Blog Post

Blogs review: the shrinking labor force

What’s at stake: There is a great deal of interest in the American blogosphere to understand the recent dynamic of the labor force participation rate. The latest Jobs reports have, indeed, shown a continuing decline in the share of working-age Americans who are in the labor force. The civilian labor participation rate fell in April to 63.6, its lowest rate since December 1981 providing a simple explanation to the seeming contradiction in the unemployment numbers — that the unemployment rate keeps dropping even though job creation has been low. The issue has obvious implications for the short term, but also for the long term potential rate of the growth of the US economy.

By: Date: May 18, 2012 Topic: Global Economics & Governance

What’s at stake: There is a great deal of interest in the American blogosphere to understand the recent dynamic of the labor force participation rate. The latest Jobs reports have, indeed, shown a continuing decline in the share of working-age Americans who are in the labor force. The civilian labor participation rate fell in April to 63.6, its lowest rate since December 1981 providing a simple explanation to the seeming contradiction in the unemployment numbers — that the unemployment rate keeps dropping even though job creation has been low. The issue has obvious implications for the short term, but also for the long term potential rate of the growth of the US economy.

The missing 5 million

David Altig – research director at the Atlanta Fed – writes that if the labor force participation rate (LFPR) had stayed at the March level of 63.8 percent instead of falling to 63.6 percent, the unemployment rate would have risen to 8.4 percent instead of falling to 8.1 percent. Brad Plumer writes at the Wonk blog that if the same percentage of adults were in the workforce today as when Barack Obama took office, the unemployment rate would be 11.1 percent. If the percentage was where it was when George W. Bush took office, the unemployment rate would be 13.1 percent.

Greg Ip points that, in January 2008, the Congressional Budget Office reckoned the labor force would be some 5m larger by now. But the labor force is only slightly larger now than in December 2007, when the recession began. What happened then to those 5m people? Evan Soltas takes the labor force participation rate of 2007, projects it to now and also finds around 5 million people missing on this basis. For the reasons outlined in the following section – namely that a large part of the decrease in participation is due to demographic factors – Ryan Avent writes that the gap is not 5m, as a look at the CBO’s projections might lead one to assume, but more like 1m-2m.

Disentangling the change in the LFPR: demographic vs. behavioral changes

David Altig writes that he decline in the LFPR is being influenced by a confounding mix of demographic change and other behavioral changes that nobody seems to understand.

Rortybomb looks at several recent studies to get an idea about how to disentangle structural and cyclical factors in the decline of the LFPR. Daniel Aaronson, Jonathan Davis, and Luojia Hu of the Federal Reserve Bank of Chicago concluded after creating a model of 44 combinations of gender, education and age to estimate projected changes, which is then compared to actual 2011 labor force participation rates that two-thirds of the long-term decline in LFPR is from demographics, and the remaining third is due to other effects, especially gender and education. Based on this decomposition, labor force participation is 1.1% below the trend of where it is supposed to be.  In a recent Federal Reserve Bank of Kansas City paper, Willem Van Zandweghe come to the same conclusion as the Chicago researchers. David Altig also finds a similar range.

To lose 1.1% of the labor force means that we are missing roughly 2.7 million people.

Brad DeLong has the following decomposition of the decline in the LFPR: Since 2007:

  • a likely 0.2%-0.6% point decline in labor-force participation from demographic changes.
  • a likely 1.5% point decline in labor-force participation as a cyclical and reversible consequence of cyclically low employment
  • a likely 0.7%-1.1% point decline in labor-force participation as the length of the economy’s depression transforms temporary cyclical unemployment into permanent structural unemployment.

Understanding the contrasting movements of the U rate and the E/P ratio

Stefania Albanesi, Ayşegül Şahin, and Joshua Abel write at the NY Fed blog notes that the unemployment rate has declined 1.7 percentage points since the unemployment peak in October 2009, but the E/P ratio has increased only 0.1 percentage point.

Jonathan McCarthy and Simon Potter of the NY Fed provide a simple framework to understand how these measures are related. To clarify the relationship of unemployment, employment, and labor force participation, we need a little math. First, we can express the employment-to-population ratio as:

 

We then construct a decomposition of labor market changes by taking the logarithmic changes in the employment-to-population ratio:

where we have used the approximation that the logarithm of (1-unemployment rate) is the negative of the unemployment rate.

Stefania Albanesi, Ayşegül Şahin, and Joshua Abel look at this decomposition in previous cycles. The labor force participation was flat-to-rising during the cycles associated with the 1973-75, 1981-82, and 1990-91 recessions. In those cases, a declining unemployment rate was associated with a rising E/P ratio, so those variables were providing consistent signals about labor market conditions. On the contrary, in the cycles associated with the 2001 and 2007-09 recessions, labor force participation declined. Consequently, declines in the unemployment rate have been associated with little increase in the E/P ratio, so those variables have provided contrasting signals about the labor market.

 

How many of the nonparticipants in the LF can we expect to return to the market?

Julie Hotchkiss of the Atlanta Fed writes that the question that seems to be on everyone’s mind is how many of the nonparticipants in the labor force can we expect to return to the market. The answer to this question has immediate implications for the unemployment rate (especially if all these nonparticipants were to return to unemployment rolls), and longer-term implications for economic growth. To answer this question, the author investigates what these labor force nonparticipants are doing. The Current Population Survey (CPS) by the BLS, asks labor force nonparticipants about their reason for absence. The reason given by nonparticipants that gets most of the attention is "discouraged over job prospects." But, in April 2012, these people accounted for only 1.1 percent of all nonparticipants. The vast majority of nonparticipants are absent because of retirement, disability, going to school, caring for household members, or other reasons. Looking at the change in the composition of reasons, the author finds an important rise in nonparticipants absent because of "School". Arguably, these individuals should re-enter the labor force with enhanced skills that will be able to make a positive contribution to overall economic growth.

Rortybomb writes that the number of people the BLS lists as "not in the labor force" but also lists as "persons who currently want a job" has increased by 1.7 million.  Indeed U-5 unemployment, which takes normal unemployment and adds in "discouraged workers, plus all other persons marginally attached to the labor force," sits at 9.5%.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.


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