Unit 1 The supply side of the macroeconomy: Unemployment and real wages

1.3 Measuring the macroeconomy: Output, employment, unemployment, and inactivity

To understand how the whole economy works, we focus on aggregate measures, such as total employment (the total number of people employed), unemployment rate, and aggregate output. (The term ‘aggregate’ just means total.) In some cases, measurement is straightforward: the number of people employed on any given day can simply be counted. In other cases—for example, measuring total output—the adding up requires summing different things: a particular make and model of a car summed with a tin of tomatoes, a gym membership, and so on.

Once you start thinking about it, measuring the total output of the economy is a complicated task. We postpone explaining how that is done until Unit 3. For now, we assume that the national statistical agency has solved the problem of how to create a measure of the economy’s total output.

Aggregate output is one important indicator of the performance of the macroeconomy; another is the state of the labour market. Whether or not someone has a job (or has a family member who is working), makes a huge difference in their life. What kind of job it is, how much they earn, and how many hours they work are also very important. Searching for one’s first job, losing a job, starting a new job, retiring … these are all important life events. Here, we take a step back from these experiences and consider the numbers—statistics on employment, unemployment, and labour force participation. At the aggregate level, these numbers tell us a lot about the health of an economy. But when you consider the numbers, don’t forget all the experiences that lie behind them.

population of working age

A statistical convention, which in many countries is all people aged between 15 and 64 years.

labour force

The number of people in the population of working age who are, or wish to be, in work outside the household. They are either employed (including self-employed) or unemployed.

economically inactive

People in the population of working age who are neither employed nor actively looking for paid work are classified as economically inactive. Those working in the home raising children, for example, are not considered as being in the labour force, so they are classified this way.

Figure 1.3 provides an overview of the labour market and shows how these components fit together. We begin on the left-hand side, with the population. The next box shows the population of working age, usually calculated as the total population, minus children and those over 64. It is divided into two parts: the labour force and those out of the labour force (known as economically inactive). People out of the labour force are not employed or actively seeking work: for example, those who are unable to work due to sickness or disability, students who are not working, or parents who stay at home to raise children. Only members of the labour force can be considered as employed or unemployed.

Labour market statistics

There are a number of statistics that are useful for evaluating labour market performance in a country and for comparing labour markets between countries. The statistics depend on the relative sizes of the boxes shown in Figure 1.3.

Participation rate

participation rate

The ratio of the number of people in the labour force to the population of working age. See also: labour force population of working age.

unemployment rate

The unemployment rate is the fraction of the total labour force that is seeking work, but is not currently employed. See also: labour force employment rate.

unemployed, unemployment

An unemployed person is someone who is able and willing to work, but is not currently employed.

The first is the participation rate, which shows the proportion of the working-age population that is in the labour force. It is calculated as follows:

\[\begin{align*} \text{participation rate} &= \frac{\text{labour force}}{\text{population of working age}} \\ \\ &= \frac{\text{employed + unemployed}}{\text{population of working age}} \end{align*}\]

Unemployment rate

The unemployment rate shows the proportion of the labour force that is unemployed. It is calculated as follows:

\[\begin{align*} \text{unemployment rate} = \frac{\text{unemployed}}{\text{labour force}} \end{align*}\]

According to the standardized definition of the International Labour Organization (ILO), the unemployed are the people who:

• were without work during a reference period (usually four weeks); in other words, they were not in paid employment or self-employment
• were available for work
• were seeking work; in other words, they had taken specific steps in that period to seek paid employment or self-employment.

Employment rate

employment rate

The employment rate is the fraction of the population of working age that is employed. See also: population of working age, unemployment rate.

Lastly, we come to the employment rate, which shows the proportion of the population of working age that are in paid work or self-employed. It is calculated as follows:

\[\begin{align*} \text{employment rate} = \frac{\text{employed}}{\text{population of working age}} \end{align*}\]

It is important to note that the denominator (the statistic on the bottom of the fraction) is different for the unemployment and the employment rate. Hence, two countries with the same unemployment rate can differ in their employment rates if one has a high participation rate and the other has a low one. Particularly in cases where a country has low unemployment rates but also low participation rates, the employment rate can be very helpful for evaluating its performance by showing the proportion of working-age people who are working.

Figure 1.4 shows that large macroeconomic shocks common to two economies produce different outcomes. Both the UK and the US experienced the global financial crisis in 2007–2009 and the COVID-19 pandemic in 2020–2021. The bottom panel shows that the unemployment rate went up in both countries in both crises by very different amounts. Both employment and unemployment are more responsive to these shocks in the US than in the UK.

Taking a longer-term view, the US began the period with a substantially larger proportion of working-age people in jobs than was the case in the UK. And although the unemployment rate in the US returned to its pre-financial crisis level by 2015, the employment rate has never regained its pre-crisis level. This is reflected in the long-run decline in the participation rate in the labour market in the US. A substantially lower share of the US population of working age are actively engaged in the labour market than was the case before the financial crisis.

The dramatic difference between the effect of the COVID-19 shock on UK and US unemployment is due to the policies adopted. In the UK, as in much of Europe, people were able to keep their jobs during the pandemic even if they did not do any work. Whole sectors of the economy, such as hospitality and entertainment, were closed in both countries, but in the UK these workers kept their jobs and were paid 80% of their wage by the government; in the US, the workers were laid off and the government paid them more generous unemployment benefits than would have occurred outside the pandemic.

Comparing labour markets

The chart in Figure 1.5 provides a picture of the labour markets in four countries—Australia, Germany, Norway, and Spain—between 2000 and 2019, and shows how the labour market statistics relate to each other.

It also shows that the structure of the labour market differs widely among different countries. The Norwegian labour market functioned better than the Spanish labour market over that period—Norway had a much higher employment rate and a much lower unemployment rate. Norway also had a higher participation rate, which is a reflection of the higher proportion of women in the labour force.

Norway and Spain are illustrations of two common cases. Norway is a low-unemployment, high-employment economy. (Other Scandinavian countries—Sweden, Denmark, and Finland—are similar; and in the figure, Australia is the country most similar to Norway.) Spain is a high-unemployment, low-employment economy. (Other southern European economies—Portugal, Italy, and Greece—are other examples.) Other combinations are possible, however: Germany’s participation rate is low like Spain’s, but its unemployment and employment rate performance are much better.