Is Unemployment Understated?

While the numbers that come out of the BLS on employment and unemployment are the gold standard — they’re the ones that everyone uses — there are some serious problems with the numbers. The most significant of these, to my mind, is what is known as the Birth/Death adjustment.

This is an attempt by the BLS to correct for new companies being formed that provide jobs but which are not picked up in the official statistics, and also the firms that go out of business that are hidden from the official numbers.  Here is how the BLS puts it:

“The net birth/death model component figures are unique to each month and exhibit a seasonal pattern that can result in negative adjustments in some months. These models do not attempt to correct for any other potential error sources in the CES estimates such as sampling error or design limitations.

“Note that the net birth/death figures are not seasonally adjusted, and are applied to not-seasonally-adjusted monthly employment links to determine the final estimate.

“The most significant potential drawback to this or any model-based approach is that time-series modeling assumes a predictable continuation of historical patterns and relationships, and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.”

So given that the economy has been dropping jobs for 18 months and is in the middle of what is arguably the worst recession since WWII, is it rational to expect that the net effect would be for this adjustment to consistently add jobs? Here are the adjustments since last April 2008 from the BLS by way of http://globaleconomicanalysis.blogspot.com/2009/07/jobs-contract-18th-straight-month.html):

So we are led to believe that in every month but one since then, the formation of new companies has added more jobs than companies going out of business have subtracted from the total job picture. These are not trivial numbers either, with 185,000 jobs added in June alone through this statistical magic.

The official numbers peg January as the worst month of job losses, but it is the only month where the B/D adjustment actually caused a net decline in jobs. The effect since the start of the year can be seen in the graph below (from http://energyecon.blogspot.com/). The B/D adjustment over the last three months totals 631,000 jobs, or more than the official job losses in any of the last three months.

Now look at some of the individual line items in the tables. With housing construction falling off a cliff at a rate that has not been seen since the Great Depression, do they seriously expect us to think that with the exception of three months in the winter that new construction firms are being formed that are hiring thousands of people a month? Do you really think that enough bars, restaurants and hotels opened up in the last month to provide 87,000 uncounted jobs?

Remember that if McDonald’s (MCD: 57.45 -0.77 -1.32%) or Yum Brands (YUM: 34.25 -0.77 -2.20%) open up a new store, those numbers would get into the official count. That 87,000 would have to entirely come from Mom & Pop-type operations.

Admittedly, over time it makes some sense to make an adjustment like the B/D model — without one the numbers would become fairly seriously distorted over time. However right now, the adjustment looks very much wrong.

It serves as a reminder that the BLS numbers are estimates, and should be treated as such, even if they are generally the best estimates we have. It also means that as bad as the official numbers look, the reality is worse.