The Unemployment Paradox

The unemployment rate dropped in July, from 9.5% in June to 9.4% in July. Many people have found the drop to be odd given that the economy wasn't really doing any better. Even more perplexing is that now that we seem to on our way out of this mess economists are warning that unemployment is still likely to rise to 10% and remain high through 2010. These same economists are projecting economic growth in 2010 and the second half of this year. How does this add up?

The unemployment rate is calculated by the Bureau of Labor Statistics (BLS) on a monthly basis. The formula is very straightforward: Unemployed/Labor Force. The catch is in the definition of labor force. The BLS defines the labor force as those currently working or actively seeking work. Unemployment is then those that are in the labor force but not currently employed. What happens is that when workers become discouraged and stop looking for work they are magically no longer unemployed because they are not a part of the labor force. The drop from 9.5% to 9.4% was primarily due to people stopping their search for work. Since those that fall out are 100% unemployed (by definition) when a large number of people give up the search the unemployment rate can drop or fail to rise month on month even as the economy sinks.

In fact there are some estimates that put the unemployment rate at closer to 15% if the so called "discouraged job seekers" were still included. This is the key to understanding how the economy can improve and unemployment rise slightly or stay high. As more jobs become available and companies start to hire, the "discouraged workers" suddenly start looking for jobs again. That adds more unemployed people to the labor force thus increasing the proportion of unemployed in the labor force - unemployment rate rises. Eventually the number of people becoming undiscouraged drops and the unemployment rates starts to stagnate and then slowly drop. This all occurs well after the economy is in recovery. This effect will likely be magnified this time since the recovery is not expected to be swift.

This is just one example of how the government, and some economists, can lie with statistics. Now you know!