A closer look at the recent increase in the Colorado unemployment rate

The Colorado Department of Labor and Employment reported today the state’s unemployment rate climber to 8.1 percent, up 0.2 percentage points from last month, yet down from 8.4 percent in May 2011. The national rate is 8.2 percent, up slightly from a month ago.

In this post I want to look a bit closer at the underlying mechanisms, as the unemployment rate is a more complicated indicator than many realize.

Let’s start with a few definitions. First, there are the “employed.” These are people with a job. It does not matter if it is full-time or part-time. It does not matter if it fully utilizes their skills and experience or not. Then there are the “unemployed.” These are people who are not currently employed, but who are actively looking for a job. They may or may not be collecting unemployment compensation benefits.

The size of the “labor force” is determined by adding up the employed and the unemployed. The “unemployment rate” is calculated by dividing the number of unemployed by the labor force.

Because both the number of employed and unemployed varies from month to month, and because the unemployed are included in both the numerator and denominator of the unemployment rate, understanding changes in the rate is trickier than understanding simply changes in employment or unemployment. As a result, we sometimes see the unemployment rate behave in ways that are counter-intuitive.

For example, as I noted above, last month’s unemployment rate increased in Colorado. But so, too, did the number of employed people. So, the unemployment rate went up despite the fact that more people are working. Why? Because the labor force–which includes the unemployed–grew even faster.

Before looking closer at Colorado, I will provide an example.

Suppose an economy has 10 unemployed workers and 90 employed workers. The unemployment rate is 10 percent (=10/(10+90).

Now suppose that the number of employed grows to 95, but the labor force adds 10 workers, increasing to 110. This means there are now 15 unemployed workers. (This could happen because people move into the state, or more people in the state begin looking for work…remember, to be unemployed you have to be actively looking for work). In this case the unemployment rate is 13.6 percent (-15/110).

So, we see that despite having more people employed, the unemployment rate has gone up. Weird.

And this is what is happening in Colorado. In the next chart I show the state’s unemployment rate since May 2008. here we see a sharp increase early only, a gradual decline, and the uptick last month.

Much of the dynamic can be attributed to changes in the number of employed. In the following chart I show how Colorado’s total employment changed from 12 months earlier. The job losses in Fall 2008 correspond well with the increase in the unemployment rate. More recently, employment growth has helped knock down the unemployment rate.

But what complicates this is the common transition that many people make between being unemployed and IN the labor force (actively looking for work) and being unemployed and OUT of the labor force. In the next chart I show changes in Colorado’s number of unemployed from 12 months earlier.

Here we see that the number of unemployed grew dramatically in 2008 and 2009, and has only declined somewhat since then. Here is another view of that.

Now, let’s pull this all together. In the following chart I show recent changes in Colorado’s labor force from 12 months earlier.

The slight increases over time are often–but not always–indicative of an improving economy.

Three things affect this over time: First, as I not above, people transition often transition between “unemployed” status and “unemployed and not in the labor force status.” Perhaps people give up looking for work (the number of unemployed an labor force decline in size, knocking down the rate). Or, perhaps they feel confident that there might be opportunities, so they start looking for work, even if they don’t have a job offer in hand. This optimism can cause the unemployment rate to increase in the short-run, as both the number of unemployed and labor force grow by the same amount.

Second, the labor force can grow due to demographic trends. Perhaps there are more people aging into the labor force than aging out of it (ie, retiring). This tends to be true in “younger” states, such as Colorado. (It is also affected if peoples retirement plans are put on hold due to financial circumstances).

Third, the labor force can grow if more working age people move into the state than out of it. This is true for Colorado, which tends to have net in-migration because the economy is relatively healthy, and because of its natural amenities.

Bottom line: the unemployment rate is a tricky indicator to interpret. Although a declining rate is generally “good,” the underlying definitions and mechanisms require a more careful analysis of both economic and demographic trends.

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