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The deceivingly low unemployment rate in the US

The Labor Department just reported that the unemployment rate is at 5%.  The Federal Reserve considers a base unemployment rate (the U-3 rate) of 5.0 to 5.2 percent as “full employment” in the economy.  Classic economic theory predicts that a tight labor market develops when “full employment” is reached.  Specifically according to this theory, once “full employment” is reached, employers begin having more difficulty filling job vacancies, followed by increases in wages (beyond the inflation rate), either to keep their employees from leaving, or to recruit good employees from someone else.  However, the US unemployment rate has been at or below this 5.0 – 5.2% range since July, 2015, with essentially no increase in wages during this time.  What gives?

Clearly, it is time for the Fed to adjust it’s definition of what “full employment” is, because if it means that it is the time when wages begin to meaningfully rise, then an unemployment rate of 5.0 to 5.2% is too high.

One clue to make sense of this is to look at a measure called the labor-force participation rate.  The “full employment” of 5.0-5.2% idea was conceived during the days when the labor-force participation rate was much higher than it is today.  Experts have even stated with an optimistic tone that recently the participation rate has increased from 62.9% to 63%, stating that it is at its highest rating in two years, and further using the upward turn to the right of the figure from the Bureau of Labor Statistics below as evidence of an uptrend:

However, what happens when we look at a longer period of time, such as all data post-WWII, when the ratio of single earner to dual earner households was much higher than it is today? Well, we see two disturbing truths in the longer term trend, particularly since 2008:

One is that from a peak of nearly 67.5% to today’s 63% (ie 4.5%) is nearly a 50% drop to it’s long term rate of just over 58% (pre-1966) when most households had one earner, not two. Given that a much higher percentage of households are dual earner today compared to pre-1966, one would expect this chart to remain above 66%  Certainly the retirement of “baby boomers” will cause some of this decrease, but not all.  The second disturbing trend more evident in the long term chart is that any recent uptrend in this chart is tenuous at best.  Rather, it is just as likely that we will not get a “V shaped” recovery in this trend, and that the continual downward trend since 2009 will continue unless more drastic changes are made to put more working class people to work, including those that have given up hope.

Maybe economists need to switch to a combination of the unemployment rate and the labor-force participation rate, and not just state the unemployment rate as a measure of “full employment”.  If this is done, it is likely that this alternate measure will more accurately predict when “a tight labor market will develop”, which would in fact bring meaningful increases in wages.

Perhaps just as importantly or more so, political policies that have been in existence since 2009 will need to change to eventually truly bring about “full employment”.  Economists can devise a more accurate measure of unemployment for today’s society, but they are not in position to get this job done.  It is up to US citizens to elect the appropriate leaders to get this done, at the State and especially at the Federal level.

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