Saturday, October 6, 2012

Who's driving who? Unemployment and labor-force participation

There are dependent variables and there are independent variables. An independent variable is--supposedly--not responsive to changes in other variables (or at least not the ones being scrutinized); when doing statistical analysis, the independent variable drives the results. It is changed to see what the consequences are for one or more other variables, the dependent variables.

A simple example: suppose you have a product to sell and you want to make at least a 20% profit, above what it costs you to make that product. How much do you sell it for? The simple equation that provides the answer:

price ≥ cost + (.2*cost)

The price you charge must be at least the cost to make the product plus an additional 20% of that cost. In this equation, price is the dependent variable, while cost is the independent variable. The cost can change, but not because of the price. In contrast, any change to the cost impacts the price. Thus, cost drives price. Got it? Easy stuff, I know. But knowing which variables are independent and which are dependent can become tricky when we're dealing with more complex analysis and systems.

With that in mind, let's talk about two of my favorite topics: the unemployment rate (UR) and the labor force participation rate (LFPR). With the recent drop in unemployment--according to the always-trustworthy BLS--the LFPR is all over the news; while Obama touts the improvement of the UR, Romney is busy criticizing the numbers because of the LFPR. For those unaware, the LFPR is currently in all-time low territory. It went up a smidgen, but it's still way down there. A chart from a few months back:

(courtesy Zerohedge.com)

Currently, the LFPR sits at 63.6, slightly higher than it was in August, yet still lower than it was in July. The significance of the LFPR is simple: the lower it is, the fewer people there are being counted to determine the UR. Look closely at the chart. The LFPR falls off a cliff in 2009, just after Obama takes office. And it's been trending down--way down--ever since. Month after month, the size of the labor force has been shrinking.

Given that the unemployment rate is figured by dividing the number of "actively unemployed" by the total labor force, this means--follow closely here--the LFPR is driving the unemployment rate, to an extent. The lower the LFPR is the lower the UR will be, if all other variables are held constant.

Here's the question no one seems to be exploring: is that right? Is the LFPR actually independent from the UR? Some of the media know-it-all types have sought to address the numbers being cited by the Romney camp,  i.e. the UR based on a constant LFPR of 65.7% (the rate it was when Obama took office). Here's a typical one at the NYT:
If you had the same labor force participation today as you did in January 2009 (65.7 percent, instead of today’s 63.6 percent), that would bring the total number of people in the labor force up to about 160 million, instead of about 155 million. 
Then if you assumed that those five million people you added into the labor force didn't get jobs, that would bring the total number of unemployed people up by five million, to a total of about 17 million. That would bring the overall unemployment rate to 10.7 percent.
Correct. That's exactly the assumption being made by Romney and others on the Right when they talk about the real unemployment rate being closer to 11%. But the author here has a justification for the falling LFPR:
This exercise, though, assumes that the entire drop in the labor force participation rate from January 2009 to the present is a result of discouraged people giving up on looking for work. It ignores the fact that the baby boomers are hitting retirement age, meaning that demographics would probably bring down the labor force participation rate even if the economy were booming. Gary Burtless, an economist at the Brookings Institution, estimates that half of the decline in the labor force participation rate “can be traced to an aging population.” The calculation above also ignores the fact that a higher share of young people are going to college, and are staying out of the work force temporarily while they improve their skills.
Where to start, where to start...

Well, let's dispense with the college nonsense first. It is true that college enrollment among high school grads has been steadily rising--or at least it was until 2009, when it began to level off--but more significantly, part-time college enrollment has been rising since 2007. This means that more young people are still working--or looking for work--while attending college across the last several years when the LFPR began to fall. So the college angle is worthless; the writer here doesn't have a clue what she is talking about.

But on to the baby boomer talking point. This one is all over the place. It's an easy position to take, since it can't be quantified. And we've been hearing about the phenomenon--the baby boomer retirement wave--for decades. In that regard, when did it begin? Because as the above chart shows, the LFPR was rising through 2000. Following a post 9-11 drop for a few years, it began rising again in 2004, plateaued for a bit, then fell off the 2009 cliff.

To buy the baby boomer argument, one would have to believe this wave began exactly in 2009. How convenient. But Pew seems to think the starting year for the wave is 2011, based on the assumption that the baby boomer generation started in 1946. Moreover, one of the chief talking points about the consequences of the 2007-2008 financial crisis was that it wiped out the retirement savings of many people who were close to retirement, forcing them to delay their retirement and keep working. Simply put, there's really no way a significant part of the drop in the LFPR can be attributed to retiring baby boomers.

So why is it dropping? What's the real reason? The answer is simple and readily apparent, if one just looks at the chart. When there is a booming economy, the LFPR tends to go up. When there is a slowdown or a recession, it goes down. Why? Because it's easier to find jobs. So more people look for them and get them. Thus, there is a simple corollary here: economic growth drives both the UR and the LFPR. More growth means a lower unemployment rate and a higher labor force participation rate. In fact, the UR drives the LFPR, as well: when the reported unemployment rate goes down, more people enter the work force because they think it will be easier to find jobs.

Watch what happens in next month's jobs report from the BLS: the LFPR is going to go up by more than just a smidgen, you can take that to the bank. Why? Because the BLS reported an unemployment rate of under 8%. The consequence? Next month's UR will go back up, likely to over 8%.

Cheers, all.

3 comments:

  1. I am with you entirely on the gist of your argument. But I disagree on one point, which you were choosing to think of as insignificant, and I think to be relevant.

    The people "hiding" in college. How to put this succinctly? Traditionally, college was a process you went through to improve yourself personally and to be more highly valued in the market place. This basic tenant has become significantly corrupted as the cost of higher education increases more than the economy in general, and wages in specific. Add to that, increasing availability of grants and loans have encouraged student debt of staggering amounts.

    What do they do when student loans come due after graduation, and the job market you were banking on to pay off those loans just isn't there? Many are finding a way to stay. Somehow.

    And it has always been a competition betwixt college and gainful employment at the outset. The decision must be made partly on economics, and the return on investment for that degree.

    When the job market sucks, and the veil has yet to be completely ripped from the perceived worth of a college degree, people on the edge who would have just picked a career and gotten started investing in it, end up spending themselves at University.

    Sometimes it is the lesser choice, even though we have been schooled to think otherwise. Bad choices have costs....

    Anyway, thanks for reading. I would write better if the edit box was larger (lame excuse) and could edit more easily.

    Yeah, the clock would wait for that.

    peace.
    I always enjoy your thoughts.

    ReplyDelete
  2. I don't disagree with what you are saying, Roy. But numbers-wise, I don't think this has an impact on the LFPR. Indeed, as I noted, the number of part-time students--relative to full-time ones--has been going up for years now. Which means college isn't having the impact on the LFPR that the author in the article I cited thinks it is having.

    Thanks for the comments!

    ReplyDelete
  3. Not entirely related, but I am pretty sure you'll like it
    http://www.powerlineblog.com/archives/2012/10/paul-krugman-then-and-now.php
    :-)

    ReplyDelete