Believe It Or Not, Our Jobless Rate Could Be Worse

The last several posts have explored why Rhode Island has such a high unemployment rate. As of February, 2012, we have regained the dubious national rank of #2. If you saw the February labor market data for Rhode Island, the one number that probably stuck out was that our state's unemployment rate returned to 11 percent from just below that level the prior month. As for good news, the local media seemed to focus primarily on the 500 gain in payroll employment (seasonally adjusted). Actually, don't be very confident that the 500 gain will survive the data revisions associated with the release of the March data.

Actually there was good news  in the February report -- our state's manufacturing sector continues to improve. Both manufacturing employment and the workweek rose, very positive signs. And, our state's manufacturing wage continued to increase at an almost 20 percent year-over-year rate, if you are willing to believe that data (I don't!). Apparently there continues to be some life in Rhode Island's goods-producing sector, in spite of continued housing weakness!

By now, you should be aware of how many ironies permeate the existing labor market data for Rhode Island. To say this state is idiosyncratic is an understatement. So, let's delve into even more possible "confusion," focusing on labor force participation here and how its bad news has ironically translated into less horrible news for our jobless rate.

A state's labor force participation rate is the percentage of its working-age population that is in its labor force. For just about every state except Rhode Island, the labor force participation rate is pro-cyclical, meaning it changes in the same direction as overall economic activity. During recoveries, the participation rate rises, as a larger proportion of the working-age population becomes part of the labor force. Similarly, during recessions, the participation rate tends to decline, as some persons stop actively seeking work, which excludes them from being counted as part of the labor force. The reason why I noted this behavior is sadly not true for Rhode Island can be seen very readily from the following graph of our state's labor force participation rate since 2009 (click to enlarge).

Based on my Current Conditions Index, Rhode Island's present recovery began in February of 2010. As the above chart shows, Rhode Island's labor force participation rate has been declining throughout almost this entire recovery! So much for a pro-cyclical participation rate. Keep in mind, however, our state's employment rate has also been falling for quite a while (see prior post).

The irony associated with our state's declining participation rate is that it has actually kept Rhode Island's unemployment rate lower than it would have been had our state's residents not continued to drop out of the labor force. This is the "bad news translating into less horrible news" I referred to above.

All of this leads to an obvious question: How much higher would Rhode Island's unemployment rate have been were it not for the "benefit" of our declining participation rate? In order to approximate this, I performed a quick econometric simulation, assuming that our participation had not been declining from its most recent peak in April of 2010. The results are not pretty, nor are they unexpected. The chart below compares the actual and simulated unemployment rates here since 2009 (click to enlarge if you have a strong stomach!).

Instead of having an 11 percent unemployment rate for February of 2012, my simulation produced a rate of 11.6 percent. In the above chart, note the divergences between actual and simulated unemployment rates since August of last year. About the only good thing that can be concluded from this chart is that the two series have gotten closer of late. That is hardly a source of comfort, however, especially since at an 11 percent rate, Rhode Island has a national rank of second overall.

In conclusion, is Rhode Island's declining labor force participation rate a major problem? Indeed it is. Not only is it the logical result of a truly deplorable labor market, where both payroll and resident employment have been falling on a year-over-year basis for quite some time now. It may single-handedly be preventing Rhode Island from reclaiming its prior title as the highest unemployment rate in the entire United States!

Our State's Jobless Rate is Declining. Is That Good News?

In recent months, Rhode Island's unemployment has been falling. In fact, whenever the monthly labor market numbers are released, the local media focus largely, if not entirely, on the unemployment rate and how it changed. So, based on these recent declines, Rhode Island's economy must be doing noticeably better. Or is it?

First, it is critical that this statistic be viewed in relative, not absolute, terms. While Rhode Island's unemployment rate has fallen from 11.5 percent, its level from August through December of 2010, to 10.8 percent in June of 2011, it remains the third highest in the entire US! So, Rhode Island continues to be known for its beautiful beaches and its very high unemployment rate. Quite a niche, isn't it? Let me also state for the record that I don't believe that our state's jobless rate was constant over that long of a period. The single value for the entire August to December of 2010 period is doubtless the result of a smoothing procedure utilized by the US Department of Labor.

Second, we must not forget to consider the way the unemployment rate itself is calculated. To be counted as unemployed, and therefore part of the monthly statistic, an unemployed person must be unemployed (obviously), physically able to work, and this is the kicker, actively seeking employment. What that last condition indicates is that it is quite possible for the unemployment rate the fall not as the result of higher employment, as most people think has to be the case, but because unemployed persons opt to cease their active job search. In economics, this is known as the "discouraged worker effect." Actually, that's a pretty dumb name, since these people obviously aren't working and they're well beyond being discouraged. So, if an unemployed person stops actively seeking employment, that person is no longer counted as being part of the labor force, and is therefore not counted as being among the "officially" unemployed. In light of all of this, you should always view the unemployment rate and labor force participation together. Has this odd combination of declining labor force and falling unemployment been occurring in Rhode Island lately? A picture is worth a thousand words. The chart below (click to enlarge) shows these two elements in Rhode Island for the last twelve months.

Do you see a pattern here? Actually, how can you miss it? For the entire time that Rhode Island's unemployment rate has been declining (all of 2011), our state' labor force participation rate has been declining as well. Note: the labor force participation rate  (the red line in the chart above) is the percentage of our state's working age population that is in the labor force. Based on the chart above, there is definite evidence consistent with recent declines in our state's unemployment rate being at least partially related to Rhode Island residents dropping out of the labor force (as they stop actively seeking employment). And there can be strange results from the monthly Household Survey (see previous blog post on this). But this doesn't tell the entire story.

Third, there are actually two labor market surveys. The unemployment rate is obtained from the Household Survey. I won't tell you how small the sample size is for Rhode Island. This survey looks at Rhode Island's working age population and does not restrict employment to being exclusively within Rhode Island. So, Rhode Island residents working in other states are included in this survey, as are self-employed individuals. The other labor market survey, the Establishment Survey (and approximations to this by the Current Employment Survey in the short-term), focus exclusively on jobs within Rhode Island. Self-employed individuals, however, are excluded from this survey. So, given these differences, it is not uncommon for the two surveys to give different results, sometimes very different results. In recent months, survey results were noticeably different at times. Fortunately, though, the results for June were more in line with each other. Looking at recent results for this employment survey, job gains since January of this year (compared to a year ago), rose from 4,100 to a high of 9,400 in May, before declining to 8,800 in June. Throughout that time period, job loss fluctuated between 4,100 and 5,100. So, the net change in payroll employment here (what the local media inevitably reports as "new jobs" has actually been in an uptrend since January of this year. For the most recent three months, the net change in employment has been greater than 4,000. Thus, part of the reason for our state's declining unemployment rate over this period has in fact been for the "right" reason - improving employment (also see previous blog post dealing with this).

Finally, the unemployment rate is what economists refer to as a lagging indicator. In other words, its behavior this month to a large extent reflects events and trends that occurred in past months. Embodied within the way the unemployment rate is calculated is the likelihood that when an economy begins to improve, some discouraged workers will begin to actively seek employment once again. When that happens, they are once again counted as being part of the labor force and unemployed. This will often result is an increase in the unemployment rate, not a decrease, as one would normally assume when economic conditions improve. Rhode Island's declining participation rate itself is a net change of persons leaving (discouraged workers) and persons re-entering the labor force once they re-commence active job search.

So, has Rhode Island's economic performance, as summarized by the recent performance of its jobless rate been improving? Yes and no. Unequivocally! To summarize: Rhode Island's unemployment rate has been improving of late, yet it remains among the highest in the US; improvements in our state's jobless rate are not entirely the result of a better employment climate, but at least partially the result of our unemployed dropping out of the labor force.

MY REQUEST TO THE LOCAL MEDIA (an economist's pathetic plea!):
Please stop focusing so much on our state's unemployment rate, it is not a very accurate basis for portraying our state's overall economic performance. You need a much broader basis to do this accurately, such as my Current Conditions Index.

If, however, you opt to continue using the unemployment rate as your primary basis for assessing economic activity here, when you drive home after writing your story, only look in your rear view mirror for guidance the entire time (a practical example of relying on a lagging indicator). Let's see whether or not you make it home in one piece!

An Interesting Difference with the US

One of the more interesting statistics I have kept up with over the last few years concerns the labor participation rate for our state. Specifically, this is referred to as the labor force participation rate, defined as the percentage of the working-age population that is in the labor force. Over the past few years, Rhode Island's labor force participation rate has taken on an interesting behavior relative to that of the US. The chart shows this (click to enlarge).

  

Nationally, there is both concern and more than a little bit of confusion concerning how this rate has been changing. It should be apparent from the graph that nationally, the labor force participation rate has continued to decline for some time now, falling to a level of around 64 percent (0.64) in February of this year. There was an excellent discussion of this on CNBC this morning, going into far more detail that I will engage in here.

At this point, the more interesting question in this state is why the participation rate for Rhode Island rose during 2009 while the US rate was declining and the reason why our state's participation rate has largely remained unchanged at very high values. While there are in reality a number of factors responsible for this, I'll give you a hint concerning why RI is so different: 99. See if you can figure out this "puzzle."

Scary Questions about R.I.'s Economy (from the ProJo 10/9/2010 as I originally wrote this plus a labor market chart)

Everyone seems to gauge overall economic performance by the recent performance of the unemployment rate. If you listen to the media and my many of my fellow economists, you will frequently hear that the only way the unemployment rate can decline is for employment to begin rising substantially from where it is today. These newly added jobs will then directly reduce unemployment, leading us at long last to a period where the unemployment rate is well below its current levels. There are two potential difficulties within this scenario, which explains why this process is taking so long. On the labor supply side, much of the current unemployment is long-term in nature, the result of jobless persons failing to possess the skills demanded by the employers who are attempting to increase employment. Economists refer to this as "structural unemployment." The result is skill shortages, even with so high a jobless rate. On the demand side, employers have continued to find ways of meeting current product demand with fewer hours worked by their labor force than they thought possible in the past. This has produced rather sharp gains in productivity. The failure to hire by small and medium-sized firms has been exacerbated by their inability to borrow funds due to inadequate collateral. And, of course, uncertainties about the future also play a role, for firms of all sizes.

But is this the only possible scenario? And, how does all of this pertain to Rhode Island? Actually, employment gains have been occurring here for several months now. Since October of 2009, job gains have generally been above 1,000 each month (except for April of 2010). In fact, over the October 2009 through August 2010 period, Rhode Island's average job gain (year-over-year) has been just over 2,000 per month (see chart below -- click to enlarge it). How can this be with so high an unemployment rate? The answer is that while job gains are occurring, so too are job losses. From October 2009 through August 2010, monthly job losses for Rhode Island averaged around 15,250. Thus the proper context for analyzing overall employment change in Rhode Island is a simultaneous focus on job gains and job losses. While monthly job loss has declined sharply since the height of the post-2008 period, job gains have increased very little. But they are increasing. So, the question becomes what will be required for Rhode Island to generate substantial and increasing job gains?

 A viable response to this question requires that we confront what I view as the two scariest questions about Rhode Island's economy at present. First, does Rhode Island have a tax and cost structure consistent with generating the types of employment gains needed to substantially reduce unemployment? Second, what are our current engines of job growth? Importantly, these questions are not unrelated. Our children have known the answers for years. Ask them when they come back to Rhode Island to visit. The answer to the first question is not yet, even with the two-year-delayed tax reforms. As for the second question, our engines of growth at present are health services and tourism. While a small but growing tech sector is helping us, past failures of economic leadership here have relegated non-defense tech to levels that require time before they can make a substantial impact on our state's overall rate of growth.

Fortunately or not, for Rhode Island there is another way we can and likely will witness material reductions in our jobless rate. Rhode Island has a very high labor force participation rate, the proportion of our (non-institutional) working age population that is in the labor force. At present, Rhode Island's participation rate is just under 69 percent, a rate almost five full percentage points above the national rate. Over the past five months, as Rhode Island's unemployment rate fell from 12.5 percent to 11.8 percent, its labor force participation rate also fell. This indicates that some of our state's unemployed stopped looking for work over that period. Based on the way labor force statistics are calculated, they were no longer counted as being in our state's labor force. So, as increasing numbers of Rhode Islanders exhaust all benefit entitlement, if they then stop seeking employment, as is likely, our state's unemployment rate could potentially decline substantially from its current level, even without large employment gains.

June marked the third anniversary of Rhode Island's current recession. We have been through a great deal since our recession began in June of 2007. Perhaps that understates things a little (if that is possible) since our employment peaked in January of 2007, almost a full year before the national peak. Things never had to be this bad for Rhode Island. Is the second way I suggested for reducing our state's unemployment rate the best we can do? I refuse to believe that.

November's elections hold the potential for our state to make meaningful changes to the way things are done here. Voters must ask very difficult questions and demand highly specific answers to anyone running for statewide office. Sorry, wish lists don't work here!

1. Candidates should be forced to outline in detail how Rhode Island will emerge from this recession.
2. What specific measures do they propose for materially increasing job gains relative to the losses that will occur over the next two (or four) years?
3. What are Rhode Island's economic strengths? How can those be built upon (i.e., what is Rhode Island's niche)?
4. What are Rhode Island's major economic weaknesses? They should outline in detail proposals to eliminate these, or to somehow turn them into positives.

The upcoming election is more important than is generally presumed for Rhode Island, since federal bailout money will no longer be available by this time next year. Fiscally, this will force us to go "cold turkey." The resulting jolt to a fragile upturn may well force our state into a double-dip recession. The citizens of this state need to be proactive, even though our elected officials seldom are.

FOR A COMPLETE HISTORY OF THE CURRENT CONDITIONS INDEX AND ITS PERFORMANCE, VISIT MY WEB SITE: http://members.cox.net/lardaro/ . THE SECTION ON THE CURRENT CONDITIONS INDEX IS: http://members.cox.net/lardaro/current.htm .