AMERICAN.COM

The official U.S. unemployment rate, the one you most often hear about in the news, is 8.3 percent.

Except it’s not really 8.3 percent. That number is misleadingly low because it is based off a dramatically shrunken U.S. labor force. If the size of the labor force as a share of the total working-age population (at least those not in the military or in jail) was the same as it was when Barack Obama took office—65.7 percent then vs. 63.7 percent today—the U-3 unemployment rate would be 11.0 percent.

Now, to be fair, a) the labor force participation rate peaked in 2000 and has been falling steadily since 2006; b) some of the decline in the participation rate is aging Baby Boomers dropping out of the labor force; and c) the labor force usually dips a bit during downturns. Yet even if you discount all that stuff, there seem to be a whole lot of discouraged Americans who have given up looking for a job and are thus no longer counted by Washington as “unemployed.”

In short, the 8.3 percent unemployment rate overstates the health of the labor market and the economic recovery. Here is how the Congressional Budget Office looks at the issue:

The unemployment rate would be even higher than it is now had participation in the labor force not declined as much as it has over the past few years. The rate of participation in the labor force fell from 66 percent in 2007 to an average of 64 percent in the second half of 2011, an unusually large decline over so short a time. About a third of that decline reflects factors other than the downturn, such as the aging of the baby-boom generation. But even with those factors removed, the estimated decline in that rate during the past four years is larger than has been typical of past downturns, even after accounting for the greater severity of this downturn. Had that portion of the decline in the labor force participation rate since 2007 that is attributable to neither the aging of the baby boomers nor the downturn in the business cycle (on the basis of the experience in previous downturns) not occurred, the unemployment rate in the fourth quarter of 2011 would have been about 1¼ percentage points higher than the actual rate of 8.7 percent.

So a generous estimate of the real unemployment rate (not considering underemployment) would be 10.4 percent. That’s still pretty bad. And if the CBO is correct, the unemployment rate might actually rise if the economy continues to strengthen as discouraged workers start to actively look for a job again and are again officially counted as “unemployed.”

Or maybe not. My pal Joe Weisenthal at Business Insider is touting a new Barclays Capital report, “Dispelling an Urban Legend: US Labor force participation will not stop the unemployment rate decline.” The study concludes the following:

• Many investors and economists appear to believe that the main reason for declining labor force participation in recent years is that a number of workers saw few job opportunities, became discouraged, and exited the labor market. These workers are thought to be ready to surge back into the labor market and stop or even reverse the decline in the unemployment rate.
• We disagree. Our models indicate that demographics, specifically retirements among the baby boomers, have played a larger role in pushing the labor force participation rate down than have cyclical factors. We see this trend continuing in the coming years.
• Consistent with our view, only a third of the drop in the labor force participation rate is accounted for by those who say they want a job, and only about 15% by those who want a job and are also of prime working age (ie, 25-54). Thus, we view the possibility of a large and sudden return of previously discouraged job seekers to the labor force as remote.

Back in the fourth quarter of 2007, the LFPR was 66 percent. Of that total, 32.2 points were people who said they did not want a job. At the end of 2011, the equivalent figures were 63.9 percent and 36 points. Of that 1.4 point increase in the “do not want a job category,” 0.8 point represented workers 55 years and older, or 57 percent.

So the nut of the Barclays argument is this: Blame the retiring Boomers, not the anemic recovery, for the steep drop in the labor force. Now, here is where it gets really good:

We believe that some find it surprising that large numbers of households are able to retire given the declines in stock market and housing prices in recent years. However, we note that most US households do not have large portions of their wealth in the stock market, and Social Security, rather than asset income, provides the bulk of retirement income for most middle- to lower-income households. Furthermore, those investors with significant stock market exposure who have maintained their holdings have recovered much of their losses; broad measures of the stock market are only down roughly 10% from their record highs. Finally, our view is that most households do not plan to liquidate their housing wealth in retirement, so the decline in housing prices may not prevent them from retiring. Clearly, some households are likely not living as well in retirement as they would have if asset prices had continued to make new highs every year or the labor market had not weakened, and the drop in wealth has likely delayed retirement for some households. However, the data nonetheless indicate that baby boomer households are still retiring in greater numbers each year.

So to buy the Barclays argument, you have to assume Baby Boomer retirement plans have been left unaffected by their shrunken nest eggs from a) a 30 percent decline in housing prices in the past five years and b) 30 percent decline in real stock returns since 2000. You also have to assume the CBO doesn’t know what it’s talking about, despite its long history calculating labor force trends.

But Team Obama should sure hope Barclays is correct givens its conclusion about where the unemployment rate is heading:

Consequently, one element of our US forecast that stands out from the consensus, and apparently the views of several policymakers, is our projection for the unemployment rate. Because our expectation of employment growth of about 200k per month throughout 2012 and 2013 is not substantially different from that of the consensus, it appears that our view that the labor force participation rate will trend lower, albeit subject to cyclical swings, is playing a significant role in differentiating our unemployment rate call. Assuming payroll growth averaging about 200k per month, Figure 7 shows the unemployment rate drops to about 7% by the end of 2013. In contrast, the consensus view that the unemployment rate will fall only slightly would require a surge in participation far above our estimate of the trend. In contrast, to keep the unemployment rate about constant under our participation rate forecast, we estimate payrolls need to grow about 75-100k per month.