The Unemployment and Labor-Force Participation Rates

During a recession, the public and media place a great deal of emphasis on the unemployment rate (=unemployed/labor-force *100) as a measure of human suffering, but, like all statistics, it is subject to errors in measurement such as that caused by discouraged workers. These workers become "discouraged" by the bad job market and stop looking for employment. By definition, an adult must be employed or looking for employment to be in the labor-force, and must be an adult without employment but looking for it to be unemployed. An increase in discouraged workers causes an equal drop in the unemployed and the labor force and makes the unemployment rate lower as the labor market worsens. Conversely, a decrease in discouraged workers makes the unemployment rate rise as the labor market improves.

Period	1	2	3	4	5	6
Adults	1,000	1,000	1,000	1,000	1,000	1,000
Labor-force	660	657	654	651	653	655
Employed	601	598	595	592	593	594
Discouraged Workers (DW)	0	4	8	12	10	8
Unemployed	59	58	57	56	57	58
Labor-force participation rate	66.00	65.70	65.40	65.10	65.30	65.50
Unemployment rate with DW	8.94	8.83	8.72	8.60	8.73	8.85
Unemployment rate w/o DW	8.94	9.70	10.15	10.61	10.30	10.00

The example contained in the Table demonstrates how the employment rate can fall as the labor market deteriorates from period 1 through period 4 and then rise as it improves from period 4 to period 6. The number of adults who wish to work remains constant at 660. They do not all remain in the labor-force. The labor market deteriorates during the first four periods resulting in a decline in employment of 3 workers each period. As the market deteriorates, the number of discouraged workers increases by 4 each period, one worker greater than the number losing their jobs. Because discouraged workers are not part of the labor-force or the unemployed the labor-force falls from 660 workers in period 1 to 651 workers in period 4 and unemployment falls from 59 to 56 during the same period. Even though employment is falling, unemployment is decreasing because workers are leaving the labor-force. The unemployment rate falls from 8.94% in period 1 to 8.60% as the labor market deteriorates. If these workers had not become discouraged and had persisted in seeking employment, the unemployment rate would have worsened from 8.94% in period 1 to 10.61% in period 4 as should happen in a deteriorating market.

The labor market improves in the last two periods with an unemployed worker being hired each period. Sensing the improvement in the labor market, two discouraged workers rejoin the labor-force each period and are now counted as unemployed. As the labor market improves, the unemployment rate rises 8.60% in period 4 to 8.88% in period 6.



Using the labor-force participation rate in conjunction with the unemployment rate paints a more accurate picture of the labor market. The graph shows the U.S. labor-force participation rate measured on the left vertical axis and the unemployment rate measured on the right vertical axis from September 2007 through February 2010. Initially, the labor-force participation rate remains stable as the unemployment rate increases. Beginning in June 2008, the labor-force participation rate falls as the unemployment rate rises suggesting a rapidly worsening labor market. Between October 2009 and December 2009, the labor-force participation and unemployment rates fall, the exact situation as described in the table. The labor-force participation rate improved from December 2009 to February 2010 as the unemployment rate improved suggesting a strengthening labor market. This analysis rests on the assumption that the labor-force participation rate declined because many workers became discouraged. If correct, it may take many months for the unemployment rate to fall to historical levels as the discouraged workers reenter the labor-force.