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Getting Our Arms Around Labor Force Participation With Two Fed Studies

May 7, 2012Mike Konczal

The short answer is: half, U-5 probably tells you everything you need to know, and women are going to play the most interesting role as it evolves.  Now for the question and longer answer....

The average labor force participation rate went from an average of 66% in 2007 to a 2011 average of 64.1%.  Last month it was 63.6%.  As a reminder, the labor force is the employed and the unemployed (those without a job who are actively looking for one) added together.  When this number decreases it means that there are less people working, though it doesn't increase the unemployment rate (because, by definition, those leaving the labor force are no longer looking for a job).  Let's try to get our arms around the latest econoblogosphere debate: how much is the decrease in labor force participation a type of shadow unemployment?

To recap, there's a handful of longer-term trends to watch in the economy. When Ben Bernanke was asked about labor force participation at his most recent press conference, he responded that labor force participation was dropping because the economy was (my bold) "no longer getting increased participation from women... society ages and also, for other reasons, male participation has been declining over time."  However a lot of it "represent cyclical factors, much of it is young people, for example, who presumably are not out of the labor force indefinitely, but given the, uh, weak job market, they are going to school or doing something else, rather than, than working."

But how to get a good estimate of what is cyclical - related to the economic downturn - and what is structural and the result of longer-term trends - what would have happened without the Great Recession?  First off, what's the largest number possible?  Evan Soltas (a new blogging superstar you should be reading) takes the labor force participation rate of 2007 and projects it to now, and finds 5.8 million people missing.  This would give us an unemployment rate of around 11.4 percent, but would also exclude the longer-term trends.  Greg Ip, looking at CBO numbers, finds 5 million people missing.

At the other end of the spectrum are those who would think that the unemployment rate is capturing all we need to know.  If someone really wants a job, they would look for one, and there's nothing interesting policy-wise in this information.  At 8.1% unemployment there's still plenty of slack in the labor market. (There's an unemployment crisis at 8.1% unemployment!)  The answer of the "true" unemployment rate should be somewhere in the middle.

Chicago, Kansas City

Daniel Aaronson, Jonathan Davis, and Luojia Hu of the Federal Reserve Bank of Chicago just put out a paper - Explaining the decline in the U.S. labor force participation rate - that shows:
the current LFPR [Labor Force Participation Rate] is roughly 1 percentage point lower than our estimated trend rate (the LFPR consistent with the contemporaneous composition of the work force and an economy growing at its potential)....As of late 2011, the actual LFPR for 16–79 year olds is 1.1 percentage points below trend LFPR...Indeed, over the 2008–11 period, we find that only one-quarter of the 1.8 percentage point decline in actual LFPR for 16–79 year olds can be attributed to demographic factors.
Labor force participation is 1.1% below the trend of where it is supposed to be.  They concluded this 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.  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.
 
Meanwhile, Willem Van Zandweghe has a paper from the Federal Reserve Bank of Kansas City, published in the first quarter of 2012, titled Interpreting the Recent Decline in Labor Force Participation.  They, strikingly, come to the same conclusion as the Chicago researchers.
 
Zandweghe breaks out a decomposition technique to seperate out the cylical from the long-term elements of labor force participation movement.  He finds that that "[t]he Beveridge-Nelson decomposition attributes 1.1 percentage points of this decline (58 percent) to the cyclical downturn. Long-term trend factors, such as demographics, account for the remaining 0.8 percentage point of the decline (42 percent)."  1.1% percent is cyclical. That 1.9 percentage point overall drop reflects the drop from the 66% average in 2007 to the 64.1% average in 2011.
 
Gender plays a role in this analysis as well.  A slight majority of men's decline in labor force participation is due to long-term trends; virtually all of women's decline is the result of the cyclical downturn in the recession.  "The average annual LFPR of men fell 2.8 percentage points from 2007 to 2011, of which 60 percent was due to a decline in trend participation...Women’s average annual LFPR fell 1.2 percentage points from 2007 to 2011. The decomposition attributes essentially all of this decline to the cyclical downturn in the labor market."
 
1.1% Means...
 
To lose 1.1% of the labor force means that we are missing roughly 2.7 million people.  Since around half of the total loss is cylical, the 2.7 million matches half of the total 5 - 5.8 million that Soltas and Ip found above, which is a good sanity check.  If we add 2.7 million people to the unemployed, that gives us a current unemployment rate of 9.7%.
 
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%.  Discouraged and marginally attached workers, and the U-5 unemployment rate that incorporates them, are designed to give us a measure of those not in the labor force who want to come back into the workforce but have given up looking.  Perhaps this will be our best measure going forward of this phenomenon?
 
Here's a chart from the Kansas City paper of how the unemployment rate looks forecasted:

Since so much of the cylical elements of the labor force participation is driven by female labor choices, those will be key in understanding how this evolves.  Catherine Rampell wrote last December about how young women dropping out of the labor force "are not dropping out forever; instead, these young women seem to be postponing their working lives to get more education."  We could see a wave of much more highly educated women enter the labor force further down the road.  And the New York Fed's blog argued that "a key factor for future aggregate labor force participation is the behavior of married women," and whether or not they look to re-enter the labor force. In general, and likely for men, as both the Kansas City paper and Ryan Avent note, many of these workers are going into disability.

Overall I agree with what Ryan Avent argues here.  If we were hitting constraints, we'd see job openings and prices, especially labor costs, shooting upwards, which we do not see.  I'm not sure what policy lessons people are drawing from these missing workers, but they amplify the case that expansionary policies, from fiscal to monetary to debt workouts, are necessary and urgent.

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