The Natural Employment-Population Ratio
This Labor Day weekend is a good time to discuss two ways of viewing the state of the U.S. labor market. The President’s reaction to the August employment report was to suggest that the fall in the unemployment rate was a sign of an improving labor market. But the unemployment rate is simply one minus the ratio of employment as measured by the Household Survey (E) relative to the measured civilian labor force (F). With E rising by a mere 21,000, the reason that the unemployment rate fell is simply that F fell, which was due to a fall in the civilian labor force participation rate from 66.2% to 66.0%. This civilian labor force participation rate is the ratio of F to the civilian adult population (P). [All data taken from the FRED database from the St. Louis Federal Reserve, which provides some near graphs.]
Several economists have suggested that the ratio of employment to the civilian adult population (let EP = E/P) is a better measure of the strength of the labor market. EP was 64.4% when Bush took office but fell to 62.2% by August 2003. For many months, EP remained virtually constant even as the Employment Survey was showing moderately strong employment growth. Some have suggested that employment growth has barely kept pace with population growth, but we noted earlier that the Household Survey was showing less growth for 2004 than the Employment Survey. We also noted, however, the jump in the Household Survey measure in July offset this tendency. So the 62.4% EP ratio reported as of August 2004 can be reasonably compared to the 62.2% figure a year ago to note that there has been a very modest improvement in the labor market situation. I shall also suggest that this measure is a better measure than the unemployment rate because of the decline in F/P, which was 67.2% as of January 2001 but only 66.0% as of August 2004. (We noted here how Brad DeLong challenged the notion that the drop in civilian labor force participation was voluntary).
If the natural EP ratio is 64.4%, then the 62.2% EP ratio as of August 2003 suggests we should have had 142.651 million employed as P was 221.507 million. Since E was only 137.693 million, this measure suggests unemployment was 4.958 million. The 62.4% EP ratio last month suggests we should have had 144.048 million employed as P was 223.667 million. Since E was only 139.681 million, this measure suggests unemployment was 4.367 million, that is, a mere 12% reduction.
Some Bush apologists are arguing we should not try to get back to an employment market where EP = 64.4%, which is odd since the Bush Administration still argues the economy was weakening when it took office. But EP’s peak in early 2000 was only 64.7%. Noting that EP reached 63.9% in July 1997 and continued to rise staying above this level through April 2004, it is reasonable to argue that the natural rate of EP is at least 64%. If the natural EP ratio is 64%, then the 62.2% EP ratio as of August 2003 suggests we should have had 141.764 million employed. This estimate suggests unemployment was 4.071 million. The 62.4% EP ratio last month suggests we should have had 143.153 million employed. This estimate suggests unemployment has fallen to 3.472 million, that is, a 15% reduction over the last year.
Unless one argues that there has been a reduction in American’s desire to work since 2001, any reasonable measure of the natural EP rate suggests two things: (1) we are still far below full employment; and (2) the recovery over the last year has lowered the employment gap by an amount between 12% and 15%.