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5 million discouraged workers

The market is not impressed with the bigger-than-expected December jobs gain and the decline in the unemployment rate. The decline in the unemployment rate is indeed overstating the health of the labor market (see below for details), but I think the market is not fully appreciating the significance of the growth in jobs.

The decline in the unemployment rate has been driven not so much by the growth of jobs as it has been by the decline in the labor force. As the top chart shows, more than 5 million people appear to have dropped out of the labor force, so discouraged about their job prospects that they have given up looking and are thus no longer counted in the labor force. As the two top charts show, the labor force for many years has grown about 1% a year, but beginning in 2009, growth ground to a halt. The bottom chart shows the labor force participation rate—the proportion of the population that is in the labor force—and it has dropped two percentage points since 2009. 2% of the 322 million U.S. population equates to about 6 million people, confirming the implication of the top chart. If you added 5-6 million people back into the labor force (as unemployed looking for jobs), the unemployment rate would be 11-12%. Something happened starting in 2009 that resulted in many millions of people deciding to "drop out" of the labor force; the only question at this point is whether they have permanently given up or whether they could be enticed to return. In the meantime, they have been the cause of the sizable decline in the unemployment rate, rendering it fairly meaningless as an indicator of improving economic health.

But: the jobs gains we have seen in the past two years are a legitimate indicator of a slowly but steadily improving economy. The most important thing is not the level of employment, or the participation rate, but the change in employment on the margin, and that is decently positive. As I mentioned in the previous post, both the household and the establishment surveys are registering similar rates of growth (1.7% annualized, or about 160K per month on average), and that has been the case for several months now. These jobs may be "low quality" jobs, but they are still jobs.

The economy is growing and things are improving, even though we would probably be doing much better by now if it weren't for the huge increase in government spending since 2008 (which wastes the economy's scarce resources), the huge increase in regulatory burdens (which make it more difficult and expensive to start and run a business), the huge increase in the deficit (which increases the expected burden of taxation), and the Fed's massive increase in the monetary base (which creates tremendous uncertainty about the future of monetary policy and the stability of the dollar).

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