Friday's unemployment report showed apparent improvement on the headline number, with the unemployment rate moving from 9.0% to 8.9%. On the surface, this seems like progress. But as usual, once you dig into the report, persistent economic problems are revealed.

Since February 2010, the labor force has contracted by -312,000, and the labor participation rate has fallen from 64.8% to 64.2%. While the number of unemployed people has dropped by almost -1.2 million people, almost 2.2 million people have left the labor force. Even though there are 875,000 more people employed than last year, that rate of increase cannot even keep up with population increases.

The decrease in the unemployment rate is only coming about because more people are leaving the workforce. In other words, they are not even trying to find work, for various reasons. Even the calculation of the broadest measure of unemployment, U-6, stops including people who have decided to leave the workforce after a period of time. One data source estimates this unemployment rate to actually be 22%.

Strangely, the problem has only worsened since the recovery began in June 2009. Since the start of the recession in December 2007, 6.76 million workers have left the labor force; but 6.48 million of that is since June 2009. The exodus of workers is what is making the unemployment rate decline.

The chart below shows the rather dramatic rise in the number of workers considered to no longer be in the workforce (click to enlarge; Y-axis data are in thousands):

The dynamics of the situation are somewhat fascinating. Economists have warned that extension of unemployment benefits raises the unemployment rate, since workers become pickier about the jobs they will perform even if jobs are available. Older workers (you're one of them if your physician starts using terms like “people of your age” during routine checkups) are deciding to collect Social Security benefits early, if they are eligible, rather than seek work that might be out of their experience range or may not offer pay to their liking. Some households decide that if an unemployed wage earner can still qualify for extended benefits another household member will not seek work. When you add that to the mix of a generally retrograde employment environment in which jobs are scarce or only temporary, the vital measure of “no longer in the workforce” worsens.

One of the rarely mentioned reasons for accepting benefits rather than pay is that you receive 5% more in spending power for every dollar collected. How? Unemployment benefits are not subject to FICA (payroll tax, or Social Security tax, more accurately). They are subject to income tax, however.

Businesses are making do with cost cutting and changing their operations, usually with some accompanying investment in computing and communications technologies. Productivity as measured by total output is still higher than GDP growth, which implies that job creation will remain stagnant; it is not until GDP exceeds productivity that more workers are needed. With materials and other input prices (as measured by the Producer Price Index) growing faster than the marketplace can tolerate them at the consumer level (as measured by the Consumer Price Index), those increased costs are being paid for by increased productivity and other cost cutting. One of the reasons that this unemployment report was so disappointing was that wages did not show any increase. This means that workers are not being paid for their increased productivity, and the purchases of everyday goods, such as food and fuel, are likely to crowd out other purchases.

Nonetheless, the general unemployment rate dropped from 9% to 8.9% and the broader definition dropped from 16.1% to 15.9%. Our forecast in December's webinar was that unemployment would drop to 8.5% by the end of this year. It appears that we are getting there in the least desirable way possible.

If the economy were improving, we would see a temporary surge in the unemployment rate because of a flood of people returning to the workforce. Right now we have the paradox of an improving economy and a rise in workforce exits. That paradox has to switch to an improving economy and a rise of workforce entrants. While that would make the unemployment rate temporarily worse, it would signify a major change in economic direction.

A Warning About All Upcoming Economic Data

The next few months will be quite interesting for those who follow economic reporting. Later this month, the Federal Reserve will be issuing revised data for its manufacturing activity data, including its capacity and capacity utilization data, going back more than two decades. In May, the Commerce Department with issue revised manufacturing industry data, going back at least one year, and possibly five. In June, the Bureau of Economic Analysis will issue its revisions to GDP and other data going back as much as five years.

About Dr. Joe Webb

Consultant, entrepreneur, and economics commentator Dr. Joe Webb started his career in the industrial imaging industry more than 30 years ago. He found his way into business research, planning, marketing and forecasting executive positions along the way, as well as consulting for firms ranging from large multinationals to small businesses. Dr. Webb started an Internet-based research business in 1995, selling it to a multinational publisher in 2000. Since that time, his consulting, speaking, and research projects have focused on the interaction of B2B economics and technology trends. He is a doctoral graduate in industrial and corporate education from New York University, holds an MBA in Management Information Systems from Iona College, with baccalaureate work in managerial sciences and marketing at Manhattan College. He has taught in graduate and undergraduate business programs in a number of Northeast US colleges, and currently resides in Rhode Island.