as new information becomes available.
Criticisms and Disparities — Inherent in the impossibility of surveying every American and every business every month is the possibility that this report will never be completely accurate. Beyond statistical shortcomings, surveys also make room for a significant level of misrepresentation. While business data is relatively easy to collect and evaluate, the household survey gives room for a considerable margin of error. Human beings often struggle to accurately self report especially in scenarios where questions are vague. As will be discussed below, concepts such as “actively seeking employment” and working “part-time by choice” leave significant room for interpretation.
U3, U6, and Labor Participation Rate
Different employment metrics have both strengths and weaknesses in the stories they are able to tell. To get a complete picture of the labor market, different measures should be reviewed and compared.
The primary difference in the metrics reported lies in how the unemployed population and aggregate workforce are calculated. The first step to calculating such metrics requires splitting the population into distinct groups.
U3 Unemployment Rate — The U3 rate is the metric politicians and newscasters almost universally point to when discussing unemployment. In recent news this number has attracted a fair amount of attention as it nears levels not seen since the early 2000’s. This midterm season the U3 has been a source of contention as parties argue over which administration deserves credit for its current level.
When calculating the U3, the numerator is the number of individuals who are unemployed and have actively sought work within the past month. The denominator includes these individuals plus all employed workers.
U6 Unemployment Rate — The U6 is referred to by many as the “real” unemployment rate as it better represents the unemployed and underemployed populations. It helps avoid some of the distortion inherent in how the U3 is calculated.
The U6 adds two additional groups when it calculates the unemployment rate. The term unemployed is extended to individuals who are stuck working a part time job due to an inability to find full time work (this does not include workers who are part time by choice). The U6 also counts workers as unemployed if they are not employed but have actively sought employment within the last 12 months (this is in contrast to the 4 week period used in the U3 calculation). Workers who have actively searched for employment during the last 12 months (but not the last 4 weeks) are referred to as the marginally attached workforce.
Labor Force Participation — The labor force participation rate was a favorite metric of presidential candidate Ben Carson while on the campaign trail. The metric has frequently served as a source of confusion for politicians. The metric can be useful from a productivity perspective, but can be deceptive when trying to assess the health of the economy.
Broadly, the metric represents the percentage of working age adults who are actively participating in the workforce. Higher percentages indicate that the economy is more efficiently utilizing its working age population. Lower percentages indicate that a higher number of unemployed adults may be serving as a drag to peak efficiency.
The denominator includes all working age adults excluding only those who are institutionalized. This means long term discouraged workers and retirees are factored into the working age population.
Adding in the retiree population makes the rate highly sensitive to surges in retirement. In recent years the rate has been drug lower by the large number of baby boomers retiring. This demographic shift accounts for most of the downward trend observed in recent years. The St. Louis Fed attributes the lower participation rate to (1) more retirees (2) people staying in school longer and (3) an increase in the female workforce participation rate accompanied by a decrease in the male workforce participation rate.
Other General Issues — Across the measures discussed above, there are observable tradeoffs between potential distortions. The U3, U6, and labor force participation rate are only a few of the many ways in which economists attempt to measure the health of the economy. The BLS also publishes metrics such as the U1, U2, U4, and U5. These, however, are far more infrequently referenced due to their inherent shortcomings.
The most commonly voiced concern around the shortcomings of official unemployment rates is the exclusion of individuals who permanently left the workforce after the financial crises. As a result, some entities have calculated alternative measures that include long term discouraged workers. These adjusted measures appear to be on a less significant downward trend than the U3 and U6.
A final issue with the metrics discussed above lies in how institutionalized persons are excluded from the working age population. It is probably fair to exclude those individuals in nursing homes or care facilities as there is very little chance of these individuals being able to reenter the workforce. However, by subtracting the institutionalized population, we are also excluding those individuals who are incarcerated.
While this might not be a distorting factor in some countries, in the United States it does mask a major drag on labor force utilization. As incarceration rates in the US far outpace those observed globally, confined adults represent workers who are not only temporarily unemployed but who are more likely struggle with employment later as they face stigmas associated with incarceration.
With an understanding of the trends in both the U3 and U6, it is perplexing to observe the lack of wage growth in recent years. Basic supply and demand would dictate that a shrinking number of unemployed persons would necessitate higher wages as employers struggle to attract new workers. This, however, has not been the case.
Where wage gains are observed, the growth in pay has accrued disproportionally to the richest Americans. Above average stock market performance in recent years accounts at least partially for this disparity. In the past 12 months stock based compensation has intensified even further as companies have used increased earnings and tax breaks to buy back stock, thus inflating the value per share.
There are a number of observable factors that have led to depressed and disparate wage growth. Such factors include things like the disappearance of labor unions and the decrease in the inflation adjusted value of the minimum wage. Observable factors, however, do not account for the extent to which wages have remained unchanged. While there is little to no consensus on the cause of wage stagnation, a handful of theories have been proposed and will be discussed below.
Non-Exporting Jobs — One assumption as to why wages are stagnating relates to the shift in the types of jobs available. On average, jobs in markets where the United States exports goods and services to other countries pay 20% more than jobs that primarily serve the domestic economy. As emerging international markets continue to draw low skilled jobs away from the US, The United States and other western countries have struggled to adapt to the resulting workforce displacement.
WHAT’S DRIVING IT — In the western world, the ramifications of globalization have driven a resurgence in the popularity of protectionist political candidates. Proponents of protectionist trade policies believe the solution to the pains resulting from an increasingly globalized economy lies in protectionist policies that serve to protect industries where a competitive advantage may no longer exist. There are certainly SOME circumstances in which this may be the right solution. Especially in scenarios where foreign governments have enacted policies that unfairly disadvantage competing nations.
Populists, however, frequently employ a much wider lens when evaluating appropriate interventionist policy measures. The recent movement has lead to policies that seek to promote industries where the competitive advantage clearly lies with foreign nations. It has also lead to a focus on dying industries that continue to become obsolete. In the mean time little focus has been given to the important role the government plays in investing in new technologies and ground-breaking research.
WHY IT MATTERS — Trying to force the unskilled jobs of the past into the America of tomorrow is an inherently short term strategy. China, the most frequent target of US populists, has acknowledged the natural shift in competitive advantage that must occur as a nation industrializes. As such, its leaders have enacted strategies aimed at preparing the country to compete in cutting edge industries in an increasingly globalized environment. If the United States does not shift its focus to the future it risks being outpaced by countries who are actively seeking to take its place.
Technology — Technology has continued to be a significant and often overlooked culprit of jobs losses in recent decades. Politicians and economists have largely strayed from acknowledging the role technology has played in displacing workers. The entrepreneurial nature of the United States places a great deal of value on technological advancements. As such the general population struggles with the cognitive dissonance that arises from acknowledging the trade off between technological advancement and job losses.
This is not to say politicians and economists should seek to stifle technological innovation. Rather it is to acknowledge the poor policy decisions that will result from a failure to recognize technology’s influence. Trade liberalization cannot continue to be the default scapegoat for shifts in job growth.
WHAT’S DRIVING IT — Strategic companies will always be looking for ways to operate less expensively and more efficiently. It means they are consistently evaluating the cost of automation versus human labor. Once labor becomes more expensive than technological investment, companies will begin to make the investment so long as they have sufficient access to capital. Automation is an ever increasing reality in a world where technology becomes better and cheaper every year.
The Trump administration’s stance on green energy serves as a recent example of politicians neglecting the influence of technology. The administration has criticized regulations promoting the use of green energy by making claims that such regulations have devastated coal mining communities. What is neglected in this argument is the increasing role automation has begun to plays in the industry. Machines can far more efficiently (and safely) do what human used to do.
WHY IT MATTERS — Technology, like it or not, will continue to erode jobs of the past. An extremely dangerous trend in western politics relates to populist candidates promising to protect dying and outdated industries. Many developing countries have seen the danger in such initiatives and have formulated plans to work towards the jobs and industries of the future. If China continues on its current path it will be the largest manufacturer of solar panels in the world. If the United States continues on its current path it will be artificially supporting coal mining until the industry reaches its inevitable death.
To compete in a world where technology is disrupting the standard norms, successful governments must invest in innovation and set up educational programs to move unskilled labor into skilled job markets. In the United States rising debt levels have limited the government’s ability to fund innovation efforts. Meanwhile, failing and underfunded education systems have inadequately prepared American workers for the skilled labor market. Lackluster efforts to retool and relocate displaced workers have left the United States with communities that suffer from lack of opportunity. To remain competitive, the United States must turn its sites to the future and away from the past.
Increase in Part Time Workers — A second, less quantitatively backed theory as to why wage growth has stagnated relates to the uptick in part time workers. As was discussed, one of the major shortcomings of unemployment metrics is the subjectivity of workers classified as part-time by choice verses part time due to the unavailability of full-time work. Even among those workers identified as part-time by choice, there are still outstanding questions as to the incentive structures that are driving the desire for part time work.
WHAT’S DRIVING IT — While little conclusive data is available for many of the points argued on the topic, speculators on both sides of the aisle have in different ways blamed social programs for lack of full time employment opportunities.
Some politicians blame labor protections and employee benefit mandates for disincentivizing employers from hiring full time workers. Others criticize corporations for taking advantage of social programs as a means of relinquishing their responsibility to provide employee benefits.
Some politicians blame social programs for incentivizing workers to cap their earnings to levels qualifying them for government assistance. Others blame the tax structure in lower tiers of household income that make additional salaries earned almost inconsequential after these individuals move beyond a given tax bracket.
WHY IT MATTERS — Part time workers are more expendable and have little wage negotiation power. Expendability dictates that an employee’s demand for higher wages will result in the employer being able to easily replace the worker. Part time employees also do not receive employer benefits such as health insurance and retirement plans. It means these employees are more likely to rely on social programs to compensate for low wages and lack of benefits.
Are Americans Better Off?
The unemployment metrics discussed above certainly seem to be on a favorable trajectory. It is hopeful that a continued downward trend in unemployment will ultimately force wages back up and open up full time opportunities. Stock prices are up, corporate earnings (in some sectors) are up, and for those invested in the stock market over the past few years retirement is looking brighter.
Nevertheless, in the current environment serious consideration must be given to increasing levels of inequality and the failure of the United States to put together a cohesive strategic plan for the future. Job growth in dying sectors does little for future generations. Failing education systems dictate a world in which US citizens are not equipped to compete internationally. Wage inequalities inevitably hollow out the middle class making the rich richer and the poor poorer.
The answer to the question of “are we are better off” is conditional to an individual’s perception of the job market. It is also relative to where we are looking. From a present day, macroeconomic perspective the answer is, by many accounts, yes. From a future looking or more geographically, racially, or financially segmented perspective, the answer may be no.