Economists worldwide need better ways to measure economic activity. Relying on GDP growth rates to assess economic health, almost all of them missed the warning signs of the 2008 financial crisis, including an US$8 trillion real-estate bubble in the US, as well as property bubbles in Spain, Ireland and the UK. Together with households, financial institutions, investors and governments, economists were swept up in the financial euphoria that led to excessive risk-taking and severe over-leveraging of banks and households. Even the eurozone’s macroeconomic imbalances largely went unnoticed.
Unemployment estimates also are surprisingly misleading — a serious problem, considering that, together with GDP indicators, unemployment drives so much economic-policy debate. Outrageously high youth unemployment — supposedly near 50 percent in Spain and Greece, and more than 20 percent in the eurozone as a whole — makes headlines daily. However, these numbers result from flawed methodology, making the situation appear far worse than it is.
The problem stems from how unemployment is measured: The adult unemployment rate is calculated by dividing the number of unemployed individuals by all individuals in the labor force. So if the labor force comprises 200 workers, and 20 are unemployed, the unemployment rate is 10 percent.
However, the millions of young people who attend university or vocational training programs are not considered part of the labor force, because they are neither working nor looking for a job. In calculating youth unemployment, therefore, the same number of unemployed individuals is divided by a much smaller number, to reflect the smaller labor force, which makes the unemployment rate look a lot higher.
In the example above, let us say that 150 of the 200 workers become full-time university students. Only 50 individuals remain in the labor force. Although the number of unemployed people remains at 20, the unemployment rate quadruples, to 40 percent. So the perverse result of this way of counting the unemployed is that the more young people who pursue additional education or training, the higher the youth unemployment rate rises.
While standard measures exaggerate youth unemployment, they likely understate adult unemployment, because those who have given up their job search are not counted among the unemployed. As the Great Recession drives up the number of such “discouraged workers,” adult unemployment rates appear to fall — presenting a distorted picture of reality.
Fortunately, there is a better methodology: The youth unemployment ratio — the number of unemployed youth relative to the total population aged 16-24 — is a far more meaningful indicator than the youth unemployment rate. Eurostat, the EU’s statistical agency, calculates youth unemployment using both methodologies, but only the flawed indicator is widely reported, despite major discrepancies. For example, Spain’s 48.9 percent youth unemployment rate implies significantly worse conditions for young people than its 19 percent youth unemployment ratio. Likewise, Greece’s rate is 49.3 percent, but its ratio is only 13 percent. And the eurozone-wide rate of 20.8 percent far exceeds the 8.7 percent ratio.
To be sure, a youth unemployment ratio of 13 percent or 19 percent is not grounds for complacency.