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Why unemployment is falling fast

Few things are more puzzling and disconcerting for an economist, and much of the American public, right now than the unemployment rate.

From late 2008 to the end of 2009, the U.S. unemployment rate jumped by 3.1 percentage points. What was so shocking about this was that the relationship between unemployment and the drop in the gross domestic product during the recession would have predicted only a 1.2 percentage point increase. This was the largest forecasting error in decades.

Since then, the baffling moves have been in the opposite direction, with unemployment falling from 9.8 percent in November to 9.4 percent in December. Since then, the unemployment rate has dropped even further, to 8.9 percent in February. We’ll get the March figures Friday.

Regardless of whether the rate ticked up or down, the 1.2 percentage point drop in the unemployment rate from its peak in 2009 is a puzzle because economic growth hasn’t been strong enough to generate such a large decline.

The conventional wisdom now holds that the rate should rise because many workers who left the labor force will come back and start looking for a job as the economy improves. To be counted as unemployed, someone must have searched for a job in the past month.

While many jobless workers have indeed given up on the search, I’m going on record as a contrarian. I suspect a large rise in the labor force won’t cause the unemployment rate to jump. Instead, I suspect we’re going to see a continuing decline in the unemployment rate, though there surely will be some blips along the way.

Here’s how my thinking goes.

First, there’s history: Once unemployment starts falling it usually does so for a while. Second, and more important, data that I computed using Bureau of Labor Statistics figures shows a remarkable development in the types of workers who have been leaving the labor force.

Those out of work for a year or longer used to have the highest labor force dropout rate. Now they have the lowest. In the last couple of years, the recently unemployed have been more likely to leave the labor force than the long-term unemployed.

What has been keeping the long-term unemployed in the labor force? There are a few possible explanations.

First, many people out of work for long periods may have been induced to stay in the labor force because they are required to search for a job in order to receive unemployment insurance benefits. Those benefits were extended to a maximum period of 99 weeks in 2009.

Second, as a result of the depth of the recession, the composition of the long-term unemployed might have shifted toward people who are strongly attached to the workforce —in other words, people who are motivated and have more advanced skills.

Third, some of the short-term unemployed might have left the labor force to get more training and education to improve their skills and job prospects. Riding out a recession and weak recovery in school isn’t a bad strategy.

Here’s something to think about. At the end of this year, extended unemployment benefits will expire, while other people will exhaust their benefits during the course of the year. Once that happens we might start seeing more people give up looking for work, restoring the pattern where people unemployed the longest leave the labor force at a higher rate than others.

After all, the prospect of finding a job after looking for two years is small, and it probably won’t improve much even if the labor market continues to heal.

So we might well see the labor force shrinking more even as the measured unemployment rate falls. Nonetheless, we still will have a serious joblessness problem even as the unemployment rate falls.

Instead of focusing on the unemployment rate, it may be better to look at the employment-to-population ratio, or the share of the population that is employed. This rate isn’t affected by whether someone is counted as in or out of the labor force.

Tellingly, the employment-to-population rate has hardly budged since reaching a low of 58.2 percent in December 2009. Last month it stood at just 58.4 percent. Even in the expansion from 2002 to 2007 the share of the population employed never reached the peak of 64.7 percent it attained before the March- November 2001 recession.

What this indicator tells me is that we weren’t creating enough jobs long before the recession that began in December 2007. If this pattern holds, even in recovery, it points to a much deeper and disturbing problem for the U.S. economy.

Alan Krueger, professor of economics at Princeton University, was assistant secretary of the U.S. Treasury for economic policy.