Why U.S. Unemployment Rate Is 12.1%

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by: Carlos X. Alexandre

There are plenty of ways of looking at the unemployment numbers, and U3 is the "official unemployment rate." The U6 measurement is often mentioned to highlight the precarious condition of the job market in America in a broader sense, and according to the Bureau of Labor Statistics (BLS), the official rate is 8.5% while U6 stands at 15.5%. The definition for U6 is as follows.

Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force.

I must acknowledge that the BLS has made modifications to its methods (pdf) over the years, but I used their numbers as published.

This exercise is not about U6, which is also higher than reported, but rather the participation rate (PR) that is often mentioned in passing. While new jobs and the official unemployment rate grab the headlines, as will be the case on Friday, the labor force ratio to civilian population - participation rate -- highlights the economic weakness, sheds light on why this recovery is not materializing, and why we're in for a long struggle.

First we must look at the growth rates for "Population," "Labor Force" and "Employed," and the seasonally adjusted data from the BLS was used for the chart below.

It's apparent that the labor force kept up with population growth until 2007, and then growth rates diverged. The lack of jobs forced the participation rate reduction, whose magnitude has not been observed over the last 20 years. Despite the recent improvement, we have a clear indication that a typical economic turnaround is not in the cards. The spikes in the "Employed" growth rate are the result of the participation rate being higher than the average.

Based on the data published by the BLS, the average participation rate between 1990 and 2011 was 66.26%, and the same average for the pre-crisis period of 1990-2006 was 66.56%. The official participation rate at the end of 2011 was much lower at 63.96%, and although the difference appears small, it delivers some sobering results.

The averages for both periods - 1990-2011 and 1990-2006 (pre-crisis) - were used to adjust the labor force numbers, and the logic is based on an assumption that in a normal economy, even in a recession, the participation rate should stay virtually constant, as observed in the first chart. While the official unemployment rate is 8.5%, the true unemployment rate is magnified considerably to 11.7% when the 1990-2011 average is applied, and a higher rate of 12.1% emerges when the pre-crisis number is plugged in. By extrapolating the results, U6 is closer to 21%.

Participation Rate Unemployment Rate
Current (December 2011) 63.96% 8.5% (official)
Using 1990-2011 PR Average 66.26% 11.7%
Using 1990-2006 PR Average
(pre-crisis)
66.56% 12.1%
Click to enlarge

The average unemployment rate for the 1990-2011 period was 6%, and assuming that population will continue to grow at roughly 1% per year, while using a rounded participation rate of 66%, we need 130,000 new jobs every month just to keep up with population growth.

But there's already a current shortage of 8.5 million jobs using the same 6% average unemployment rate, and to close the gap we need another 360,000 jobs every month, non-stop, for the next three years, or close to 500,000 jobs monthly to return to the norm. Certainly if the period is shorter, the required number of new jobs per month is higher.

One way is to achieve a lower unemployment rate is to freeze job creation and layoffs today, and drop the participation rate to 60%. By the end of 2012, even with population growth at 1%, the official unemployment rate will be 3.55%, or literally full employment.

How did the participation rate increase over time? A paper (pdf) published by the BLS explains.

As has been well documented, labor force participation rates among married women have increased dramatically in recent decades, rising from 35 percent in 1966 to 61 percent in 1994.

The writing is on the wall, and the expectation of a garden variety economic turnaround is misplaced. The question remains on how to navigate the future, despite the pockets of hope that will emerge along the way. If we must adapt to the current participation rate, or even drop to the 62.86% average for the 1948-2011 period, we are faced with an excess of business capacity.

Furthermore, if the future indicates that more dual-earner households will switch to single "breadwinners," then consumption will decline, and somewhere out there we'll find the balance. But finding that balance will not happen any time soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.