Principles of Managerial Economics
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Effect of Quantitative Easing on Stock Markets
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Is a World Without Inflation Possible?
In the previous many articles, we have been discussing a lot about the various concepts of inflation. We have understood in great detail, the way things are. However, when it comes to inflation, the ideal way that things must be is also extremely important. The only way to reach an amicable solution is to have […]
The Subvention Scheme Trap
Real estate investments are known for fancy financing schemes. The right financing can make any real estate investment very lucrative whereas the wrong financing can end up giving disastrous results. Real estate developers have started using several different types of financing schemes to woo wary home buyers in the time of an industry slowdown. One […]
The Economics of Human Resources in the Informal Economy
Nonexistent Rules in the Informal Economy The informal economy operates in a very different way from the formal economy. Whereas the latter is structured and governed by laws and regulations, the former operates pretty much on the rules made by individual players and in a “make as you go” manner wherein on the spot rules […]
In this article, we will explain the first and probably the largest flaw in the calculation of unemployment rate i.e. the discouraged worker flaw. This issue has been widely debated in the media and amongst the experts for years. However, little has been done to make the average person aware of it.
The unemployment rate is supposed to be a fair metric which gives the correct picture of the number of people which are unemployed in any given country. However, there is some fine print in the definition, a loophole which works in the favor of governments. It works in the government’s favor because it makes the unemployment rate appear smaller in bad times i.e. less worse than it actually is. However, when times are good, there is no effect on the unemployment rate.
The fine print in the definition is that:
The logic used behind the discouraged worker exclusions is grounded in solid fact. If some people decide that they are not interested in working anymore, they must be removed from the calculations. However, the criterion adopted to identify such discouraged workers is preposterous.
Consider the first criterion i.e. 4 weeks of active job search. Compare and contrast this with the fact that the average person who loses his job in the US takes about 40 weeks to get another job! Let’s say that for any 4 consecutive weeks, they were not looking for a job because of any reason, they are simply classified as people who do not wish to work and are removed from the labor force!
Consider the second criterion. This is even harsher. A person that has been unemployed from the past 52 weeks is simply removed from the labor force regardless of whether or not they were actually looking out for a job! Now compare and contrast this with the statistic that during recessionary times, the average American will be unemployed for 90 weeks before they can find a job. Therefore, most of the average Americans will simply be excluded from the labor force in recessionary times. As a result of this the unemployment rate will appear to be much better than what it should look like!
Consider the following example, to understand the gravity of the situation. Let’s say a recession hits the US and in reality about 40% of the workforce is unemployed. However, half of those 40% have been unemployed for over a year. Hence common sense would say that the situation is grave and the 20% that have been unemployed for over a year are the worst affect and must be rehabilitated as soon as possible.
This is not however, how the official unemployment rate calculation works. The official rate would reduce the 20% from the labor force. The people who were therefore the worst affected and therefore need the most rehabilitation are simply ignored from the calculation. The other 20 will be considered unemployed. However, the labor force has fallen to 100-20 i.e. 80 after excluding the so called discouraged workers. The official unemployment rate would therefore be 20/80 i.e. 25% when in reality the situation is much worse since 40% people are unemployed and over half of them for a very long period!
The discouraged workers are removed from the calculation in bad times whereas they have no effect on the calculation in good times. If the 4 week and 52 week criteria are met, then the discouraged worker issue becomes meaningless. However, the ironical part is that the unemployment rate is usually important in bad times. Bad times are when governments are supposed to create policies based on this number and if this number is misleading at that moment, then the policies can be adversely affected!
The discouraged worker flaw makes the unemployment rate a completely biased metric. Hence, when an average person reads the unemployment rate, they must also pay attention to the labor force participation rate. A fall in unemployment should not be in conjunction with a fall in labor force participation rate or else the real reason behind the fall of the unemployment rate could be the exclusion of people from the calculation.
As a result of persistent lobbying by many economists, governments all over the world now also include the number of discouraged workers in their unemployment rate reports. However, this number is usually mentioned in the fine print and not well publicized. As a result, only people who know a fair bit about unemployment can and do include this number in their analyses.
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