Investopedia/Elvis Picardo: How The Unemployment Rate Affects Everybody

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How The Unemployment Rate Affects Everybody

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By Elvis Picardo
Updated Jun 25, 2019
Table of Contents

    Why Unemployment Rate Matters
    Compiling Labor Statistics
    Employment vs. Unemployment
    The Labor Force
    Classifying Unemployed
    Measures of Unemployment
    U-6: The Real Unemployment Rate
    The Unemployment Test
    The Bottom Line

The national unemployment rate is defined as the percentage of unemployed workers in the total labor force. It is widely recognized as a key indicator of labor market performance. A closely watched economic indicator, the unemployment rate attracts a great deal of media attention, especially during recessions and tough economic times.
Why the Unemployment Rate Matters

As the U.S. Bureau of Labor Statistics (BLS) notes, when workers are unemployed, their families lose wages, and the nation as a whole loses their contribution to the economy in terms of the goods or services that could have been produced. Unemployed workers also lose their purchasing power, which can lead to unemployment for other workers, creating a cascading effect that ripples through the economy.

Unemployment even affects those who are still employed. When workers are let go, it increases the amount of work those who are still employed have to cover. And because unemployment usually increases when companies are trying to cut costs, those expected to pick up the slack are not receiving any additional compensation for extra hours worked. Unemployment can also have a negative mental effect on those who are still working. They may become more concerned about losing their own jobs or be hesitant to look for something better because they "are lucky" to be employed at all. They may even feel guilty about having a job when their co-workers are out of work.

To better understand the nature of unemployment, policymakers need information on many aspects of it, including the number of unemployed people, the period of time for which they have been unemployed, their skill levels, the trend in unemployment, regional disparities in unemployment and so on. Once these statistics have been obtained and interpreted, policymakers can use them to make better-informed decisions about steering the economy and countering unemployment.
Compiling Labor Statistics

One misconception about the unemployment rate is that it is derived from the number of people filing claims for unemployment insurance (UI) benefits. But the number of UI claimants does not provide accurate information on the extent of unemployment, since people may still be jobless after their benefits run out, while others may not be eligible for benefits or may not even have applied for them.

Counting each and every unemployed person on a monthly basis would also be a very expensive, time-consuming and impractical exercise. Therefore, the U.S. government conducts a sample survey—the Current Population Survey (CPS)—to measure the extent of unemployment in the nation. The CPS has been conducted monthly in the U.S. since 1940. About 60,000 households, or approximately 110,000 individuals, are in the CPS sample survey, selected to be representative of the entire U.S. population. A typical household included in the sample survey is interviewed monthly for four consecutive months and then again for the same four calendar months a year later.

The survey itself is carried out by 2,200 trained and experienced Census Bureau employees. They interview persons in the 60,000 sample households for information on labor force activities or non-labor force status of their household members during the survey reference week (generally the week that includes the twelfth of the month).

When a sample survey is used, rather than a survey of the entire population, there is a chance that the sample estimates may differ from the actual population values. The BLS notes if, at an unemployment rate of 5.5%, the 90% confidence interval is about +/- 280,000 for the monthly change in unemployment, and is about +/- 0.19% for the unemployment rate. In other words, there is a 90% chance the monthly unemployment estimate from the sample is within about 280,000 of the figure obtainable from a total census of the entire population.
Employment vs. Unemployment

The basic definitions used by the BLS in compiling labor statistics are quite straightforward:

    People with jobs are employed;
    People who are jobless, looking for jobs and available for work are unemployed; and
    People who are neither employed nor unemployed are not in the labor force.

The Labor Force

The sum total of employed and unemployed people makes up the labor force. The remainder is people who have no job and are not looking for one, such as students, retirees, and homemakers.

Note that labor force measures such as the unemployment rate are based on the civilian noninstitutional U.S. population that is age 16 and older. Labor force measures exclude persons who are below age 16, people confined to institutions such as nursing homes and prisons, and all personnel on active duty in the Armed Forces.

While the basic concepts that determine whether an individual is employed or unemployed are simple, given the millions of people that constitute the U.S. labor force, numerous situations can complicate matters and make it difficult to ascertain the correct category to which a person belongs.

People are considered employed if they did any work at all for pay or profit during the survey week. People are also counted as employed if they have a job at which they did not work during the survey week, for reasons such as being on vacation, falling ill, doing some personal work, etc.

(For related reading, see: What You Need to Know About the Employment Report.)
Classifying Unemployed

People are classified as unemployed if they fulfill the following three criteria:

    Do not have a job;
    Have actively looked for work in the prior four weeks; and
    Are currently available for work.

The official unemployment rate that is widely quoted in the media is based on the above definition of unemployment.

The criteria for being considered unemployed are rigorous and well-defined. For example, actively looking for work includes such measures as contacting prospective employers, attending job interviews, visiting an employment agency, sending out resumes, responding to job advertisements and so on. Therefore, this excludes passive methods of job search such as attending a training course or scanning the job advertisements in newspapers.

As such, the total unemployment figure includes people who have lost their jobs, as well as persons who have left their jobs to look for other employment, temporary workers whose jobs have ended, individuals looking for their first jobs and experienced workers returning to the labor force.

(For more, see: How Is Unemployment Defined?)
Measures of Unemployment

The official unemployment rate has often been cited as being too restrictive and not representative of the true breadth of labor market problems. Some analysts contend the official unemployment measure is too broad, and they would like a more narrowly targeted measure. However, they are in the minority, far outnumbered by those who believe the unemployment rate is too narrowly defined, which results in the full dimensions of the unemployment problem being understated.

To address these issues, the BLS, under the direction of Commissioner Julius Shiskin, in 1976 introduced a range of labor market measures entitled U-1 through U-6. In 1995, following the redesign of the Current Population Survey in the previous year, the BLS introduced a new range of alternative measures of labor underutilization. Regular publication of these measures commenced with the February 1996 Employment Situation report.

The measures range from U-1, which is the most restrictive since it only includes those people who were jobless for at least 15 weeks, to U-6, the broadest definition of labor underutilization. The U-3 measure is the official unemployment rate. U-1 and U-2 are more restrictive and therefore lower than U-3, while U-4, U-5, and U-6 are higher than U-3. (For related reading, see: The True Unemployment Rate: U6 vs. U3.)
U-6: The Real Unemployment Rate

The U-6 measure provides the broadest measure of labor underutilization. It is defined as the total unemployed populace, plus all marginally attached workers, plus all persons employed part-time for economic reasons, as a percentage of the civilian labor force plus all marginally attached workers.

Marginally attached workers are defined as persons without jobs who are not currently looking for work (and hence not considered unemployed) but who have demonstrated some degree of labor force attachment. To be included in this category, individuals must indicate they currently want a job, have looked for work in the last 12 months and are available for work.

One subset of the marginally attached group is discouraged workers. Discouraged workers are those who are not currently looking for work because of they:

    Believe no job is available to them in their line of work;
    Have been unable to find work;
    Lack of the necessary schooling, skills or experience; or
    Face some form of discrimination from employers (for example, being too young or too old).

The U-6 measure is being increasingly referred to as the real unemployment rate. Proponents of this measure contend it represents the true nature of the unemployment problem since it includes:

    People without jobs;
    Those who would like to work but have not actively seeking jobs in the past four weeks due to issues such as child care, family obligations or other temporary problems;
    Discouraged workers who have stopped looking for work because they think it is futile; and
    Underemployed people, which includes those who are actually employed but are working fewer hours than they would like.

The Unemployment Test

Consider the following hypothetical cases as examples of how the official unemployment rate (U-3) understates the magnitude of the labor underutilization problem:

    A single mother who has been unemployed for three months, but is unavailable for work for the past two weeks in order to care for her sick child, would be classified as "not in the labor force." She would be excluded from the U-3 measure but would be included in the U-6 measure.
    A 60-year-old former executive who lost his job in a corporate restructuring a year ago is keen to return to the workforce. However, after sending out more than 100 resumes in the first three months of unemployment, he is discouraged by the fact that he has not received a single interview call or acknowledgment letter, and has stopped his job-hunting efforts. He would be excluded from the U-3 measure but would be included in the U-6 measure.
    A sales executive with a family to support and bills to pay has been unable to find full-time work after six months of unemployment. He finally takes up a three-month contract that entails only six hours of work a week. While the U-3 measure would consider him employed, the U-6 measure would take his obvious degree of underemployment into consideration.

The Bottom Line

While the alternative measures show very similar movements over the course of the business cycle, they differ significantly in magnitude from the official unemployment rate. The strict definition of unemployment under the official U-3 measure may result in understating the magnitude of the actual unemployment situation. It is therefore advisable to look beyond the headline (U-3) unemployment number, as it may not convey the whole story. The U-6 measure, by virtue of being the least restrictive and therefore the highest unemployment rate, may provide a truer picture of the degree of labor underutilization. (For related reading, see: The Cost of Unemployment to the Economy.)
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Related Terms
The U-6 (Unemployment) Rate
The U-6 rate is the unemployment rate that includes discouraged workers who are no longer job seeking and part-time workers seeking full-time employment.
more
Unemployment Rate
The unemployment rate is the percentage of the total labor force that is unemployed but actively seeking employment and willing to work.
more
What Is a Discouraged Worker?
A discouraged worker is someone who is eligible for employment and can work, but is currently unemployed and has not attempted to find employment.
more
Civilian Labor Force
Civilian labor force is a term used by the Bureau of Labor Statistics to refer to Americans whom it considers either employed or unemployed.
more
Underemployment Definition
Underemployment is a measure of employment and labor utilization in the economy that looks at how well the labor force is being utilized.
more
Unemployment Definition
Unemployment is the term for when a person who is actively seeking a job is unable to find work.
more

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