Each month, economists and analysts pour over monthly unemployment figures as a means of understanding hiring conditions within the economy. Unemployment is perhaps the single-most well-known — and perhaps most important — economic variable in gauging the economic prosperity of a country.
So, what is unemployment?
Unemployment refers to the number of people actively searching for work within an economy that are not currently employed.
This is an important distinction: You must be both actively looking for employment and out of work to be considered unemployed. Simply not working wouldn’t immediately make one unemployed.
As such, the unemployment rate measures the percentage of unemployed people within the labor force. The labor force is the number of people aged 16 and older who are either working or unemployed.
For example, if you take a labor force of 100 people, three of which are unemployed (and, by definition, seeking work), while the other 97 have jobs, the unemployment rate would 3%.
Unemployment is often mixed up with the labor force participation rate. The labor force participation rate measures the percentage of qualified, working-age people in the labor force.
Using the prior example of a labor force of 100 people, let’s say the total population of working-age people in this imaginary country is 150 people. In this case, the labor force participation rate would be 67% (100 ÷ 150).
A relatively low unemployment rate and high participation rate is a goal of most every modern economy.
The standards of employment are actually relatively lax. One need only work as little as one hour a week to be considered employed. This explains why even working-age teenagers are sometimes included in the unemployment calculation!
Different Kinds of Unemployment
There are actually several different kinds of both voluntary and involuntary unemployment. Each one has unique implications regarding the ever-changing structure and trajectory of the economy.
Frictional Unemployment. Frictional unemployment occurs when people voluntarily change jobs. When a person leaves a company, there’s usually a transition period before landing a new job. This is, in essence, frictional unemployment. As such, frictional unemployment is usually rather short term.
Unlike other kinds of joblessness, frictional unemployment is sometimes kind of a good thing. When people feel secure enough to leave their job in pursuit of a better, potentially higher-paying new job, it reflects positively on the economy as a whole. It also generally improves the allocative efficiency of the labor market as a whole. New graduates are a common source of frictional unemployment.
Cyclical Unemployment. Cyclical unemployment is unemployment resulting from changes in the business cycle of the economy. When deteriorating economic conditions or recession eats away at corporate confidence, many businesses will lay off their workers as a cost-cutting effort. This, in essence, is cyclical unemployment.
On the flip side, during periods of economic expansion, cyclical unemployment tends to be quite low. During these periods, companies typically hire more employees to fuel growth.
Cyclical unemployment is of chief concern to economists. Various policy initiatives have targeted reducing the ebb and flow of cyclical unemployment over the years, with some success.
Structural Unemployment. As its name suggests, structural unemployment occurs as due to structure of the economy. Frequently, structural unemployment results from a technological innovation that effectively makes some jobs obsolete.
There are myriad examples of technical innovations that resulted in structural unemployment over the years. The advent of computers, cars and clothing manufacturing plants all resulted in some jobs being lost in pre-existing industries.
Structural unemployment isn’t limited to technological breakthroughs, however. Changes in consumer preferences can also result in structural unemployment as producers of a now-unwanted goods are forced to lay off employees due to changes in economic structure.
Seasonal Unemployment. Seasonal unemployment refers to jobs that hire and fire on a seasonal schedule each year. This is also included under structural unemployment. The most obvious example of seasonal unemployment are shopping mall Santas, who have nowhere to go after the Christmas season!
Institutional Unemployment. Institutional unemployment stems from long-lasting, institutional factors in the economy. Things like minimum wage laws, unionization and hiring laws all contribute to institutional unemployment.
Both seasonal and institutional unemployment are frequently included as part of structural unemployment.
Understanding Unemployment Data
On a monthly and weekly basis, the U.S. releases data on the number of newly unemployed people in the country. This data is crucial to understanding hiring conditions in the country as well as gauging whether a recession is looming.
Every Thursday, the U.S. Department of Labor (DOL) releases initial jobless claims for the week prior. This is a count of the number of people who applied for unemployment benefits for the first time.
While not as closely watched as the monthly jobs report, the initial claims data is helpful in seeing emerging trends in the labor market. Elevated claims numbers tend to suggest economic weakness ahead while lower figures point to economic strength.
On the first Friday of every month, the Bureau of Labor Statistics (BLS) releases the “Employment Situation Summary.” This closely watched economic report details the notable changes in the country’s labor market in the month prior.
The monthly jobs report regularly moves markets and offers important insight into the state of the economy. The jobs report is perhaps the single-most important piece of economic data, period!
Included in the jobs report is the number of new nonfarm jobs, or payrolls, added to the economy last month, as well as the effective unemployment and participation rates. It’s worth noting that, because of the nature of the employment calculation, a large increase in new jobs doesn’t necessarily mean the unemployment rate will change one way or the other.
The monthly report also offers data on different demographics. This includes jobless rates for people of varying races, genders and ages.
Shortcomings of Unemployment
While economists rely heavily on unemployment data, that doesn’t mean it’s a perfect gauge of either the economy or the labor market.
Indeed, because of how unemployment is calculated, there are several ways in which our current data may underrepresent just how many unemployed people there are within the economy.
Monthly unemployment data is based on the results of a monthly survey called the Current Population Survey (CPS), conducted by the U.S. Census Bureau. The survey samples an ever-changing pool of roughly 60,000 eligible households in order to calculate the U-3 unemployment rate.
Remember the definition of the unemployment rate? The percentage of unemployed people in the labor force. Well this is actually the definition of the U-3 unemployment rate, the most commonly cited jobless metric, calculated by the BLS using survey data. U-3 unemployment, however, fails to consider discouraged as well as underemployed workers in the country.
Discouraged workers are previously unemployed individuals who, for whatever reason, ceased pursuing new employment for the last four weeks. Often stemming from inability to find a job, they are no longer considered in the unemployment calculation.
On the other hand, underemployed workers are those who are unwillingly employed in low-skill or part-time jobs due to failure to get more skill-intensive or full-time roles. Think individuals with high-level skills or education forced to take on minimum wage work due to a tight hiring market. These individuals are also disregarded in the typical U-3 unemployment calculation.
As such, the BLS actually calculates several other employment rate categories intended to include some of these variables absent in U-3 unemployment. Indeed, there are actually six total categories, ranging from U-1 unemployment (which only includes unemployed people for 15 weeks or more) to U-6 unemployment (which includes both underemployed and discouraged workers).
Many economists believe the U-6 unemployment rate should be the standard for evaluating joblessness in the country, as it paints the broadest picture of the hiring market. The U-6 unemployment rate is typically much higher than the U-3 rate.
Full Employment
While the unemployment rate may fluctuate quite dramatically within a given time period, typically the U.S. targets full employment. Now, despite its name, full employment doesn’t mean an unemployment rate of 0%. Indeed, full employment is simply a theoretical economic condition in which labor resources are “being used in the most efficient way possible,” per Investopedia.
Full employment is essentially an economic state in which anyone that is willing and able to work can do so. This would put unemployment at its natural rate. When at its natural rate, the economy is at full employment, and real GDP is equal to potential real GDP. It’s a sort of goldilocks environment for the economy where everything is humming along at a sustainable level.
Under full employment, cyclical unemployment should theoretically be zero. Instead the unemployment rate should consist of the sum of structural and frictional unemployment.
Full employment conditions vary from country to country, sometimes drastically. The Congressional Budget Office (CBO) estimates the U.S. natural rate of unemployment is about 4.4%, although the U.S. has averaged an unemployment rate of 5.7% between 1948 and 2024.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
