Unemployment Rate Drops, but Economists Aren't Smiling

Illustration by Erik T. Johnson

By Peter Coy

The U.S. unemployment rate lurched downward in November to 8.6 percent, from 9 percent in October. That’s the lowest level since March 2009, and it emboldened some optimists to predict the U.S. could be back near full employment within a couple of years. Pessimists, on the other hand, say the jobless rate will rise between now and 2013. The consensus view is pretty bearish, too. The median forecast of economists is for scarcely any decrease in the unemployment rate over the next two years.

Economists disagree on the job question because they entertain different scenarios for the factors that affect it. Those include the underlying health of the U.S. economy, spillover from Europe’s financial crisis, fiscal policy in Washington, and swings in the labor-force participation rate.

James F. Smith sees blue skies ahead. The chief economist of Parsec Financial Management, a wealth-management firm in Asheville, N.C., thinks the jobless rate will average 7.8 percent in 2012 and 6.4 percent in 2013. That latter number is close to full employment, estimated at 5 percent to 6 percent—the lowest the jobless rate can go before wage inflation heats up. Smith predicts the economy will grow 3.9 percent next year and 4.5 percent in 2013. Companies are about to go on an investing and hiring binge, Smith says, because “if you want to stay competitive you must have the latest, greatest equipment and also the best, brightest people.”

High household debt doesn’t worry Smith because “increasing employment will raise incomes and allow for both consumption and savings to increase.” He’s optimistic on housing, too. Bolstering that view, Goldman Sachs economists said on Dec. 2 that home prices will probably hit bottom next summer. In another positive sign, on Dec. 1 the Institute for Supply Management reported a nice gain in its November manufacturing index.

At the darker end of the range is John E. Silvia, chief economist of Wells Fargo Securities in Charlotte. He predicts a jobless rate of 9.2 percent in 2012 and 9 percent in 2013. Silvia worries more than Smith about contagion from Europe, mostly via the intertwined financial systems of the two regions. Although he favors more fiscal rectitude in Washington, he’s concerned that the short-run effect of deficit reduction will be to suppress demand and thus growth. Worse for workers, Silvia says, companies are getting better at expanding output without hiring. “We’re adding a lot more capital than labor to produce, and we’re changing what we produce,” he says. “That’s a challenge for our society.”

Many economists also continue to worry about the drag from household debt. Last January in Denver, Stanford University economist Robert E. Hall gave an address at the annual meeting of the American Economic Assn. in which he attributed the sluggish recovery to consumers’ indebtedness, which limits their spending power, giving companies little reason to hire. “I’m not a forecaster,” Hall says now, “but I have no reason to disagree with the consensus forecast of unemployment not reaching 6 percent until late in the decade.”

Most likely the jobless rate will fall somewhere between Smith’s bullish and Silvia’s bearish forecast. The median of the 57 forecasts in a Bloomberg News survey is an average unemployment rate of 8.8 percent in 2012 and 8.3 percent in 2013. That’s premised on gross domestic product growth of 2.2 percent next year and 2.5 percent in 2013—not the robust numbers needed to bring joblessness down rapidly.

A big drop in the jobless rate isn’t always good news. A lot depends on what causes the drop. Remember, the unemployment rate is calculated by adding up all the people who tell government surveyors that they can’t find work and dividing it by all the people in the labor force—those either employed or actively looking. So if people give up searching, they’re no longer counted as unemployed, and the rate falls. In November about two-thirds of the improvement in the jobless rate came from people dropping out of the labor force and thus out of the calculation of the unemployed. Only one-third was because of actual job creation.

What makes unemployment so hard to bring down is that new people keep entering the labor force, while the productivity of those already working goes up, lessening the need for new hires. To lower the jobless rate, the economy has to grow fast enough to overcome the triple challenges of rising productivity, a growing population, and the reentry of workers into the labor force as business conditions improve and they see hiring prospects get better, notes Michael R. Englund, chief economist at Action Economics in Boulder, Colo.

Since December 2007 the U.S. population has increased by a little more than 3 percent, while the labor force has decreased by about 50,000 workers (chart). This is the longest it has taken for the labor force to regain its pre-recession high since the Bureau of Labor Statistics began keeping records in 1948. According to a back-of-the-envelope calculation, if the labor force had grown at its usual pace instead of shrinking, then all else being equal, the November unemployment rate would have been 11.4 percent rather than 8.6 percent. A healthy job market is still a long way off.

The bottom line: Despite a better-than-expected jobless number, few economists foresee a recovery healthy enough to push unemployment down soon.

Coy is Bloomberg Businessweek's Economics editor.

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