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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 $8 trillion real-estate bubble in the United States, as well as property bubbles in Spain, Ireland, and the United Kingdom.
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% in Spain and Greece, and more than 20% in the eurozone as a whole—makes headlines daily. But 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 labour force. So if the labour force comprises 200 workers, and 20 are unemployed, the unemployment rate is 10%.
But the millions of young people who attend university or vocational training programs are not considered part of the labour 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 labour 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 labour force. Although the number of unemployed people remains at 20, the unemployment rate quadruples, to 40%. 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 European Union’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% youth unemployment rate implies significantly worse conditions for young people than its 19% youth unemployment ratio. Likewise, Greece’s rate is 49.3%, but its ratio is only 13%. And the eurozone-wide rate of 20.8% far exceeds the 8.7% ratio.
To be sure, a youth unemployment ratio of 13% or 19% is not grounds for complacency. But, while the eurozone’s youth unemployment rate has increased since 2009, its ratio has remained the same (though both significantly exceed pre-2008 levels).
During the 2006 French student protests, France’s 22% youth unemployment rate appeared to compare unfavorably to rates of 11%, 12%, and 13% in the United Kingdom, the US, and Germany, respectively. But the Financial Times showed that only 7.8% of French under-25’s were unemployed—about the same ratio as in the other three countries. France simply had a higher percentage of young people who were full-time students.
Failing to account for the millions of young people either attending university or in vocational training programs undermines the unemployment rate’s credibility. And, while some young people use higher education to escape a rocky job market, their choice to build new skills should not negatively impact perceptions of their country’s economic health.
Policymakers do, of course, need to address the problem of youth unemployment; but they must also acknowledge that the problem is not as serious as the headlines indicate. Unfortunately, these distorted results have become conventional wisdom—even for respected economists like the Nobel laureate Paul Krugman, who recently invoked the flawed “50% youth unemployment” figure.
Thus, four years after the crisis erupted, methods for measuring and assessing economic health remain alarmingly inadequate. As any pilot knows, flying without radar or accurate weather forecasts is likely to end in a crash.