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On Friday, the Bureau of Labor Statistics released its Employment Situation report. In the headline establishment survey, the nonfarm payroll gain of 151,000 attracted most of the attention. It was well above the 60,000 consensus estimate and showed strength in the private sector with 159,000 jobs added (government employment fell 8,000). From the household survey we find the unemployment rate held steady at 9.6%. It is this household surgery that I will focus on as the composition of the unemployment rate will be something to keep an eye on going forward and may contribute to the rate remaining elevated.

The household survey consists of those employed, unemployed and those not in the labor force. These three categories add up to the total population however the employment rate is calculated as the unemployed divided by the labor force (employed plus unemployed). As the number not in the labor force increases, as it has during this recession, it serves to reduce the unemployment rate. However, as the economy recovers adding those not in the workforce back to the denominator of the unemployment rate calculation will serve to inflate the rate. Not only do the unemployed have to find jobs but also those currently counted as not in the labor force but that will chose to return when prospects for employment improve.

For example, in January of 2007 the 230 million of survey population was comprised of 146 million employed, 7 million unemployed and 77 million not in the labor force (63%, 3% and 34% respectively). As of October 2010, the 239 million population is comprised of 139 million employed, 15 million unemployed and 85 million not in the labor force (58%, 6% and 35% respectively). See chart below. The bottom line is that those not in the workforce has grown as a percentage of the total; as the number is reduced to the extent that they don’t go straight to employed it will be an upward pressure on the unemployment totals.

click to enlarge

Another way to look at this is through the employment to population ratio. As can be seen in the chart below the ratio was near 63% percent prior to the recession and has fallen to 58.3% in October, the lowest level since December ’09. Essentially, new jobs created since the end of ’09 have only kept pace with population growth.

The decrease in unemployment rate from 10.0% at the end of last year to 9.6% currently is primarily due to people leaving the workforce. If we hold the percentage of population in the labor force constant from the beginning of the last recession (December ’07) the effect of people leaving the workforce on the unemployment rate really becomes clear. As you can see in the chart below, the official rate is 9.6% but holding the labor force constant as a % of population gives an unemployment rate of 11.7% (adjusted unemployment rate in chart below). As people as decide to resume looking for work and are thereby added back to the labor force, this downward contribution to the unemployment rate will reverse and serve to put upward pressure on the recovery of unemployment rate.

Finally, some anecdotal evidence from a conversation I had this week with a small business owner. We were discussing business conditions and I was completely surprised to find the biggest problem he is currently facing; finding employees. He has work lined up for two to three years out and could triple the size of the operation if he could find employees to hire. These are not minimum wages jobs either; they pay $40,000 per year or higher with overtime.

Granted, his line of business requires hard, somewhat dangerous work, but his experience is that it is hard to find people willing to get out of bed in the morning and willing to work. When I mentioned to him that the maximum length of unemployment benefits were 99 weeks this immediately was congruent to the problem he faces. His opinion; we need to let people starve a little to get them motivated. While, I actually doubt he wants people to starve his point is well taken; in some cases people need motivation to get back to. After all, it is much easier to make 75% of your former income sitting on your couch than going out working 40+ hours a week.

One solution may be letting people keep up to 50% of their unemployment benefits if they take a job that pays below what they earned before being laid-off. This would incentivize both people to get back to work by allowing them to earn significantly more than they would with just an unemployment check and cut taxpayer expense of paying for the benefits.

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Source: Number of Those Not-in-Labor-Force Suggests Unemployment Rate to Remain High