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We are now aware of the basic steps involved in the calculation of unemployment rate. We now know that there is a vast difference in what we call an intuitive guess of what the unemployment rate means and what the statistics published by the government mean. Let’s crystallize this understanding with the help of an example.
Country A has a population of 100 million. There are 10 million children and 5 million retired personnel over the age of 60. Then, there are about 12 million housewives and other people who have opted not to work. Lastly, 5 million people are unemployed as per the statistics. What is the unemployment rate ?
Common sense viewpoint would make us believe that most of the information in this example is unnecessary. The population is 100 million and out of those, 5 million people are unemployed. Hence, the unemployment rate is 5%.
The common sense viewpoint is incorrect. This would be a severe understatement of the unemployment rate.
Contrary to the commonsense viewpoint is the prescribed method. This is the method followed by most countries across the globe when it comes to calculating the unemployment statistics. The method is a 4 step process aimed at reducing the denominator from the entire population to the relevant population which is actually interested in finding work.
Children and old people do form a part of the entire population. However, they are not expected to find employment.
In fact, most countries around the world have laws prohibiting the use of labor of children less than 16 years of age. Therefore the denominator has to be adjusted according.
Instead of the denominator being 100 million, we will subtract 10 million children and 5 million retired personnel from it and the modified denominator is 85 million. This 85 million is what we call, the working age population.
Now, the job of the government is to find jobs for the people who are interested in working. At any given point of time, there may be a large portion of the labor force that may not be interested in providing services in the market. This category usually includes housewives as well as other people who have simply opted out of the labor market.
Hence, we need to further adjust our denominator to reflect these. Hence, from the 85 million, we need to subtract the 12 million disinterested people. This gives us our labor force of 73 million people.
Governments have a tendency to include a lot of people in this category of disinterested workers. This makes their statistics look good and helps them avoid blame when the going gets rough. To monitor this tendency, economists have created a metric called labor force participation rate.
This rate measures the total number of people who are part of the working age population with the number of people who actually work i.e. the labor force. In our case, the labor force can be calculated by dividing 73 million by 85 million and converting it into a percentage i.e. 86%.
Minor movements in the labor force participation rate are ignored. However, if significant movements occur, the new figure becomes incomparable with the earlier numbers.
The lat step is to calculate the actual unemployment rate. The unemployment rate is calculated by dividing the number of unemployed people by the number of people in the labor force.
The logic is that it is the government’s job to try and find employment for all the able bodied laborers in the economy who are willing to work.
Hence in this case, we will divide 5 million by 73 million to obtain the unemployment rate. This is an unemployment rate of 6.8% which is about 40% higher than the rate of 5% which we guessed using the common sense method.
It is therefore essential for every student of economics to be well versed with this calculation of unemployment rate for both academic as well as practical purposes.
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