How to Calculate the Unemployment Rate

The discouraged worker trap

This is the single most tested idea on the page, and the arithmetic is counterintuitive enough to be worth doing.

Start with a population of 250 million, a labour force of 160 million and 8 million unemployed. The unemployment rate is 8/160 = 5%, and the labour force participation rate is 160/250 = 64%.

Now suppose 2 million of the unemployed give up looking. They are no longer counted as unemployed, and they are no longer in the labour force either. The rate becomes 6/158 = 3.8%, and participation falls to 158/250 = 63.2%.

Unemployment FELL, and nobody found a job. That is why the participation rate is reported alongside it: a falling unemployment rate paired with a falling participation rate usually means people are leaving the labour force, not entering work. Discouraged workers are the standard example, and the same logic explains why the headline rate can look healthy in a weak economy.

Who counts, and who does not

To be unemployed you have to be out of work, available for work, and to have actively looked in the past four weeks. All three conditions matter, and questions are built around dropping one of them.

Not in the labour force at all: full-time students who are not looking, retirees, stay-at-home parents, discouraged workers, and anyone institutionalised. None of these push the unemployment rate up, because they are in neither the numerator nor the denominator.

Counted as employed, which surprises people: part-time workers who want full-time hours, and unpaid workers in a family business working at least fifteen hours a week. Someone working one hour a week and wanting forty is employed for these purposes, which is why underemployment does not show up in this number at all.

The three kinds, and which one the rate cannot reach

Total unemployment splits into frictional, structural and cyclical. Frictional is people moving between jobs, which is short-lived and to some extent healthy: it is the sign of a labour market matching people to work. Structural is a mismatch between the skills people have and the jobs that exist, which lasts longer and is what retraining policy targets. Cyclical is the part caused by a downturn.

The natural rate of unemployment is frictional plus structural, and it is the rate the economy sits at when cyclical unemployment is zero, which is to say when output is at potential. It is not zero and policy cannot drive it to zero, because there will always be somebody between jobs.

So the useful reading of any unemployment figure is the gap from the natural rate. Above it means a recessionary gap and positive cyclical unemployment. Below it means an inflationary gap, an economy running past potential, which is possible in the short run and is what the Phillips curve describes.