Why the decline in the unemployment rate isn’t a necessarily good thing

Jan. 12, 2014 @ 03:25 PM

It’s too early to declare victory for North Carolina’s jobs crisis, since most of the improvements we’ve seen in the state’s unemployment rate haven’t shown up in real job creation. Instead, North Carolina finished 2013 with fewer jobs in November than existed in January -- a net loss of jobs. And even more troubling, the total size of the workforce has shrunk dramatically to the lowest levels in two years.

It is true that in 2013, we observed a strong improvement in the state unemployment rate. We ended 2012 with a December unemployment rate of 9.4 percent, and by November 2013 the unemployment rate was 7.4 percent. By contrast, the improvement in the national unemployment rate was from 7.8 percent in December 2012 to 7.0 percent in November 2013. 

This sounds quite like an impressive victory for North Carolina economic policy, but is in fact just a warning that the state is postponing its unemployment problems. Consider the following figures drawn from the US Department of Labor database. During 2010, North Carolina created 80,000 jobs on net and reduced its unemployment by 0.6 percentage points. During 2011, North Carolina created 70,000 jobs on net and reduced its unemployment rate by 0.7 percentage points and in 2012, North Carolina created 100,000 jobs on net and the unemployment rate fell by 0.4 percentage points. In 2013, there were 6,000 jobs LOST on net and the unemployment rate fell by two percentage points.

Six thousand fewer people employed, and yet the unemployment rate fell by two percentage points? How can this be? The answer is found in the definition of unemployment. In 2013 there were 6,000 fewer people employed in November than at the end of the previous year, but there were 104,000 fewer people reported as unemployed. (In 2012, by contrast, there were 100,000 more people employed, but only 12,000 fewer people reported as unemployed in December than in December 2011.)

By convention, we measure employment status by survey. If a survey respondent indicates that (a) she does not have a job and (b) she is actively searching for work, then she is classified as unemployed. If she responds that she does not have a job and is not actively searching for work, then she is not considered “unemployed;” she is treated as outside the labor force. The precipitous fall in those unemployed in 2013 even though fewer residents were employed indicates that these residents are no longer actively seeking work. This shows up in the reported size of the measured labor force in North Carolina: it declined by 2.5 percent in the first 11 months of 2013, after many years of growth at an average of 1 percent per year.

Why would we observe such a rise in those outside the state labor force? Two possibilities are demographic shifts (more workers retiring than are labor-force-entry age) and emigration from the state. I don’t have the data to reject these, but neither seems relevant to North Carolina.  The most likely explanation, in my view, is that large numbers of workers became discouraged in seeking work and simply stopped looking. Legislative policy may have encouraged this in 2013:  the reform of Unemployment Insurance (UI) led to large numbers of residents being cut from the rolls or having their payments under the program terminated more quickly. The UI program requires recipients to be actively searching for jobs; without the program, the unemployed have less incentive to search.

We can see, then, that the correct interpretation of the unemployment-rate decline has important policy implications. We can’t simply sit back and take credit for a recovery; we need to recognize that the current fall in unemployment rate simply means that many more of our residents have left the labor force at least temporarily. Once our recovery begins, many of these will once again actively search for jobs. 

A better metric for policy in this recovering economy will be the rate of growth of employment.  We’ve seen a small uptick in the period September-November 2013, but this will have to be much more pronounced to bring all of our eligible residents back into employment. Ending the year with fewer people employed than at the beginning of the year should not be considered a success. (The best metric for policy will consider not only the rate of growth of employment but also the wage at which new employment is offered. New employment at wages that leave the worker below the poverty line is less attractive than new employment at a higher wage.)

In short, let’s save our celebrations until we learn more about the real employment and wage outcomes.  

Patrick Conway is a professor of economics at the University of North Carolina at Chapel Hill. This column was distributed by N.C. PolicyWatch.