We have been consistently covering the uneven recovery in the US labour market for our clients. In particular, we have focused on the now mainstream concern that although the unemployment rate might have been declining the underlying conditions have little improved. Our main argument remains that it is unclear if not very uncertain that this trend is cyclical and thus that it can be affected by monetary policy at all.
Still, this trend remains a critical challenge for the US. If you look at a long term time series of the US labour force participation rate, it peaked between 1998 and 2001 at 67.3% and has since declined to 62.8%.
(click on charts for better viewing)
You have to go back to the end of the 1970s to find such a low reading. This also serves to highlight the point that while the change of the labour force participation rate may be argued to be cyclical (a case of empirical study really), the trend seems much more structural in nature.
What’s more, the focus on this issue is not mere academic. Assuming an unchanged labour force participation rate it is unclear that there has been any significant improvement at all in the US labour market.
This obviously puts US monetary policy makers in a tight spot in relation to their mandate to foster full employment since what does this really mean if people are leaving the workforce at a structurally increasing rate.
A recent piece by Ellyn Terry, an economist at the Atlanta Fed, provides important evidence and information on the drivers of the decline in the US labour force participation rate. The interesting aspect of this small study is that it breaks down the drivers on age groups which allows us to get a much closer look at the recent trends in the US labour force participation rate; here is the main point.
Since the recession began, the labor force participation rate (LFPR) has dropped from 66 percent to 63 percent. Many people have left the labor force because they are discouraged from applying (U.S. Bureau of Labor Statistics data indicate that a little under 1 million people fall into this category). But the primary drivers appear to be an increase in the number of people who are either retired, disabled/ill, or in school.
This chart in particular offers a very interesting look into the drivers of the labour force participation decline across age groups. The prevalence of school attendance among the younger age groups is logical and probably a big part of the cyclical variation in the labour force participation rate. All age groups can be argued to be incited to re- or further educate themselves if the job market becomes difficult, but even more so for the younger age groups.
The most interesting aspect of Terry’s analysis however is the finding that the bulk of the decline in the US labour force participation rate (80%) is due to one of three reasons.
- Wants a job, but can’t find one
The disabled/ill category is interesting because of the increasing evidence that receiving disability aid is better paid than having a low wage job. Several academic and journalist sources have been pointing to the unsustainable rise in the prevalence of social disability entitlements in the US. Finally, it is interesting to ponder retirement as one of the major causes of the decline in the labour force participation rate. This is significant for two reasons in our view. Firstly, because retired workers are unlikely to re-enter even if economic conditions improve (and if they do it will most likely be in part-time and/or low wage occupations). Secondly, it casts a pessimistic empirical light on the prospect (in all OECD economies) to increase the labour supply by inducing later retirement to correct for a rise in life expectancy. This may work in theory, but it seems much more difficult to implement in practice.