Economist Insights

Underemployed and understated

15 July 2013Asset management

The financial crisis created the worst unemployment situation

in the US for three decades, but since then the unemployment

rate has been falling. Unfortunately, the news is not as good

as it appears. As Chairman Ben Bernanke of the Federal

Reserve stated last week: “the unemployment rate probably

understates the weakness of the labor market”. For many

Americans, it is a situation of “congratulations, you are no

longer unemployed; but unfortunately you don’t have a job”.

The confusion is one of definition. The unemployment rate

only considers those who are actively looking for work. Such

a measure is useful for economists because it excludes those

who are not looking for a job at all (students, the retired,

disabled who are unable to work, and those who choose to

stay at home), and therefore it is good at measuring pressures

on wages in the market. However, when the economy has

been as bad as it is for so long, many people will become

discouraged and give up looking. Others may not enter the

labour market at all. The unemployment rate will not capture

these people who are outside the labour force because they

are not active participants and hence will not affect wages.

Pick a person at random on the street in the US, and the

probability that they have a job will be the same as it was three

years ago, despite the improvement in the unemployment rate

(see chart 1). The fall in the participation rate (all those people

not looking for jobs any more) has flattered the headline

unemployment rate. This is the wrong type of improvement,

and Chairman Bernanke knows it.

The drop in the participation rate is unprecedented in both size

and speed, so this cannot be blamed on the recession. The

participation rate was on an upward trajectory from the 1960s

onwards as women joined the labour force, broadly levelled

out from the 1990s to early 2000s and then started to fall. Up

to half of the drop in participation rate may have come from

demographics as the population is aging and people move into

age groups that usually have lower participation rates, but that

still leaves much of the divergence to explain.

Break things down into a bit more detail, and there are

some interesting observations. As is the case in Europe now

and in past recessions around the world, the biggest losers

from the recession have been the young. The increase in the

unemployment rate during the crisis for those aged 16-24 was

approximately double that of older cohorts (see chart 2), and

the fall in unemployment since then has been proportionately

less. The employment to population ratio also fell by more for

Joshua McCallum

Senior Fixed Income Economist

UBS Global Asset Management

 joshua.mccallum@ubs.com

Gianluca Moretti

Fixed Income Economist

UBS Global Asset Management

gianluca.moretti@ubs.com

Source: Bureau of Labor Statistics

Chart 1: Gainful unemployment

US unemployment rate and employment to population ratio (%)

4

5

6

7

8

9

10

11

Jan-13Jan-12Jan-11Jan-10Jan-09Jan-08Jan-07Jan-06

Unemployment rate (lhs)

58

59

60

61

62

63

64

65

Employment to population ratio (rhs)

The US unemployment rate has been falling but the news

is not as good as it appears. The unemployment rate only

considers those who are actively looking for work so it

does not capture those who have become discouraged

and given up looking. The summary unemployment rate

also obscures a lot of differences in the detail, such as

differences between age groups. The Federal Reserve

knows that the labour market is far more complicated

than just the unemployment rate and has given the market

a reminder of this – so do not expect rates to rise sooner

than the Fed has indicated.

 

this age group than any other, which can only be explained in

part by more people staying in education (rather than leave

without any job prospects).

One of the most striking features has been the performance

of those aged over 55. This pre-retirement and retired cohort

actually has a higher proportion of people employed than

before the crisis, even though their unemployment rate has

risen almost as much as their slightly younger counterparts.

The participation rate has actually risen for this group: so they

gained more jobs than they lost, but even more of them are

actually looking for work than before. This may have a lot to

do with the value of their pension pots: many people close to

retirement age may have been planning imminent retirement,

but the crisis slashed the value of their home and their equity

investments. Finding themselves with insufficient funds to

retire, many will have remained in their jobs wherever possible.

The decision to remain in jobs can have a knock on effect on

younger cohorts. When a worker postpones retirement there

is no vacancy created. Like all good economists, we know full

well that the ‘lump sum of labour fallacy’ is a fallacy – there is

not a limited number of jobs around so that old people working

may keep younger people unemployed. (If there was a limited

number of jobs the unemployment rate would just keep rising as

the population grew.) However, during a recession when firms

are reluctant to hire other than to replace workers that have left,

workers who already have jobs are at an advantage over those

who do not. This creates a transitional impact; the young will

really only benefit when the recovery finally takes off.

The recession has also been harsher on American men than

women, though much of this can likely be explained by the

industry-bias of the genders. There were disproportionately

more men working in construction and manufacturing, both

of which were especially badly hit. There are more women

employed in services, and in particular healthcare, which did

not suffer as much during the downturn.

There is a similar story when it comes to ethnicity. People

of Black & Caribbean or Hispanic origin (as defined by the

Bureau of Labor Statistics) suffered far more than those of

Asian or White background. Once again, this really a story

about another factor: education. Far fewer of those from Black

& Caribbean or Hispanic backgrounds have benefited from

further education, and the recession has been particularly bad

for those without qualifications. The rate of unemployment for

these groups was much higher to start with. So college may be

expensive in the US, but it clearly brings employment benefits.

While it is useful to have summary statistics like the

unemployment rate to quickly describe the economy, relying

too much on these numbers means that you miss a lot of

the detail. When it set its thresholds for raising interest rates,

the Federal Reserve knew full well that the labour market is

far more complicated than just the unemployment rate. For

the sake of simplifying communication the Fed headlined the

unemployment rate because it is familiar to everyone, but

warned that it would be looking at other statistics as well.

The market has been focusing on the steady improvement in

the unemployment rate, but Chairman Bernanke looks at the

employment to population ratio as well and he knows that the

improving unemployment rate is largely illusion: your economy

is not getting stronger when job-seekers are giving up.

Chairman Bernanke has also said that he believes that much

of the decline in the participation rate is cyclical: in short,

when the economy gets better people will start looking for

 jobs. If he is right, then this means that the economy will have

to generate even more jobs in order to absorb these people

returning to the labour force. That would require a very strong

recovery indeed, so no wonder Chairman Bernanke felt that it

might have been time to warn the market that their reaction

to the ending of tapering was overstated. He even warned

that “it may well be some time after we hit 6.5% before rates

reach any significant level” – so it looks like the Fed target

itself may be overstated as well.

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Chart 2: Divided and asymmetric

Change in the US employment to population ratio and the

unemployment rate by age, gender, race and educational

qualifications. Changes show from best outcome (pre-crisis) to

worst outcome (peak of crisis), and then from wors t outcome to

most recent reading (June 2013).

Source: Bureau of Labor Statistics, UBS Global Asset Management

Best to worst Worst to now

Employment to population Unemployment rate

-10 -5 0

Total

16-24

25-34

35-44

45-54

55+

Male

Female

No high school

High school

College

Further education

0 5 10

White

Asian

Hispanic

Black