1 out of 5 Jobless in Normal Labor Force

Economic policies have kept the U.S. GNP down from its full potential, keeping unemployment higher than it should be --- which is barely (if at all) keeping up with population growth. And antiquated ways of measuring the real unemployment rate greatly under-defines the real jobless numbers.

Adjusted for the labor force participation rate (LFPR), the U-3 unemployment rate would be nearer to 11% today. And counting ALL "discouraged workers" who "dropped out of the labor force" (using the U-6, Alt U-6 or U-7 rates of measurements), the unemployment rate would skyrocket, making one out of every five working aged adults (who would normally be in the labor force) unemployed today.

Research by Christopher Erceg and Andrew Levin is providing solid evidence that the decline in the labor force participation rate since 2007 has been due to cyclical factors --– the recession and slow recovery --– rather than to demographic factors.

In other words, the fact that such a large number of people have dropped out of the labor force is associated with the weak economy, rather than to their reaching their retirement years --– or some other typically mentioned demographic trend.

Because the unemployment rate does not count the people who dropped out of the labor force, it no longer gives a good reading of the state of the labor market. The unemployment rate would be much higher without this large decline in labor force participation.

In the latest version of their paper Chris and Andy estimate how large the US unemployment rate would be without this abnormal decline in the labor force, and they produced this amazing chart which summarizes their findings.

The fascinating chart from their recent paper shows that the decline in labor force participation rate is far greater than the demographics would suggest.

That the actual unemployment rate has become such a poor indicator of labor market trends is one reason why many economists have focused on the employment to population ratio.

Jim Devine at Econoclast, when describing NBER recessions vs. actual recessions (Part One), he writes: "For most people, there's a more important issue than GDP...for most people what counts is jobs, jobs, jobs." He calls what some call the jobless recovery an oxymoronic phrase:

It should not be surprising that there are controversies surrounding the issue of whether a "recession" is really over or not. This is especially true when we’re talking about a world-shattering episode like the Great Recession that started in late 2007 and ended in the middle of 2009... So-called "ordinary" folks, for whom the economy’s situation is up close and personal, often see a "recession" as including, not only the period when the economy is falling, but also the quarters -- or even years -- when it’s stagnating in the aftermath of an "official" NBER recession.

In Part Two of his article, Jim Devine explains why "real" GDP must grow faster than 3 percent per year to get unemployment rates to fall --- and why anything less will lead to higher unemployment. He says one possibility of the so-called "jobless recovery" arose because of what economists call “Okun’s Law,” named after the late economist Arthur Okun, who says that the slow growth of the U.S. economy since the 2009 should imply rising official unemployment rates (U3), but that the exact opposite has happened:

Okun's law captures the nature of a real problem. This idea goes beyond the common-sense idea that producing more real GDP means that more jobs are available, so that unemployment rates fall. It says that in order to prevent unemployment rates from rising, the year-to-year growth rate of real GDP must exceed approximately 3 percent per year.

Back in 1962, Okun's Law holds that for each increase of 1 percentage point in real GDP, the unemployment rate would fall by 0.30 percentage points. Updated research (including all the quarters from 1948 up into 2013) shows that a 1 percentage point rise in the growth rate of real GDP is associated with a 0.28 percentage point fall in the unemployment rate --- almost exactly the same as what Okun found in 1962.

The study concludes that Okun's Law does appear to be a robust empirical relationship that has endured over the past 50 years, including during the Great Recession.

From Brookings: Okun's Law says we're growing well below our economic potential:

"The 4.6 percent unemployment rate in the two years preceding the Great Recession are a reasonable estimate of full employment. Unemployment in the second quarter of this year was 3 points higher than that, so the output gap was about 6 percent of GDP, or roughly $800 billion. This measure of today's output gap is quite consistent with estimates of today's employment shortfall that my colleague Gary Burtless recently made using a different methodology. He estimated that employment today is about 5 percent, or 7.4 million jobs, below what it would be at full employment."

Excerpted and edited from a post by Paul Krugman:

Macroeconomic Advisers has a new report showing that since the GOP takeover of the House, the combined effects of uncertainty in the bond market and cuts in discretionary spending have subtracted 1% from the GDP's annualized rate of growth --- meaning almost 3% of actual GDP --- with losses around $700 billion of wasted economic potential. And the report also estimates that the current unemployment rate is 1.4 points higher than it would have been without those Tea Party/Republican policies.