Explainer: How to tell if the job market is improving

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(MoneyWatch) The government's latest jobs report shows unemployment increasing from 7.2 percent in September to 7.3 percent last month. In many ways, however, the employment-to-population ratio is a better indicator of labor market conditions. And even as the economy was adding many more jobs than forecasters had predicted, that key metric fell to 58.3 percent, down 0.3 percentage points from the previous month.

The problem with using changes in the unemployment rate as the most important measure of the job picture is that it can fall even when labor market conditions get worse. When the unemployment rate declines because more jobless people find work, that reduction reflects a positive development in the labor market. But the unemployment rate also falls when people get discouraged about their prospects for finding a job and drop out of the labor force.

Thus, to properly interpret a change in the unemployment rate, it's important to know whether the change is due to a change in the proportion of people finding jobs or from a change in the labor force participation rate.

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This is especially important recently because there has been a large change in labor force participation, meaning the number of working-age people who are employed or who are looking for work. The civilian labor force participation rate has fallen from 66 percent at the start of the recession in December 2007 to 62.8 percent in October of this year.

According to the Bureau of Labor Statistics, there are 2.3 million people among those who have dropped out of the labor force who wanted and are available for work. These individuals are not counted as unemployed because they have not searched for work in the previous four weeks. If all of these workers had been counted as part of the labor force, the unemployment rate in October would have been 8.6 percent instead of 7.2 percent, a major difference.

One big unknown for the future is how many of these workers will return to the labor force once labor market conditions improve. If they return in substantial numbers, it would make it harder for the unemployment rate to fall.

The employment-to-population ratio does not have the discouraged worker problem. The civilian working-age population used to calculate this measure of labor market performance includes people both in and out of the labor force, so the movement between the two groups does not change the statistic.

This measure of labor market conditions tells a different story than the unemployment rate. The unemployment rate has fallen steadily from a peak of 10 percent in October 2009 to 7.3 percent as of last month. However, the employment-to-population ratio was 62.7 percent at the start of the recession in December 2007, fell to a low of 58.2 percent in November 2010 and has only increased to 58.3 percent in October of this year.

According to this measure of labor market performance, in other words, there hasn't been much improvement in the job market.

There are other factors besides the discouraged worker problem to watch out for when interpreting movements in either the unemployment rate or the employment-to-population ratio. If, for example, there is demographic change (such as the aging population we are seeing in the U.S.) and this causes a decline in the labor force participation rate as older workers drop out of the labor force, the employment-to-population ratio and unemployment rate calculations will be affected.

But there is an easy way around this problem for the employment-to-population ratio. The employment-to-population ratio for prime age workers aged 25-54 should be relatively independent of demographic change of the type we are currently experiencing because it excludes older workers. However, the story this measure tells is much the same. The ratio was 79.7 percent at the onset of the recession, fell to 74.8 percent in December of 2009 and has only increased to 75.4 percent since. It also has been flat for the last year or so.

So this measure also paints a somewhat gloomier picture of the labor market than the unemployment rate.

There are two other factors that are important to consider when interpreting movements in either the unemployment rate or the employment-to-population ratio. Both measures of labor market performance assume that anyone with a job is working as much as they want to and is in the job he or she is best suited for. But some workers who are counted as fully employed will only be able to find part-time work; they would rather work full-time if they could, and others end up in jobs they are overqualified for.

The Bureau of Labor Statistics publishes an alternative measure of the unemployment rate that corrects for the discouraged worker and part-time worker problems, and when these corrections are made the unemployment rate increases from 7.2 to 13.8 percent in October.

Of course, no single measure of labor market conditions is perfect, so it's best to look at the full range of indicators rather than focusing on any one measure. But the employment-to-population ratio should be among the set of statistics that is more carefully scrutinized, especially when there are substantial changes in labor force participation of the kind we have seen in recent years.