‘Marginal workers’ impact unemployment rate

Jed Armstrong and Ozer Karagedikli – 

Reserve Bank of New Zealand

Each quarter, on average, about 18,000 people transit from unemployment to employment and about 24,000 people from employment to unemployment.

These worker separations and accessions are typically thought of as drivers of the unemployment rate.

If worker separations exceed worker accessions, the unemployment rate will rise, and if worker accessions exceed worker separations the unemployment rate will fall. However, there is a third state of the labour market, which is non-participation (often denoted not in the labour force or NILF), which is typically omitted from macroeconomic models.

‘Active’ Non-Participants

NILF refers to those working-age individuals in the economy who are neither officially employed nor officially unemployed.

According to formal economic definitions, non-participants do not take part in the labour market. They do not officially contribute (or seek to contribute) formal labour resources, and hence should not impact the equilibrium unemployment rate or wage level.

As such, non-participants are traditionally modelled as exogenous to labour market dynamics. More recently, there has been a rise in international economic evidence to suggest that non-participants can be ‘active’ in the labour market, which means that they play a role in determining labour market outcomes.

Two Main Forms

The role of non-participants comes in two main forms.

Firstly, non-participants may determine labour market outcomes indirectly by acting as a potential pool of labour that can erode wage bargaining power.

If there is a large number of labour market non-participants in the economy, firms may be less willing to compete for workers by offering higher wages due to the large pool of potential workers.

Secondly, non-participants may influence the labour market directly by transitioning from NILF into employment or unemployment when they desire.

Marginal workers

In this sense, non-participants act as marginal workers, entering the labour force only when competition for workers is sufficiently intense and wages are sufficiently high. As such, when we see large transitions in and out of NILF, it is likely that these non-participants have a material impact on the equilibrium determination of unemployment and wage rates.

The most suitable dataset for analysing labour market dynamics through the lens of transitions between labour market states is gross flows data. These data measure the total number of workers who transit each quarter between each of the three states of labour market participation- employment (E), unemployment (U), and non-participation (N).

Gross flows data

Gross flows data highlight churn and labour market dynamism more fully than the stock numbers reported by most statistical agencies.

Using gross flows data, we (among others) find that movements in and out of NILF occur with high frequency in New Zealand, and that these flows typically follow the broad economic cycle.

The movements in these flows suggest that there may be a large role for non-participants in determining labour market outcomes in New Zealand.

This role is amplified by the fact that the stock of non-participants is very large: in 2015 there were (on average) 1.1 million non-participants in the labour market. Given this large stock of NILF, even small changes in the probability of non-participants entering the labour market can lead to large changes in the unemployment rate.

Jed Armstrong and Ozer Karagedikli work in the Economics Department at the Reserve Bank of New Zealand based in Wellington. The above is a small part of their detailed analysis. For full text, please visit www.rbnz.govt.nz

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