FRBSF Economic Letter
2005-15; July 15, 2005
Age and Education Effects on the Unemployment Rate
The national unemployment rate fell
slowly during the first half of 2005, reaching 5.0% in
June. While this is above
the lows reached in 1999-2000, it is noticeably below the
rates that largely prevailed during the mid-1970s through
the mid-1990s. This Economic Letter focuses on two demographic
factors that help explain the reduction in the unemployment
rate over the past few decades. The first is the composition
of the population by age group, and, in particular, the
contribution of the aging of the "baby boom" generation
to the long-term decline in the unemployment rate. The
second is rising educational attainment among the population.
In our analysis, we account for joint influences of age
and education. Our results suggest that both factors made
a significant contribution to the downward trend in the
unemployment rate over the past few decades, although their
influence was not large enough to fully account for the
very low rates achieved near the most recent business cycle
peak (years 1999-2000).
Impact of the "baby boom"
At least since Perry (1970), demographically adjusted
unemployment rates have been used to understand how
changes over time
in labor force composition have contributed to trends
in the unemployment rate. The most commonly applied
demographic
adjustment to the observed unemployment rate is based
on changing labor force shares by age group. As Figure
1 illustrates,
younger groups generally have noticeably higher unemployment
rates than older groups; indeed, the difference is most
striking for teenagers (age 16-19), whose unemployment
rate typically is about three or more times that of people
aged 35 and over. Informal observation and systematic
analysis both point to high rates of job turnover among
young workers
as an explanation for higher equilibrium unemployment
rates among these groups. As a result of these differences in
equilibrium unemployment rates by age, the movement of
the large baby boom generation
through the age distribution caused aggregate unemployment
rates first to rise in the 1960s-1970s, when the share
of young workers rose, and subsequently to fall, as the
aging of the baby boom increased the labor force shares
of prime-age workers, that is, those aged 35-54 (Figure
2). Changes in the sex composition of the labor force
also have been used as a basis for adjusting the aggregate
unemployment
rate. However, the impact of adjustments for changing
shares by sex has become quite small over the past few
decades,
due to convergence in unemployment rates between men
and women and relative stability in women's labor force
shares
since the 1980s (see, for example, Shimer 1999).
The impact
of changing age composition on the unemployment rate
can be assessed through calculation of an "age-adjusted
unemployment rate." This series is formed by multiplying
each age group's unemployment rate over time by its labor
force share in a fixed base year. We use 1978 as the base
year; Shimer (1999) identified 1978 as the "worst" year
in recent U.S. history in demographic terms, in that
the labor force shares of age groups with high unemployment
rates were at their post-World War II peak (see Figure
2 for the list of age groups used). Figure 3 displays
the
official and age-adjusted unemployment rates as the two
solid lines—the dotted line is a third series that is
discussed below. The gap between the two series reflects
rising labor force shares for age groups with lower unemployment
rates; this gap grew noticeably during the 1980s and
then grew only a bit more during the 1990s. Comparison
of the
two series across years is most informative when done
at similar points in the business cycle. For example,
the
official unemployment rate declined by 1.8 percentage
points between the business cycle peak years of 1979
and 2000,
while the age-adjusted rate declined by 1.3 percentage
points. The changing age structure of the labor force
accounts for the difference between these two figures—0.5
percentage
point, or just under 30 percent of the change in the
actual unemployment rate. A slightly larger impact of
changing
age structure (0.7 percentage point) is uncovered when
we examine the change in unemployment rates between the
labor market troughs of 1982 and 2003; however, this
represents a relatively small share of the change in
the actual unemployment
rate, which fell 3.7 percentage points between these
trough years.
Rising educational attainment
 Following a line of reasoning similar to that used for
age adjustments, past research also has investigated
the merits of adjusting the aggregate unemployment
rate for
rising educational attainment (e.g., Summers 1986). Unemployment
rates vary substantially by educational attainment, with
individuals lacking a high school degree on average experiencing
unemployment rates that are three to five times greater
than the rates experienced by individuals with a college
degree or more (Figure 4; all ages). In addition, educational
attainment has risen steadily since the mid-1970s: the
labor force share of individuals who attended at least
some college rose from 33 to 57 percent between 1976
and 2004, with a corresponding drop in the share of
individuals
possessing a high school degree or less (data not shown).
Several
aspects of the process by which educational attainment
rises argue against the use of educational adjustments
to the aggregate unemployment rate, especially when age
and education adjustments are applied in an additive,
independent manner. First, employers may care primarily
about relative
rather than absolute educational attainment in their
hiring activities (Shimer 1999). If so, as educational
attainment
rises, the shrinking stock of less-educated individuals
may consist of increasingly unattractive job candidates.
The resulting rise in the unemployment rates of less-educated
individuals would reinforce the estimated decrease in
aggregate unemployment arising from their declining labor
force share,
resulting in an overestimate of the contribution of rising
educational attainment per se to declining unemployment
rates. Second, even if one accepts that adjusting the
unemployment rate for rising educational attainment is
conceptually
reasonable, adding age and education adjustments together
is likely to lead to an overstatement of their net effects,
through "double counting" of age and cohort influences
on educational attainment. For example, teenagers constitute
a disproportionate share of individuals with low educational
attainment; therefore, an adjustment that accounts for
the reduction in the labor force share of individuals lacking
a high school degree will reflect in part the aging of
the labor force that has reduced the share of teenagers.
An
adjustment to the aggregate unemployment rate based on
changing shares of groups defined jointly by age and
education avoids the problems inherent in separate, additive
adjustments for age and education. In particular, as
suggested by the argument in the previous paragraph, adjustments
to the aggregate unemployment rate based on changing
group
shares rely heavily on the assumption that group-specific
unemployment rates do not change in response to changes
in group-specific labor force shares. Empirical tests
conducted as part of this research indicated that, for
the period
we analyze, this assumption of independence between unemployment
rates and labor-force shares is strongly violated when
groups are defined by age or education alone, but for
most years it is met quite closely when we divide the labor
force by joint age and education groupings. Moreover,
by
separately identifying the changes in educational attainment
by age group, the joint age/education grouping eliminates "double
counting" of age and cohort effects on educational
attainment.
The calculation we perform to obtain the unemployment
series adjusted for joint changes in age and educational
attainment
is similar to that performed for the age-adjusted unemployment
series, with 1978 as the base year once again. The group
breakdown used for this calculation relies on four age
and four education groups, for a total of sixteen groups
(with two excluded, due to the very low incidence of
college experience for 16-19 year olds). The resulting
series is
displayed in Figure 3 as the dotted line. As was the
case for the age adjustment, the impact of the joint age
and
education adjustment was larger in the 1980s than in
the 1990s. Comparing the official and adjusted series across
comparable points in the business cycle, we find that
changing
labor force shares of groups defined jointly by age and
education led to a reduction in the unemployment rate
of 0.9 to 1 percentage point between the business cycle
peaks
and troughs of the late 1970s/early 1980s and the early
2000s; this equals about one-half to one-fourth of the
overall decline in the unemployment rate (1.8 to 3.7
percentage points). As discussed above, the effect of changing
age
alone is equal to 0.5 to 0.7 percentage point, which
is larger than the additional impact associated with the
incorporation
of changing education (0.3 to 0.4 percentage point). Conclusion
Our results suggest that the aging of the labor force
and rising educational attainment can account for a
significant
portion of the decline in the unemployment rate over
the past two and a half decades. In particular, after
adjusting
the unemployment rate for these factors, we find that
the rate in recent years is equal to a rate about one
percentage
point higher in terms of the age structure and educational
attainment of the labor force around the year 1980. While
the incorporation of education into demographic adjustments
to the unemployment rate is not standard in the economics
literature, our research findings support the inclusion
of education over the period we examine, and its inclusion
produces an overall adjustment that is within the numerical
range of adjustments discussed in other work (see, for
example, Shimer 1999).
Although rising age and education made important contributions,
they explain only about one-half or less of the decline
in the unemployment rate over the past few decades. This
suggests that other factors contributed to the decline
and help explain the very low unemployment rates—below
4.5%—achieved in 1999-2000. Indeed, prompted by the
lengthy economic expansion of the 1990s, labor market conditions
were unusually strong in 1999-2000. By contrast, employment
growth has remained sluggish and uneven well into the
current
expansion, and the decline in the unemployment rate has
been correspondingly slow.
Rob Valletta
Research Advisor
Jaclyn Hodges
Research Associate
References
Perry, George. 1970. "Changing Labor Markets and Inflation." Brookings
Papers on Economic Activity, pp. 411-448.
Shimer, Robert. 1999. "Why Is the U.S. Unemployment
Rate So Much Lower?" In NBER Macroeconomics
Annual 1998, eds. Ben S. Bernanke and Julio J. Rotemberg, pp.
11-61. Cambridge: MIT Press.
Summers, Lawrence. 1986. "Why
Is the Unemployment Rate So Very High Near Full Employment?" Brookings
Papers on Economic Activity 2, pp. 339-383.
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