Financial Review

Basic Economics – Unemployment

It has come to my attention that we sometimes talk about certain things on the Financial Review that can be confusing to some people, so today we embark on what will become a series of segments that I call, “What you need to know about basic economics.”

 

Now you may have heard economics referred to as the dismal science, but it really is about much more than just statistics and numbers. On a more basic level, economics is the study of people: how we interact, how we work, how people succeed or fail, how we play games, how we negotiate, and how we are motivated to get out of bed each day.  It looks at what makes us happy and content, and can even help us understand how mankind has progressed over generation to become more healthy and prosperous than ever before. So, economics encompasses history, psychology, politics, and a few statistics thrown in to make it more believable.

 

Speaking of politics, you may have noticed that this is campaign season, and one of the first and most important promises you hear from politicians is that they want to create jobs for everybody. You will hear the same pledge from all political parties, not just in the US but around the world. And in economics, everything comes back to jobs and unemployment. However much attention the experts and politicians pay to gross domestic product, inflation, interest rates, and wealth, the most vital question is whether people do or do not have a job. So, today’s lesson is on unemployment.

 

The definition of unemployment simply means the state of not having a job. But wait, there’s more. There is a big difference between a temporary office worker who is merely between jobs for a few weeks (which is known as frictional unemployment) and a factory worker whose skill are no longer in demand because his  industry has moved production overseas in search of cheaper labor. The temp worker will soon be back at work and adding to private sector economic output. The displaced factory worker needs to be retrained and will likely be unemployed for a much longer term.

 

So economists have developed different classifications of unemployment. The strict definition of unemployment is when someone is out of work but actively seeking a job. The U.S. Bureau of Labor Statistics (BLS) is responsible for measuring the nation’s unemployment rate by carrying out a monthly survey, known as the Current Population Survey. Each month, the BLS contacts 60,000 randomly selected households across the country and records the employment status of each person 16 years old or older. The collected data is then used to extrapolate a variety of national labor force statistics, including six different technical measures of the unemployment rate.

 

These six unemployment rates are labelled U-1 through U-6, respectively. For the Current Population Survey, an unemployed person is not currently working but is available to work and has actively looked for work at some point during the prior four weeks. The civilian labor force is the sum of all employed and unemployed people. A person who has no job and has not looked for a job in the last four weeks is not technically an unemployed person and is not included in the labor force.

 

The U-3 unemployment rate is the officially recognized rate of unemployment, measuring the number of unemployed people as a percentage of the labor force. The U-3 unemployment rate in February was 4.9%. The U-6 unemployment rate includes people who are out of work plus people who work part time because full-time work is not available due to economic conditions. The U6 unemployment rate was 9.9% in February.

 

Unemployment tends to ebb and flow and full unemployment is impossible in practice because people change jobs, or take some time off, or some workers need to be retrained. So the unemployment rate will never be zero. Which raises the question, what is full employment? Or what is known as the “natural rate of employment”?

 

Economist A.W. Phillips uncovered an uncanny relationship between unemployment levels and inflation. If unemployment falls below a certain level, it will push wages higher, and higher wages are likely to result in higher inflation; that is known as wage push inflation. In order to maintain profits after an increase in wages, employers must increase the prices they charge for the goods and services they provide. The overall increased cost of goods and services has a negative effect on the wage increase, and eventually, higher wages will be again needed to compensate for the increased prices for consumer goods. The opposite is true with high unemployment, which tends to push down inflation. Phillip’s theory resulted in an equation which came to be  known as the Phillip’s Curve, which more or less illustrates the negative correlation between unemployment and inflation, such that if you want low unemployment, say around 4%, you will probably end up  with high inflation, say around 6%. If you want inflation around 2%, you might have to accept higher unemployment, say around 6%. That’s the theory, even though we now have 4.9% unemployment and inflation is still less than 2%.

 

So, when you hear the politicians tell you they want a job for everybody and a chicken in every pot, remember the economist who tells you that zero percent unemployment is impossible.

 

Anyway, the government reports on non-farm payrolls on the first Friday of each month, and we then report it and analyze it hear on the Financial Review, so be sure to tune in Friday.

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