Question

In what manner does its measurement overstate the economic hardship caused by unemployment? Understate the hardship? Explain.

Answer 1

The official unemployment rate is estimated and reported monthly by the Bureau of Labor Statistics (BLS) of the U.S. Department of Labor using data obtained from the Current Population Survey. Given that the BLS is charged with estimating the employment, unemployment, and labor force status of over 200 million people each month, they do a commendable job. However, like any measure of economic activity in a complex, dynamic economy, the unemployment rate is not flawless.

The imperfections of the official unemployment rate fall into two categories. One that suggests the "true" unemployment of labor resources is likely greater than the official unemployment rate and the other that suggests the "true" unemployment of labor resources is likely less than the official unemployment rate. Two items that show up in the understated category are discouraged workers and part-time workers. Two items that shows up in the overstated category are unreported legal employment and unreported illegal employment.

While the two categories of imperfections might seem to cancel each other, the understated imperfections tend to be most pronounced during business-cycle contractions while the overstated imperfections tend to be most pronounced during business-cycle expansions.

The BLS, however, is not oblivious to these problems. In addition to the "official" unemployment rate, the BLS actually tracks five other unemployment measures that seek to address some of these imperfections and give a better picture of unemployment situation in the economy.

Understated?

First, consider the understated items, discouraged workers and part-time workers. Both of these result from the inability of the BLS to accurately measure "intent" combined with the practical need to place each person into one, and only one, of three possible categories: employed persons, unemployed persons, or not in the labor force.

Discouraged workers might "want" to work, but they have demonstrated no effort to obtain employment, so they are placed in the "not in labor force" category. Part-time workers might "want" to work full time, but they are in fact working, and are thus placed completely in the "employed persons" category. Correctly categorizing unemployed labor resources is likely to increase the unemployment rate above the official level.

• Discouraged Workers: Discouraged workers are people who are willing and able to work, and would gladly accept work, but because they have had no success finding a job they have given up actively seeking employment.

  To be officially counted as unemployed, a person must be actively seeking work. When the BLS tabulates the official unemployment rate, discouraged workers are placed in the "not in labor force" category. Because they are NOT officially considered to be unemployed and are they NOT considered part of the labor force, then they are NOT included in the official unemployment rate calculation. However, these discouraged workers do, in fact, represent unemployed labor resources. They SHOULD be included in the unemployment rate. Doing so would boost the unemployment rate by up to half of a percentage point (that is, from 5.0 percent to something like 5.5 percent).

• 
  
• Part-time Workers: Part-time workers are people who are willing and able to work full-time (35 to 40 hours per week), but are forced to work less because employers do not need their productive efforts. While they have jobs, and are officially included in the "employed" category when the official unemployment rate is calculated, their labor resources are really only partially unemployed. For example, a person working 20 hours a week, who is willing and able to work 40 hours a week, should be considered as "half employed," but is officially consider only as "employed."

  This problem results because the official unemployment rate "counts heads" to measure of labor resources, rather than something like "hours." While, ten people working 20 hours a week are the productive equivalent of five people working 40 hours a week and five people working 0 hours per week, they are not equivalent for the unemployment rate. Ten part-time workers generates a lower unemployment rate, than five full-time workers combined with five unemployed workers. Part-time workers SHOULD be included in the unemployment rate. Doing so would raise the unemployment rate by two to three percentage points (that is, 5.0 to 7.0).

Overstated?

Second, consider the overstated items, unreported legal employment and unreported illegal employment. These problems result from the inability of the BLS to verify the truthfulness of the information provided by respondents. Some respondents in the Current Population Survey intentionally lie about their employment status. These respondents fail to report legal employment because this might jeopardize income that is being fraudulently received through transfer payments. Other respondents fail to report illegal employment because this could place them in jeopardy of criminal prosecution. Correctly categorizing employed labor resources would decrease the unemployment rate below the official level.

• Unreported Legal Employment: Government transfer payments (especially unemployment compensation and welfare) are based on the needs of recipients. In general, working individuals are not eligible to receive these payments (or they receive reduced payments).

  Some people collect these transfer payments by fraudulently "neglecting" to inform government officials of their actual employment. While their jobs are legal, fraudulently collecting transfer payments is not. Even though respondents of the Current Population Survey are assured that the information collected remains confidential, most of these "double-dippers" are not inclined to reveal their actual employment status to "government" census takers. While they might say that they are unemployed, they are in fact working. Correctly categorizing these people as employed would decrease the unemployment rate below the official level.

• 
  
• Unreported Illegal Employment: The underground economy is comprised of illegal productive activities, such as gambling, the sale of controlled substances, and prostitution. Firms engaged in these illegal activities employ workers just like firms operating in the legal "above ground" economy.

  Due to the illegal nature of the activities, workers are somewhat less forthcoming about their employment status. When "government" census takers use the Current Population Survey to inquire about their employment status, they are inclined to hide the truth for fear of criminal prosecution. While they might say that they are unemployed, they are in fact working in an illegal activity. Correctly categorizing these people as employed would decrease the unemployment rate below its official level.

Over or Under?

So which imperfection, if either, is worse? Is the official unemployment rate understated or overstated? Is it too high or too low? Or do these imperfections cancel out, making the unemployment rate approximately correct? Here is the story behind the story.

• Contractions: Discouraged workers and part-time workers tend to be most pervasive during business-cycle contractions. With fewer jobs, people are more likely to become discouraged or be forced into part-time employment. However, the economic downturn is also likely to affect the underground economy and those who fraudulently try to collect transfer payments. When workers claim to be unemployed during a contraction, they probably are.
• 
  
• Expansions: By contrast, the problems of discouraged workers and part-time workers tend to be much less pervasive during business-cycle expansions. With more jobs available, people are less likely to become discouraged or be forced into part-time employment. However, the economic upturn is more likely to affect the underground economy and those who fraudulently try to collect transfer payments. A greater number of workers who claim to be unemployed during an expansion, might very well receive incomes from other employment, legal or illegal.