What the Unemployment Rate Signals on the Economy

Rebecca M. Blank
Rebecca M. Blank Chancellor - University of Wisconsin-Madison, Former Brookings Expert

April 4, 2008

The March unemployment rate finally inched up over 5 percent. Unemployment — the share of the labor force without a job but actively seeking work – has been largely unchanged since last July and is far below the high unemployment rates of past recessions. Some argue that this is a sign that jobs are still available, and that policies to help the unemployed – such as extending Unemployment Insurance benefits – are not currently necessary.

Don’t believe these arguments. Serious labor market problems loom: both employment and wages have fallen in recent months. Job losses are not limited to one or two areas of the economy, but are increasingly evident in all almost industries.

Most troublesome, long-term unemployment is higher than it has ever been at this point in the economic cycle. Almost 20 percent of all unemployed persons have been out of work for six months or longer. At the beginning of the last two recessions, that number was closer to 12 percent. This suggests that a substantial fraction of those who lost jobs in 2007 are having serious difficulties finding new jobs.

By my calculations, 9 percent of the labor force is in trouble right now. I’ve added the number of unemployed to those who are involuntarily working in part-time jobs because they can’t find full-time work, and included those who say they want to work but have given up looking.

With these problems in the labor market, why is the unemployment rate not rising rapidly? There are at least three reasons. First, the American work force is aging as the baby boom bulge moves into their 50s. This demographic shift lowers overall unemployment rates because older workers are more stably employed and have less unemployment. If you compare the current unemployment rates by age group with equivalent rates in July 1990 – the first month of the 1990-91 recession—it turns out that unemployment rates are as high or higher among virtually every age group in 2008. Yet overall unemployment in March 2008 was 5.1 percent, still lower than the 5.5 percent in July 1990. This is because the share of the population in the high-unemployment (younger) groups has fallen, while it’s risen in the lower unemployment (older) groups. But any worker who looks around at others in her age group will find unemployment is as high as in past periods.

These shifting demographics should change our expectations about what constitutes low versus high unemployment. If the population in 2008 looked like the population in 1990, our current unemployment rate would be 5.5 percent, not 5.1 percent, the same unemployment rate recorded in the first month of the 1990 recession.

Second, the share of the population that is working or looking for work has fallen over the past year. If we’re losing jobs, but unemployment hasn’t increased, this means that some people are dropping out of the labor market entirely. This ‘discouraged worker’ effect is often a sign that workers are pessimistic about their chances of finding a new job. The declines in labor force participation are particularly noticeable among very low skilled workers and among younger workers. Growing numbers of discouraged workers are not a good sign for the labor market.

Third, the rising share of young men in jail or prison depresses unemployment rates among younger men. The Pew Foundation recently reported that 1 out of ever 100 adult Americans are now in prison. Our labor force statistics exclude these individuals, who are disproportionately likely to be young men of color, a population that tends to have high unemployment rates.

The overall unemployment rate among men would be about 8 percent higher if those in prison were out and experiencing the same labor market as others of their race and age. By expanding our prison population, we have reduced the unemployment numbers.

In short, today’s unemployment rate cannot be directly compared to unemployment in earlier periods. If we had a similar population in the labor force today as in earlier periods, our current unemployment rate would much higher.

It’s also important to note that unemployment is always a lagging indicator in an economic slowdown. Unemployment rises during recessions and often peaks after a recession has ended. If, like me, you believe that the U.S. economy is in a recession, then unemployment rates are likely to increase steadily in the months ahead.

Given this, now is the time to enact extended Unemployment Insurance benefits. Unemployment payments typically end after six months. Extended benefits would provide longer-term payments to those still seeking jobs and can assist these workers as they continue to look for work. Waiting for the unemployment rate to rise higher before we take action in the current economic slowdown would be a mistake.