Why Unemployment Could Spike By Election Day

The labor market is slowly healing, but for a while it will look worse.

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As if Democrats don't have enough problems, the economy they've tried so hard to revive is lapsing back into a stupor. By the midterm elections in November, it might even seem worse than it is now. And that could add fresh punch to the Republican "wave" some forecasters think could sweep Democrats out of the majority in both houses of Congress.

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If there's one headline number that signals the health of the economy, it's the unemployment rate. As we all know, it's unacceptably high. On top of that, President Obama's economic team made the unfortunate prediction early in 2009 that if the government spent $800 billion on stimulus projects, the unemployment rate would peak at about 8 percent. The stimulus passed, and unemployment promptly shot up to 10.1 percent by the fall of 2009. It has since drifted down and plateaued in the range of 9.6 percent. But there's a good chance it will shoot up again—perhaps even cresting the distressing 10 percent level by election day.

Economically, that's not necessarily bad news. At the beginning of the recession, unemployment went up because companies were axing vast numbers of workers. That's not really happening any more, and some companies that laid people off are stretched to the limits of what they can get out of their existing workforce. The problem is that few companies are hiring, because consumers aren't spending money and business remains down.

[See 5 reasons companies still aren't hiring.]

The biggest job losses these days, in fact, aren't in private companies, they're in government, once considered recessionproof. The recession has battered state and local finances, with tax revenues down sharply in many places. The stimulus spending and other aid to states from Washington delayed the pain, but now those funds are running out, leaving no choice but to downsize. When the stimulus passed in early 2009, few forecasters thought the economy would still be gasping for air by the 2010 midterms. So Democrats didn't see that coming.

In the private sector, it's a different story. Small businesses remain hamstrung by weak demand and scarce credit, but big companies are in pretty good shape. Corporate profits are healthy and companies have loads of cash they can use to hire new workers—when they feel the economy is finally picking up. Companies are hiring more temporary and part-time workers and asking current staff to work more hours, typical steps before adding to their full-time workforce. A few companies are even hiring full-timers, with overall private-sector employment up modestly this year.

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The pace of layoffs is now at a 10-year low, according to outplacement firm Challenger, Gray & Christmas. So job security is improving, and as confidence gradually grows, discouraged workers who lost their jobs and gave up looking for work will start looking again. That too will drive up the unemployment rate, since somebody who's not looking for work isn't counted as part of the labor force, and is therefore not counted among the unemployed. Once you start looking for work again, you become part of the labor force and are technically unemployed.

We've got an epidemic of discouraged workers and long-term unemployed, arguably the most pernicious problem in the economy right now. The Labor Department says there are 1.1 million discouraged workers not even looking for a job and 2.4 million who are "marginally attached" to the labor force. Those are people who used to be counted as part of the labor force but now aren't. As the job situation improves, many of them will return to the labor force, and first be counted as unemployed as they look for work.

There are currently 14.9 million Americans counted as unemployed. If the labor-force dropouts were counted, it would be 18.4 million. By that measure, the unemployment rate would be about 11.6 percent—and it's headed in that direction. It won't get as high as 11.6, because all those dropouts won't flood the market at once. Some will never return and others will get jobs quickly. But as the labor force expands, unemployment is going to seem worse.

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For Democrats, the timing is obviously unfortunate. With private-sector companies finally starting to hire in small numbers, labor-force dropouts could very well decide that now's the time to get back in the game. When the stimulus passed 18 months ago, it was reasonable to hope that this would have happened more quickly, with unemployment peaking sooner and starting to drop by the time of the midterms. So much for predictions. Now the Democrats have to conjure a way to explain why rising unemployment is actually good news.