Unemployment is an important statistic when looking at the economy. A lot of weight is placed on unemployment when developing and implementing both monetary and fiscal policy.

Of course, 100% full employment would be impossible. However, what many people don’t know is that a certain level of unemployment is desirable. This is called the natural unemployment rate. We will look at this more later on.

Statistics never lie, but liars use statistics.

Anonymous

Unemployment is often used as a statistic to determine the health of the economy. If it is a main determinate if our economy is in good health or bad health, we would want it to be as accurate as possible. Just like when we go to the hospital, we want the test they run to be as accurate as possible.

There are many other misconceptions about unemployment. We hope to help set some of the misconceptions on the right path. The two big questions we want to answer are; What is unemployment? And, is unemployment as accurate as we think?

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What is Unemployment

At its core, unemployment is simply the state of being unemployed. However, if it were that simple, the unemployed cohort would have to include the retired, the clinically unemployable, children, students, etc.

The simplest way to calcualte unemployment is:

Unemployment rate = (Number unemployed/Civilian Workforce) x 100

Due to this, unemployment statistics only include those actively searching for employment that are unable to find work. I think most of us would agree that is fair.

There are many causes of unemployment, but are typically categorized in three ways: Cyclical Unemployment, Frictional Unemployment, and Structural Unemployment.

Cyclical Unemployment

Cyclical unemployment is the component of overall unemployment that results directly from cycles of economic upturn and downturn. Unemployment typically rises during recessions and declines during economic expansion.

This is the type of unemployment that governments and central banks look at more closely when deciding on fiscal and monetary policy decisions.

Frictional Unemployment

Frictional Unemployment is the result of voluntary employment transitions within an economy. This type of unemployment naturally occurs, even in a growing, stable economy.

People entering the workforce for the first time out of school, or those leaving their jobs for potential better opportunities both contribute to frictional unemployment.

Structural Unemployment

Structural unemployment is a long-lasting form of unemployment caused by fundamental shifts in an economy and exacerbated by extraneous factors such as technology, competition, and government policy.

This type of unemployment is impacted when available workers lack the required skills, live too far away from available jobs, etc. In essence, jobs are available but there is a disparity between what workers can do/offer and what companies need/require. This type of unemployment is often brought about by technological advancements.

Natural Unemployment

Both structural and frictional unemployment play into natural unemployment. Natural unemployment, or the natural rate of unemployment, is the minimum unemployment rate resulting from real or voluntary economic forces.

If unemployment is not deemed to be ‘natural’ it is often referred to as cyclical. Much like inflation targets (~2%), governments have targets for what natural unemployment should be. These targets are generally in the ballpark of 3.5% – 4.5%.

Why Some Unemployment is Good

There are several reasons why having some unemployment is healthy for an economy. Much the same way having some inflation is healthy for an economy.

The first reason is that there are people available to fill new jobs. As companies grow, economies expand, and technology advances, new jobs are often created. Having some unemployment means that there are people able to fill that role if they have the desired skills.

The second reason is a bit more complex. Inflation and unemployment are inversely correlated. This means that as unemployment rises, inflation decreases, and vice versa. Why is this?

Well if unemployment is high, it means that people will most likely be willing to work for less money then they are actually worth. In turn, this would give them less consumer purchasing power, and decrease the velocity of money (how fast money moves around the economy).

Conversely, if unemployment is low, or 0%, for business to fill vacant positions they will have to make that position more desirable than the one a perspective employee currently holds. The easiest way to do this is to increase the wage. This will have the opposite effect of lower wages.

Another common argument for some unemployment has to do with technological advancements. Since one of the main causes of structural unemployment is advancements in tech, if there was no unemployment, one could conclude that there is minimal or no tech advancements.

How Unemployment is Measured

If you were to take unemployment statistics at face value they would paint you quite a picture. It might not be the most accurate picture though. For instance, as a recession ends, natural unemployment typically rises. Seems counter intuitive does it not?

Well natural unemployment takes into account frictional unemployment. This type of unemployment will increase as a recession ends since workers can finally quit their jobs feeling confident they can find a better one.

In order to get the most accurate picture of what unemployment represents you have to go deeper than just the percentage statistic. For that reason it is beneficial to look deeper at how unemployment is calculated and is taken into account.

When it comes to employment an individual can fall into 1 of 3 possible categories: employed, unemployed, out of the labor force. So, the labor force is composed of all employed and unemployed. According to Statistics Canada, the labor force is defined as “that portion of the civilian non institutional population 15 years of age and over who, during the reference week, were employed or unemployed.”

Employed is a pretty easy concept to understand, however, unemployed is a bit more cumbersome. According to The Canadian Encyclopedia, “The unemployed include those without work but seeking work, those available for work but not looking for work because they were on temporary layoff and expected to return to the job for which they were laid off, those laid off for less than 6 months but available for work or those who have not sought work in the previous 4 weeks but have a job to go to within 4 weeks.

There are a couple terms that pertain to employment that should be defined; Labor Force, Potential Labor Force, and Participation Rate.

Labor Force

Refers to the total adult population available to the labour market at a specific time. Stats Canada defines it as “that portion of the civilian noninstitutional population 15 years of age and over who, during the reference week, were employed or unemployed.

Canada’s Labor Force in July 2020 was 20,029,500.

Participation Rate

This refers to the number of employed and unemployed people as a percentage of the population aged 15 and older. To figure out participation rate you just divide the labor force by the population, then multiply by 100.

(Canada labor force (20,029,500) / Population (31,171,500)) x 100 = 64.3%

Potential Labor Force

Includes people in the labor force, and people not in the labor force who wanted a job but didn’t search for reasons such as ‘waiting for recall (to former job),’ ‘waiting for replies from employers,’ ‘believes no work available (in area, or suited to skills),’ ‘ long-term future starts, and ‘other’.

according to the most recent labor force survey on Statscan, they mention the potential labor force three times. Two times in their definitions section, and once when talking about labor underutilization. The only stat they give in reference to potential labor force is that 22.4% of the potential labor force was partially or fully underutilized.

Problems with Unemployment

After reading to this point, you may be able to see at least one of the points we are trying to make. Of course, no system is perfect. Maybe the system we have in place now is as good as it could possibly be. However, there is one issue worth mentioning; not including potential labor force.

Not Including Potential Labor Force

As mentioned above, finding stats on how large the potential labor force is has proven difficult. Let’s assume that for every 100 people in the labor force, there is 1 additional person in the potential labor force. That seems like a pretty fair assumption, if nothing else then for arguments sake.

So we know the labor force in Canada is roughly 20,029,500. That means the potential labor force would be 20,229,795. Calculated as 20,029,500/100 = 200,295. 200,295 + 20,229,500 = 20,229,795.

These people that are in the potential labor force but not in the labor force, obviously don’t have jobs. So, if we add an additional 200,295 people to our current amount of unemployed people, our unemployment rate rises to 11.7% rather than 10.9%.

Calculated as follows: (2,183,600 (current unemployment) + 200,295 (potential labor force addition)) / 20,229,795 (potential labor force).

Another way to look at the people in the potential labor force that aren’t currently accounted for is discouraged workers. This is someone who is of working age, but has not been seeking employment or who hasn’t found employment after long-term unemployment, but who would prefer to be working.

This is extremely applicable in today’s society. Someone who was fired or layed off in March has now been without work for 5 months. Maybe they were looking for work but couldn’t find anything, got discouraged, and haven’t looked recently because they believe things haven’t changed. This type of person is considered to be unemployed.

The longer these potential workers remain unemployed, the harder it will be for them to get employment. This is similar to what was mentioned under Structural Unemployment.

Conclusion

In the end, although reported unemployment has been dropping, it could be due to more than people just finding jobs. Maybe more people are becoming discouraged workers, maybe they have been unemployed long enough to no longer be in the labor force.

As mentioned in the beginning, no system is perfect. However, that doesn’t mean we shouldn’t strive to make it better, or in this case more accurate. A great way to give a more accurate picture of the unemployment picture would be to provide information on the potential labor force.

Let us know your thoughts in the comments below. Do you think unemployment could be understated? What are some things you think should be implemented (or unimplemented) to help with current unemployment.

To read more on unemployment check out our previous post: Unemployment Hits 50-Year High.

Sources:

https://www.benzinga.com/general/education/16/12/8766111/why-the-unemployment-rate-should-never-go-to-0

https://www.thebalance.com/natural-rate-of-unemployment-definition-and-trends-3305950

https://www.thecanadianencyclopedia.ca/en/article/labour-force#:~:text=The%20labour%20force%20refers%20to,was%20taken%5D%2C%20were%20employed%20or