The Labor Participation Rate (March 6)

Update 335 — The Labor Participation Rate: After the Shouting, What Have We Learned?

We tear ourselves away from the House floor debate on H.R. 1 — the anti-corruption political reform package scheduled for a vote on final passage at 11 a.m. on Friday — to provide a labor market update focused on the labor participation rate.

The rate is a statistic that has been appropriated by the GOP to argue that Obama must have been bad for workers because this number shrank during his presidency.  The argument fails because the timeframe is narrow and slanted and because it assumes the higher the rate, the better off workers and the economy are.

Really?  We challenge this assumption, not because the labor participation rate isn’t a meaningful measure with a consensus policy target, but because it doesn’t tell the full story of why people are not participating and allides and obscures the distinction between good and bad jobs.

Best,

Dana

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During testimony before both chambers of Congress last week, Fed Chairman Jerome Powell expressed concern about the U.S. labor force participation rate (LPR) — workers and those looking for work as a percentage of civilians between 16 and 64 years old. The current U.S. LPR is 63.2 percent, down from a high of 67 percent in 2000. Powell said that while labor force participation has improved since levels dropped below 62 percent last year, progress since the Great Recession has been slow.

Can policymakers use LPR as a metric to assess the health of the labor market and is there an optimal rate for which policy should aim? The LPR was the only macro-indicator moving in the “wrong” direction during much of the economic recovery under President Obama. Republicans often cited the stagnant LPR as evidence that Obama’s economic policies were not helping the average American seeking work. Now that it’s marginally improving under President Trump, Republicans still hang their hats on the stat.

LPR in Historical Context

In October 2018, the unemployment rate fell to 3.7 percent — its lowest level since 1969.  Wages are finally starting to rise after a long period of stagnation, but the persistently low LPR still perplexes many economists, as well as Chair Powell. The rate rose steadily from the 1960s until 2000 when it began to dip. It took a deeper dive after the Great Recession and has not recovered.

Source: St. Louis Fed

Nevertheless, the labor market appears to be in good shape. There is record low unemployment and wages are beginning to outstrip inflation.

Confounding Labor Market Conditions

The US may be experiencing relatively low labor participation, but this situation could be a result of many different factors. Economists point to three leading explanations:

  • Automation: As employers look to cut costs, they often turn to automation. Since 1980, automation has led to a 250 percent increase in productivity and around 40 percent decrease in manufacturing jobs. Low-skilled employees have had difficulty transitioning into high-skilled work, leading to an excess of certain jobs that cannot be filled.
  • Outsourcing: Accelerated trade with China in the 2000s also played a significant role in the steep decline in US manufacturing employment. Trade policies allowed companies to offshore jobs in pursuit of cheaper labor and workers displaced were not re-absorbed by the labor market. The U.S. has lost close to five million manufacturing jobs since 2000, around the same time the LPR began to decline.

Source: Bureau of Labor Statistics

  • Demographics: As the country ages, we should expect early retirees to negatively impact the LPR. Per the Atlanta Fed, half of the LPR decline since 2000 is due to aging demographics.

Workers exit the labor force for many other reasons, as well: going back to school, raising a family, taking an early retirement, contracting an illness, etc. Older, wealthier people also tend to drop out of the labor force for different reasons than their younger, less-wealthy counterparts.

Fed Chair Powell and other policymakers tend to focus primarily on the LPR among those aged 25 to 54 in order to exclude those leaving the labor force for schooling and early retirement or illness. That rate stands at 82.4 percent, down from 84.4 percent in 2000.

LPR a Red Herring?

If the LPR were 100 percent, everyone between the ages of 16 and 65 would either have a job or be actively seeking one. In this scenario, workers would never leave a job to care for family or go to school, no one would retire early, and workers might need more than one job. Just as a zero percent unemployment rate is neither attainable or desirable, neither is a 100 percent LPR.

When the LPR decreased from 64.9 percent in 2008 to 63 percent in 2011 following the Great Recession, Republicans argued that it was due to lackluster economic recovery efforts by the Obama Administration. They argued the expansion of social safety net programs disincentivized work. Stanford economist Robert Hall and San Francisco Fed Advisor Nicolas Petrosky-Nadeaum say otherwise. In testimony before to the Senate Finance Committee in 2015, they explained how the government safety net is not leading the poorest Americans to avoid work and that most LPR reductions occur among high-income households. In stark contrast to the GOP’s claims, LPR among the lowest quartile of income earners steadily rose from 1996-2015.

There may not be an optimal LPR in terms of a singular percent figure, but there are trends within the LPR of which economists and policymakers should take note:

  • A higher, stable LPR among those under 54 years old means more, able-bodied adults are participating in the labor market.
  • A diminishing LPR among people under 54 years old may mask unemployment that stems from underlying shifts in the economy and an unskilled workforce, rather than changes in the business cycle. (The Bureau of Labor Statistics’ official unemployment figure may stay low in this environment since some unemployed have stopped looking for work and would not be included in its count.)

In Search of a Qualitative Measure

Problems with labor metrics abound and we don’t mean to single the labor participation rate out as uniquely obscurantist. Wage growth tells a more dimensional and qualitative story about the overall state of the labor market. The recent uptick in wages suggests that we have a tighter labor market than before, but the lack of inflationary pressure indicates we may not actually be at full employment, traditionally defined as four percent or less. Unfortunately, this measure too suffers from many of the same the limitations as the LPR, further underscoring the need for several metrics in evaluating the state of the economy.

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