The potential for labor force participation

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The potential for labor force participation

The potential for labor force participation

Behind the Numbers, July 2014

Participation in the labor force declined substantially after the financial market crash in 2008. Demographics accounted for about half of this decline, but even adjusted for demographics, labor force participation has fallen significantly. In a way, that’s good news. It suggests that there are plenty of unused resources to be put to work as the US recovery finally begins to pick up steam.

Labor force participation reflects demographic changes and the weak labor market

US labor force participation has been remarkably volatile over the past 25 years. Figure 1 shows that the mid-1990s were marked by a surprising rise in labor force participation. Tight labor markets drew people into the workforce, and welfare reform pushed others to look for jobs. The participation rate rose to over 67 percent in 1997 and remained at about that level until the 2001 recession. It then declined by about 1 percent before stabilizing again as the economy recovered during the mid-2000s. The Great Recession, however, saw a steep decline in the labor force participation rate, which has continued through the current recovery.

Figure 1. US labor force participation rate

The recession was not the only reason for this decline. The earliest Baby Boomers—the leading edge of a large increase in retirements—turned 62 in 2008. As the portion of the population over 60 years old started to increase, the overall labor force participation rate likely would have declined, even if labor markets had remained healthy. However, this does not account for all of the fall in the labor force. The blue line in figure 1 shows how much the labor force would have declined if participation rates for each cohort remained the same. About half of the 2.7 percent decline in the participation rate was because of demographics—the other half was because people just left the labor force.

Both men and women left the labor force after the 2008 financial crisis. Figure 2 shows labor force participation rates by gender. Labor force participation among women peaked in the 1990s at around 60 percent.  After the recession, the female labor force participation rate fell by about 2 percent. The participation rate for men has been declining for years, but the decline steepened after 2008. Men’s labor force participation fell 3 percent after the financial crisis, but it remains about 10 percentage points above the participation rate for women.

Figure 2. US labor force participation by gender

Older people are working more

There is another twist to this story, however. The participation rate for older Americans has been rising, despite (or perhaps because of) the financial crisis and recession. Figure 3 shows that the growth of labor force participation by older people continued through the recession and slow recovery, even as participation by younger people fell. Older people may stay in the labor force because they are healthier. They may also want to keep working because they are financially unable to retire. Whatever the cause, a larger share of the older population is staying in the labor force.

Figure 3. Labor force participation rate by age

This raises some difficult questions in forecasting the labor market. Several trends are offsetting each other:

  1. Younger workers appear to have dropped out of the labor force because the labor market is weak. They are likely to reenter the labor force when the labor market improves. That could help boost the labor force participation rate in the near term.
  2. On the other hand, as more Baby Boomers reach their 60s, they will likely leave the labor force (older cohorts have lower labor force participation rates). This will result in a declining trend in overall labor force participation.
  3. But the trend toward higher participation by older people might offset some of the decline because of the aging labor force. Thus, the declining trend implied by demographics may overstate what will actually happen.

Two projections of the labor force

I calculated two projections of the labor force through 2020 based on different assumptions. One projection assumes that the younger cohorts return to their 2002–2007 average participation rates. The other projection assumes that younger participation rates remain at their current low levels. In both cases, I assumed that participation rates for people aged 60 and over remain at 2013 levels.

Figure 4. Labor force participation rate projections

Figure 4 compares the two projections. The difference is quite large. If younger cohorts recover to their 2002–2007 participation rates, the US labor force will have over 7 million more workers than if participation rates by cohort remain at current levels. For comparison, calculations from the May 2014 employment release suggest a shortfall of around 1.2 million jobs compared to full employment.1 But that’s not the real level of slack. If participation by cohort is to return to its 2002–2007 level, the economy would need to absorb an additional 7 million workers beyond the 1.2 currently identified as unemployed.

There is no reason to believe that younger cohorts are any less willing to work than previous generations. The experience of the 1990s indicates that when jobs are on offer, people will respond.  That argues for a rise in participation rates once the economy takes off.

Implications

  • For policymakers, this means there is plenty of room to err on the side of keeping growth-oriented policy in place. There’s a lot of room for growth in those 7 million younger people who might have stayed in the labor force if there were more jobs.
  • For businesses, there are plenty of workers out there. As the economy picks up steam, businesses will want to figure out how to exploit this hidden labor force before competitors find it.

Endnotes

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  1. Assuming a 5.5 percent unemployment rate is full employment, the May reading of 6.3 percent unemployment would indicate that the economy was 0.8 percentage points of the labor force—or 1.2 million jobs—below the full employment level.

About The Author

Dr. Daniel Bachman

Dr. Daniel Bachman is a senior manager for US macroeconomics at Deloitte Services LP.

The potential for labor force participation