Academic Literature

Finland – Is the unemployment rate a good measure of labour market slack?

Observations that the official unemployment rate does not describe labour market slack
sufficiently broadly have led to the development of broadened measures of
unemployment. These types of measures are regularly used, at least in the United
States and have also occasionally been explored by the ECB. Such measures seek to
include, in addition to people counted as officially unemployed, also those outside the
labour force who could find work if only economic growth were to accelerate, rather than
those who are outside the labour force for structural reasons.
Below, we present a review of broad measures of unemployment based on Finnish labour
market statistics. Indicators based on Statistics Finland’s Labour Force Survey include,
besides the unemployed, also those who are classified as part of hidden unemployment. and the underemployed[8] (Chart 1). These broader measures show that there are more
persons for whom economic growth could help find employment than would be inferred
merely from the official unemployment data. It is not surprising that these less stringent criteria indicate there is a larger number of unemployed. It is, however, worth noting that, if broad unemployment is only higher than official unemployment in terms of its level, this will only revise upwards the estimated level of structural unemployment. The estimate of the extent of slack will not change directly. This signals that the need for structural policy to improve employment is increasingly apparent, but the choice of how unemployment is measured has no relevance for counter-cyclical policy.

It would be meaningful for counter-cyclical policy if different measures of unemployment
behaved differently in business cycles, as this would also change the estimate of the
extent of slack. Visual assessment of Chart 1 does not allow us to say much on this
matter. It would be easy to assume that there is a considerable degree of slack in the
economy in a situation where there is a large proportion of underemployed. Economic
recovery and higher demand could then reduce the number of underemployed.
Unfortunately, Chart 1 would suggest this does not seem to be the case, with the number
of underemployed remaining fairly constant. In recent years, however, unemployment
gauged in terms of the broadest measure would appear to have risen by slightly more
than the official unemployment rate suggests, and it has not yet moved on to an equally
pronounced decline.

Simple statistical analysis of time series shows that cyclical behaviour across different
measures is very similar, except for major turnarounds in the economy. In such
situations, the broadest measure in Chart 1 appears to react more strongly than the other
measures. The proportion of underemployed, i.e. those involuntarily engaged in parttime
work, decreased very much in the strong economic upswing preceding the financial
crisis and increased in the steep downturn in 2009 and 2010. After this, the cyclical
behaviour of the different indicators does not differ significantly. The widespread use of lay-offs as an element of elasticity when Finland was in deep recession is likely to explain this phenomenon, as those working less than normal because of lay-offs are included in the underemployed.

In a situation where the economy is recovering from a deep recession, labour market
slack can thus be underestimated if official unemployment statistics alone are used for
estimation. In Finland’s case, it would appear to be important to pay particular attention to the number of workers laid off. Visual assessment and simple statistical analysis are,however, too uncertain to draw very far-reaching conclusions of the actual
unemployment gap. For identification of cyclical unemployment and structural
unemployment other methods will also be needed, as discussed later in this article.
Broad unemployment measures according to the employment statistics of the Ministry of
Economic Affairs and Employment provide a picture similar to that calculated from
Statistics Finland’s data (Chart 2). These indicators take account of not only unemployed
jobseekers but also people laid off, those on a reduced working week, persons covered by
activation services fostering employment and those in training. In principle, like the
actual unemployed, these are all people who have only temporarily exited the labour
market.

The marked growth in unemployment according to the broadest measure, which includes
all these groups, is largely accounted for by the fact that the groups covered by activation services and in training have only existed since 2013. These persons were before statistically classified under other persons outside the labour force. Owing to this statistical change, the differences between the official and the broadest concept of unemployment are not useful for analytical purposes. If the groups covered by activation services and in training are removed from the broad measure of unemployment, the picture will be very similar to that emerging from the statistics compiled by Statistics Finland. The measure including, on top of unemployed jobseekers, also those laid off and those having a reduced working week is comparable to the broadest measure of unemployment calculated on the basis of data compiled by Statistics Finland. According to this gauge, too, official and broad unemployment appear to differ mainly in terms of level, with no significant divergence in cyclical behaviour.

Based on the indicators presented, taking account of the broad measure of unemployment for estimation of labour market slack does not materially change the picture. Structural unemployment estimated on the basis of the broad definition of unemployment may, therefore, simply be at a higher level than if gauged on the basis of official unemployment measures alone. This observation thus refers to structural labour market rigidities rather than volatility in labour market slack caused by aggregate demand.

Consequently, in the current upswing, the official unemployment rate could still provide
a useful point of departure for an evaluation as to how much room there is for a cyclical
improvement in employment.

Chosen excerpts by Job Market Monitor. Read the whole story at  Estimation of structural unemployment important, but complicated

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