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WebMemo #550 on Economy

August 6, 2004

A Problem with Payrolls?

By and

Here. We. Go. Again. The Department of Labor's July Employment Situation Report is out this morning, and the news is good. And not good. The unemployment rate stands at 5.5 percent in July, compared with 6.3 percent a year ago and an average of 5.8 percent in the 1990s. Fundamentally, the employment situation in America is solid, but the sluggishness of payroll job growth is stunning and out of line with a host of positive indicators. The strength of today's labor market is yet another sign that the President's 2001 and 2003 tax cuts were effective policies and must be extended.

 

Employment growth is not a problem in America, but the establishment survey of payrolls has a clear problem. According to the official statement from the commissioner of the Bureau of Labor Statistics, which publishes the monthly figures, "As measured by the household survey, employment rose by 629,000 over the month, compared with a change of 32,000, as measured by the establishment survey." Since 1948, there have been 62 instances where household data reported 500,000 new jobs or more, coinciding with a payroll average of 240,000. July's net gain in payroll jobs marks the 11th straight month of rising payroll employment but still came in well below analysts' expectation of 247,000. What's going on?

 

The key, once again, is the difference between the two employment surveys. The payroll survey measures employment at established firms but does not count self-employed consultants, contractors, farmers, and the like. Worse, the payroll survey is highly susceptible to changing rates of turnover. When job-changing dips due to higher uncertainty, the payroll survey artificially deflates. So the gap between the two surveys, which had narrowed a bit in recent months, is now at 3 million (see Chart 1). Since March 2001, the payroll survey suggests there are 1.24 million fewer jobs, in contrast to the household survey's measure of 1.81 million more working Americans-more than ever before.

 

Diverging Surveys

 

And today of all days, the Labor Department published its very first, preliminary assessment of the impact of job-changing on the payroll survey (see "Effects of Job Changing on Payroll Survey Employment Trends"). It acknowledges the Heritage Foundation's analysis from March 2004 (see "Diverging Employment Data: A Critical View of the Payroll Survey" by Tim Kane, Ph.D.) that worker turnover has a significant effect on the payroll survey, inflating the total count by over a million jobs, but also by over-emphasizing job losses during business cycles when turnover declines. Since March 2001, BLS estimates that the "job-changing effect" has led to an overstatement of 251,000 job losses in currently published data.

 

Which Survey to Believe?

It is important to understand the methodological problems of the payroll survey, but it is more important still to consider both surveys in light of all the other labor market indicators, which are generally positive. The ISM manufacturing and non-manufacturing employment indices, for example, have been at 50 or above-indicating improvement-for 14 and 10 straight months respectively, including several all-time highs. Consumer confidence is rising.

 

One of the best independent indicators is the weekly report of initial jobless claims, which have been dropping for the past twelve months and are now steady in the range of 340,000 a week. Levels below 400,000 are widely perceived to reflect a healthy, growing workforce. Further, real GDP growth averaged 3.75 percent annually during the first half of 2004, a period of strong job creation.

Declining Unemployment Claims

 

Fewer Long-Term Unemployed

The last few months have brought needed relief to long-term unemployed workers. The number of long-term unemployed has declined by over 300,000 workers since March (see Chart 2). In July alone, the number of workers unemployed for more than 27 weeks declined by almost 100,000. Workers who have been unemployed for less than 5 weeks have grown as a percentage of the unemployed.

 

Furthermore, the length of unemployment spells dropped sharply in July from 10.8 weeks in June to 8.9 weeks. And the average length of unemployment dropped from 19.9 weeks in June to 18.6 weeks because of the decline in long-term unemployed workers. It is good news for unemployed workers that the duration of the period of unemployment has declined since the summer of 2003.

 

Summary

Today's employment report is significant for two reasons. First, it underscores the positive trends in the economy with the 11th consecutive month of improvement. Second, it is the largest divergence in measures of total employment between the two BLS surveys in years, which means that economists must finally reckon with the problems of the payroll survey. The household survey has been under attack by pessimists for a variety of reasons, but today's report shows that it to be more in line with other indicators of a strengthening economy. Jobless claims are down, unemployment durations are falling, and average pay is rising.

 

Finally, it is important to remember what the report does not show. The President's economic policies are keeping the unemployment rate low, and predictions of rising claims for unemployment insurance have not materialized. Maintaining free trade in the face of the outsourcing scare has not resulted in lower worker earnings or weak employment, but the opposite. Most importantly, the tax cuts of 2003 have been followed by 11 straight months of payroll job growth and millions of entrants to the labor force.

 

Tim Kane, Ph.D., is Research Fellow in Macroeconomics and Rea Hederman is a Senior Policy Analyst, in the Center for Data Analysis at The Heritage Foundation.

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