It’s first Friday of the month and time for the employment report. And we’ve got quite a muddle on our hands.  The headline numbers, what the media will highlight and the politicians spin, show a big decline in unemployment rate but with a very disappointing number of new jobs.  That’s conflicted enough, but the muddle gets worse.  Read on, there’s some lessons here but not much clarity on the direction of the economy. First let’s go to Calculated Risk for the headline numbers:

From the BLS:

The unemployment rate fell by 0.4 percentage point to 9.0 percent in
January, while nonfarm payroll employment changed little (+36,000),
the U.S. Bureau of Labor Statistics reported today.

So what’s happening? What are we supposed to learn from this report? There are several lessons to take from this report, but probably the most important is that we should never place too much importance on a single month’s employment report – despite the the decimal points and precise-looking numbers. Like all macro data, these are highly flawed statistics from complex methods. But, it’s the best we have based on the best methods we’ve figured out so far and it’s a heck of a lot better than complete ignorance. Since this report offers such a muddle, I’m going to explain it in three posts.  This post will deal with the numbers and possible first-pass explanations for the difference between an improved unemployment rate but a really bad new jobs created number. The next post will explain some of the hidden methodological problems that lead to odd reports this because when you dig deeper, this report gets even more contradictory. And finally I’ll offer a post commenting on what conclusions I think we can draw for the state of the economy.

First, when unemployment rate declines but the number employed goes up, even by a little, the first suspect is a change in labor force participation. In other words, the unemployment rate only measures what portion of the labor force is unemployed. It is strongly affected by changes in the number of people in the labor force – new entrants and people who drop out of the labor force. In “normal times” (can we really expect that to exist again?) we would expect that new entrants, young people seeking a first job and returnees like housewives getting back in, would exceed the number who drop out of the labor force. In fact, in “normal times” the labor force in the U.S. will grow by 150,000-175,000 people every month, requiring that many new jobs just to keep unemployment rate constant. Of course in a “normal” month there are also people leaving the labor force. People who are retiring, dying, going back to school, or just wanting to pursue other activities like staying home with the kids. But in periods of recession and for quite some time after a recession, there’s an unusual number of people leaving the labor force because they get discouraged. That is, they really do want to work but they’ve been unemployed, often for extended periods, and have abandoned actively searching for job. Remember active search is necessary to be included in the labor force. When this happens in significant numbers, the denominator in the unemployment rate calculation declines relative to the numerator. The unemployment rate declines even though there really weren’t very many, if any new jobs added to the numerator. An easy check to see if this discouraged-worker phenomenon is happening is to look at the labor-force participation ratio, the percentage of the adult civilian non-institutionalized population, the people who conceivably might be in the labor force, who have chosen to be available for work, in other words, be in the labor force. Again back to CR:

The following graph shows the employment population ratio, the participation rate, and the unemployment rate.
Click on graph for larger image.

The unemployment rate decreased to 9.0% (red line).

The Labor Force Participation Rate declined to 64.2% in January (blue line). This is the lowest level since the early ’80s. (This is the percentage of the working age population in the labor force. The participation rate is well below the 66% to 67% rate that was normal over the last 20 years.)

So what’s happened is that a large number of people are no longer participating in the workforce. In fact it’s been well over 27 years since the participation has been this low. Now that fact by itself is worthy of more exploration, research and discussion, which I hope to touch on in my third post in this series.  But up next is a post on the methodology used for the employment situation report – where the numbers come from, because there’s a big story this month there as well.