Why a Higher Minimum Wage Can Result in a Lower Unemployment Rate

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Those who argue in favor of raising the minimum wage often point to examples of when the unemployment rate fell after the government increased it. One reason why this can happen is the unemployment rate only includes people who are actively looking for work. As a result, the more people who give up looking for work, the lower the unemployment rate will be.

One of the most popular statistics reported by the government is the unemployment rate: “the percentage of the total labor force that is unemployed.”1 However, this statistic is not an accurate measure of unemployment. If a person has not searched for a job in the past four weeks, they are no longer counted as a member of the labor force.2 The U.S. government classifies them as a discouraged worker: someone “who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment.”3 If a higher minimum wage results in companies laying off employees or hiring fewer new ones, then more people will become discouraged workers. Although increasing the minimum wage is supposed to help reduce income inequality, it can have the unintended consequence of driving more people out of the labor force due to a lack of job opportunities. Ironically, this can cause the unemployment rate to go down.

To measure the true economic impact of a minimum wage increase, the labor force participation rate is a better statistic than the unemployment rate. The labor force participation rate is “the percentage of the population that is either … working or actively seeking work.”4 For example, in June 2015, the U.S. added 223,000 jobs, and the unemployment rate fell to 5.3% from 5.5% in May.5 However, the size of the labor force decreased by 432,000 as the labor force participation rate fell to 62.6% from 62.9%.6 The unemployment rate fell by .2%, but the labor force decreased by .3%. The unemployment rate went down because of the sharp increase in the number of discouraged workers.

While a higher minimum wage can sometimes result in a lower unemployment rate, forcing companies to pay a higher price for labor will not benefit all workers. According to the law of demand, “all other factors being equal … the higher the price, the lower the quantity demanded.”7 If all other factors remain the same, the higher the price of minimum wage labor, the less hourly units of labor a company will purchase from workers. Raising the minimum wage is an economic policy that is motivated by good intentions, but it will not produce good results for everyone who wants a job.

Notes

  1. Investopedia, s.v. “Unemployment Rate,” accessed May 10, 2016, http://www.investopedia.com/terms/u/unemploymentrate.asp
  2. “Labor Force Characteristics,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/cps/lfcharacteristics.htm#discouraged
  3. Investopedia,v. “Discouraged Worker,” accessed May 10, 2016, http://www.investopedia.com/terms/d/discouraged_worker.asp
  4. “Labor Force Participation,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/bls/cps_fact_sheets/lfp_mock.htm
  5. Claire Zillman, “U.S. economy adds 223K jobs in June as unemployment dips to 5.3%,” Fortune, July 2, 2015, http://fortune.com/2015/07/02/june-2015-jobs-report-unemployment/
  6. Ibid.
  7. Investopedia, s.v. “Law of Demand,” accessed May 11, 2016, http://www.investopedia.com/terms/l/lawofdemand.asp

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Why the Unemployment Rate is not the Real Unemployment Rate

Can-US-Employment-to-population-ratio

The unemployment rate is defined as “the percentage of the people in the labour force who are unemployed.”1 Although it is considered one of the most important measures of the success or failure of a government’s economic policies, it is a misleading statistic because it does not include people who have stopped looking for work. To determine the real unemployment rate, the labour force participation rate must also be considered, and more importantly, the employment-population ratio.

The labour force participation rate is “the percentage of the working-age population who are members of the labour force.”2 The labour force includes everyone who has a job or is actively seeking one. In August 2015, Canada’s labour force participation rate was 65.9%, while the unemployment rate was 7.0%.3 In contrast, the U.S. had a lower unemployment rate (5.1%), but the labour force participation rate was only 62.6%, the lowest level since 1977.4 Although Canada had a 1.9% higher unemployment rate, the labour force participation rate was 3.3% higher. This means that a higher percentage of working-age Canadians had jobs than Americans did.

The chief problem with the unemployment rate statistic is it only includes people who are actively seeking work. If a person stops looking for work, they are no longer counted as members of the labour force. For example, in August 2015, 1.8 million people in the U.S. were “marginally attached to the labour force.”5 Even though they had applied for a job in the past twelve months, they were not counted among the unemployed because they had not applied for a job in the past four weeks.6 Long-term unemployment can be emotionally discouraging for an individual, but if that person “gives up” looking for work, the U.S. government no longer considers them unemployed, and the unemployment rate drops.

A second problem with the unemployment rate is it can fall if the size of the labour force falls at a faster rate. In June 2015, the U.S. added 223,000 jobs, and the unemployment rate fell to 5.3% from 5.5% in May.7 However, the size of the labour force decreased by 432,000 as the labour force participation rate fell to 62.6% from 62.9%.8 The unemployment rate fell by .2%, but the labour force decreased by .3%. What appeared to be good news was actually bad news for the economy.

The most accurate measure of unemployment is the employment-population ratio: “the percentage of people of working age who have jobs.”9 Unlike the labour force participation rate, the employment-population ratio includes people who have stopped looking for work. In August 2015, the U.S. ratio was 59.4%,10 while in Canada it was 61.3%.11 Despite having a 1.9% higher unemployment rate, 1.9% more working age Canadians had jobs than Americans did.

When the unemployment rate falls, the media will often report this as good economic news; however, the actual reality may be better (or worse) than what is reported. The next time you hear the unemployment rate reported, compare it with the labour force participation rate and the employment-population ratio. These two statistics reveal the true state of unemployment.

Notes

  1. Michael Parkin and Robin Bade, Macroeconomics: Canada in the Global Environment (Toronto: Pearson, 2008), 494.
  2. Parkin and Blade, Macroeconomics, 494.
  3. “Labour force characteristics, seasonally adjusted, by province (monthly),” Statistics Canada, accessed September 16, 2015, http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/lfss01a-eng.htm
  4. Andy Kiersz, “The labor force participation rate falls to a 38-year low,” Business Insider, July 2, 2015, http://www.businessinsider.com/labor-force-participation-rate-falls-to-38-year-low-2015-7
  5. Ibid.
  6. Ibid.
  7. Claire Zillman, “U.S. economy adds 223K jobs in June as unemployment dips to 5.3%,” Fortune, July 2, 2015, http://fortune.com/2015/07/02/june-2015-jobs-report-unemployment/
  8. Zillman, “U.S. economy adds 223K jobs in June as unemployment dips to 5.3%,” http://fortune.com/2015/07/02/june-2015-jobs-report-unemployment/
  9. Parkin and Blade, Macroeconomics, 495.
  10. “Labor Force Statistics from the Current Population Survey,” U.S. Department of Labor, accessed September 16, 2015, http://data.bls.gov/timeseries/LNS12300000
  11. “Labour force characteristics, seasonally adjusted, by province (monthly),” http://www.statcan.gc.ca/tables-tableaux/sum-som/l01/cst01/lfss01a-eng.htm

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