Unemployment Metric Needs Help: Economists

NEW YORK ( TheStreet) -- The unemployment rate might be making headlines, but some economists say investors may be better advised looking at a different metric: the employment-to-population ratio.

The employment-to-population ratio, or EPR, measures the number of working-age people who have jobs as a percentage of total number of people aged 16 years and above.

"The employment-to-population ratio is like capacity utilization ratio," said Patrick O'Keefe, of J.H. Cohn and former deputy assistant secretary at the Department of Labor. " It measures how our potential workforce is being utilized."

It is superior to the unemployment rate, which O'Keefe says has "too many moving parts."

The unemployment rate counts only those workers who are actively seeking jobs. It does not count discouraged workers -- those who want and are available for work but have not sought a job in the last four weeks. As the economy recovers and more job openings are created, previously discouraged workers start applying for jobs and start to get included in the unemployment count.

There were 1.3 million discouraged workers in December, according to the household survey, all of whom could potentially re-enter the workforce as the economy recovers.

That means a spike in the unemployment rate is quite likely even as job growth accelerates, which makes it a rather unreliable indicator of where the economy is headed.

"We know from the household survey that the number of discouraged workers is extremely high," says O'Keefe." Over the course of 2011, assuming expansion in the economy goes according to script, unemployment will drift lower, but the rate will finish above 9% as new entrants enter the workforce."


Assessing the employment situation based on the unemployment rate can be tricky. Take the latest drop in unemployment, for instance. The number of underemployed dropped by 556,000 to 14.5 million last month partly because more people found employment but also because the labor participation rate unexpectedly dropped.

Scott Brown, economist at Raymond James, says a possible explanation for the drop in the labor participation rate could have been the temporary lapse of unemployment benefits in December. "In order to get unemployment benefits, you need to be actively seeking work, which incidentally is also the definition of unemployment. As the benefits lapsed, people probably stopped actively seeking work," said Brown.

Another explanation could be the still-high rate of discouraged workers at 1.3 million. "Households are yet to accept that the economy is adding job opportunities. The JOLTS (job openings and labor turnover data) tells us differently, but it is yet to sink into their consciousness," said O'Keefe.

Still, the metric has been in focus in the last few months more than ever, as the Federal Reserve remains concerned about unacceptably high levels of unemployment. The central bank has indicated it will continue its $600 billion quantitative easing plan and loose monetary policy as the economic recovery is still too sluggish to make a dent on unemployment.

In testimony before the Senate Budget Committee Friday, Chairman Ben Bernanke reiterated the Fed's concerns on unemployment. "The projections submitted by Federal Open Market Committee (FOMC) participants in November showed that, notwithstanding forecasts of increased growth in 2011 and 2012, most participants expected the unemployment rate to be close to 8% two years from now. At this rate of improvement, it could take four to five more years for the job market to normalize fully," Bernanke said.

"The unemployment rate is definitely a number that the average citizen watches, and that all funnels into the consumer-driven economy, said TC Robillard of Signal Hill Capital. "But it is not the most important factor."

Robillard suggest that a positive trend in payroll growth over the next few months should be what investors should focus on in the coming months, rather than the unemployment rate. Economists say an additional 150,000 jobs needs to be created each month to keep pace with population, and between 200,000 to 300,000 jobs needs to be added to signal a strong recovery.

"The market places too much emphasis on the unemployment rate. A lot of things can happen as the economy recovers to boost the rate," said Brown, of Raymond James. "The employment-to-population ratio takes out a lot of the participation rate disruption."

So just what does the EPR look like? Unfortunately, the news is not good on that front either. The employment to population ratio ticked up by a tenth of a point to 58.3% in December. That is four percentage points lower than prior-recession levels of 62.7%.

What's more, the rate has been more or less flat since the recession officially ended in June 2009, further evidence of just how much the job market has lagged the economic recovery in the past 18 months.

Layoffs have slowed down, even though Northrop Grumman ( NOC) , Yahoo! ( YHOO) recently announcing job cuts. Ford ( F) recently said it will create 1,800 jobs to build sports-utility-vehicles.

--Written by Shanthi Bharatwaj in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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