Since Q4 2008, the U.S. Federal Reserve (Fed) has had a mandate to promote “maximum employment” in addition to its previously-existing mandate to promote “price stability”. Since December 2012, the Fed has been specifically striving to achieve unemployment of 6.5% or less. For these reasons, it is important to understand the unemployment rate better. In fact, it is important to understand the unemployment rate better less these factors.
The unemployment rate that is almost always quoted and that the Fed is striving to lower is not the true unemployment rate. It is a subset of the true unemployment rate. The true unemployment rate is much larger and somewhat unknown. In this article, I will provide an approximation of what the true unemployment rate is and define how the U.S. can obtain a true unemployment rate.
On Friday, June 7, the U.S. Department of Labor Bureau of Labor Statistics (BLS) said that the unemployment rate in May was 7.6%. When the BLS said this, they were quoting the U-3 rate. The U-3 rate is the rate that the Fed is striving to lower to 6.5% or less. The BLS also provides other unemployment rates, including rates known as U-4, U-5, and U-6.
The U-4 rate is the U-3 rate plus “discouraged workers”. Per the BLS: “Discouraged workers are persons not currently looking for work because they believe no jobs are available for them.” The U-5 rate is the U-4 rate plus “all other persons marginally attached to the labor force”. These people “wanted and were available for work”, but they “were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey…for reasons such as school attendance or family responsibilities”.
It is important to note that both discouraged workers and all others marginally attached to the workforce “looked for a job sometime in the prior 12 months”. Using this criterion approximately eliminates people who say they want to work but are not reasonably willing to look for work. Basically, you need to test the market occasionally to know that the effort of looking for work is not worth it. It is possible that you have a friend(s) looking for work that has about the same qualifications as you, so you do not need to test the market yourself. It is also possible that you tested the market in the last 12 months but did not put in a good effort in doing so. These things considered, the 12-month criterion is, arguably, a good one.
The U-6 rate is the U-5 rate plus “persons employed part-time for economic reasons (sometimes referred to as involuntary part-time workers). These individuals were working part-time because their hours had been cut back or because they were unable to find a full-time job.” They “want and are available for full-time work”. If you “usually work less than 35 hours per week”, the BLS counts you as part-time. Within U-3, U-4, and U-5, “people are classified as employed if they did any work at all as paid employees during the reference week”.
The true unemployment rate is somewhere between the U-5 and U-6 rates. This number approximates everyone who wants to work and is reasonably willing to seek work, and it gives only partial credit for being employed to those who work part-time but desire full-time work.
In its Current Population Survey (CPS), it appears that the BLS fails to ask a key question to those who are involuntary part-time workers. They fail to ask how many hours the involuntary part-time workers worked. The BLS should also ask the involuntary part-time workers how much money they made. If the number of hours a person worked was greater than the amount of money they made divided by the minimum wage, the BLS should only give hours-worked credit for the amount of money made divided by the minimum wage. If we had this information, we could calculate the true unemployment rate more precisely.
If we assume that part-time workers who desired full-time work were working, on average, 17.5 hours a week, the true unemployment rate in May was about 11.3%. This, and more, is illustrated in the following chart.
I do not expect that the BLS will enhance the CPS as I suggest and begin calculating and primarily communicating the true unemployment rate. Often, in America and other places, what is true is secondary to putting a better face on things. The U-3 rate puts a much better face on the unemployment situation. However, it is the true unemployment rate that should be calculated and primarily communicated; and this is the rate that the Fed should be basing its decisions off of―not the U-3 rate.
Some people claim that the true unemployment rate is even higher than I described because some people are employed in positions that are beneath a position they are qualified for. The fact that some people are employed in lower positions than they are qualified for does not make the true unemployment rate higher. Basically, someone has to fill the lower positions too. If everyone in the nation had an engineering degree and only 5% of the workforce was engaged in appropriate-level engineering or better positions, it would not equate to a 95% true unemployment rate. Quality of employment and unemployment are related but distinct items.
There are some important investor lessons that can be derived from the fact that the true unemployment rate is much higher than the unemployment rate usually quoted and utilized.
(1) The U.S. is not analyzed or managed as well as it could be due to focusing on an unemployment rate statistic that is window dressing.
(2) The U.S. was not and is not as economically strong across-the-board as presented.
(3) Comparing unemployment rates between countries can be deceptive. You may not only need to know the rates. You may also need to know how the rates were calculated.