A Take on Labor Force Participation and the Unemployment Rate

By now, if you’ve been paying attention to the coverage following the April employment report, you know the following:

The March to April decline in the unemployment rate from 8.2 percent to 8.1 percent was arithmetically driven by yet another decline in the labor force participation rate (LFPR).
The decline in the LFPR, now at its lowest level since the early 1980s, is itself being influenced by a confounding mix of demographic change and other behavioral changes that nobody seems to understand—a point emphasized by a gaggle of blogs and bloggers such as Brad DeLong, Carpe Diem, Conversable Economist, Free Exchange, and Rortybomb, to name a few.

 

With respect to the first observation, in a previous post my colleague Julie Hotchkiss described how to use our Jobs Calculator to get a ballpark sense of what the unemployment rate would have been had the LFPR not changed. If you follow those procedures and assume that the 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.

It is clear that interpreting this sort of counterfactual experiment depends critically on how you think about the decline in the LFPR. The aforementioned post at Rortybomb cites two Federal Reserve studies—from the Chicago Fed and the Kansas City Fed—that attempt to disentangle the change in the LFPR that can be explained by trends in the age and composition of the labor force. These changes are presumably permanent and have little to do with questions of whether the labor market is performing up to snuff.

The following chart, which throws our own estimates into the mix, illustrates the evolution of the actual LFPR along with an estimate of the LFPR adjusted for demographic changes:

 

As the header on the chart indicates, our estimates suggest that roughly 40 percent of the change in the LFPR since 2000 can be accounted for by changes in age and composition of the population—in essentially the same range as the Chicago and Kansas City Fed studies. (If you are interested in the technical details you can find a description of the methodology used to generate the chart above, based on work by the University of Chicago’s Rob Shimer.

In other words, 0.9 percentage points of the decline in the LFPR since the beginning of the past recession can be explained by demographic trends (as the baby boomers age, the labor force will grow more slowly than the total population [ages 16 and up]). Subtracting the demographic trends still leaves 1.5 percentage points to be explained, a number right in line with Brad DeLong’s back-of-the-envelope calculation of “cyclical” LFPR change.

As DeLong’s comments make clear, the interpretation of the nondemographic piece of the LFPR change requires, well, interpretation. And the consequences of connecting the dots between changes in the unemployment rate and broader labor market performance are enormous.

In the recently released Summary of Economic Projections following the last meeting of the Federal Reserve’s Federal Open Market Committee, the midpoint of the projections for the unemployment rate at the end of 2013 is 7.5 percent. Turning again to our Jobs Calculator, we can get a sense of what sort of job creation over the next 20 months will be required given different values of the LFPR. For these estimates, I consider three alternatives: The LFPR stays at its April level, the LFPR reverts to our current estimate of the demographically adjusted level (that is, increases by 1.5 percentage points), and an intermediate case in which the LFPR increases by 0.7 percentage points—the lower end of DeLong’s estimate of “people who really ought to be in the labor force right now, but who are not.”

 

DeLong asks:

“Are [people who really ought to be in the labor force right now, but who are not] now part of the ‘structurally’ non-employed who we will never see back at work, barring a high-pressure economy of a kind we see at most once in a generation?”

As you can see, the answer to that question matters a lot to how we should think about progress on the unemployment rate going forward.

This post originally appeared at macroblog and is posted with permission.

6 Responses to "A Take on Labor Force Participation and the Unemployment Rate"

  1. DAA   May 10, 2012 at 12:41 pm

    The sad part is that is a stupid question. All he needs to do is go down to of placement office and see how many people graduating do not have jobs. Since DeLong is lazy and can’t find his way out of the ivory tower, I will help him out.
    Of course this is anecdotal but hey.
    Me, IBM sent my job to India in 2002. The most I was offered was about 40% of what I made before. That is with 4 years of graduate school.
    My nephew graduated Michigan business school and then law school – unemployed. Another nephew graduated Notre Dame – unemployed. My step dad’s daughter 20 years with SEC as lawyer – unemployed – 3 years now. She graduated from Northwestern.
    Another relative graduated Carnegie Mellon from their industrial program – menial job.

  2. DAA   May 10, 2012 at 12:42 pm

    Another nephew graduated electrical engineering – was making blueprints and now is seeking a Ph.D.
    Another person 55 fired – now on disability.
    It’s easy to talk retraining and all that but I have been asking DeLong for years retrained at what. They tell unemployed roofers to go to technical school and become a web designer. They tell unemployed web designers to go to tech school and become a roofer.
    The problem is the IBMs of the world where they fire Americans and transfer the jobs to India.
    Of the top 20 needed jobs, only 3 require more than on-the-job training, no college, no tech schooling.
    They will hear the same thing I heard, over qualified, too much experience.
    But anyone that thinks all of these potential high earners, paying no social security, no income taxes is good for this country — well that seems to be the problem.

  3. DAA   May 10, 2012 at 12:42 pm

    People like myself, Bruce and Rebecca that lose our peak earning years, and young people starting out moving into their 30s with nothing is not healthy. It is only a matter of time until the Arab spring, and now the European spring come to a neighborhood near you.

  4. DAA   May 10, 2012 at 1:31 pm

    From BAC

    But Bank of America/Merrill Lynch's U.S. Economics team thinks there's more to it than aging.

    From a recent note to clients:

    The four reasons we believe that the drop in the LFPR is not permanent:

    1. The drop in the participation rate coincides almost exactly with the collapse in employment. How is this structural? And if a strong job market attracted extra people into the market when times were good, why wouldn't it happen again if this job recovery becomes well established?

    2. The drop in the participation rate is happening in many age cohorts. Population shifts into historically lower age ranges is a small slow-moving factor that will extend over a generational period of 25 years or so.

  5. DAA   May 10, 2012 at 1:31 pm

    3. The permanent drop argument ignores the shock to household wealth and confidence. Once the period of distress is over and job opportunities return, don't people have a lot of catching up to do? Or do they simply resign themselves to a much lower standard of living in retirement, even as
    Medicare spending is cut and taxes increase?

    4. Doesn't it make sense that the duration of unemployment is driving the participation rate lower? If I spend two years sending out resumes with almost no response, don't I give up or go back to school? Isn't the surge in student loans telling? http://www.businessinsider.com/boa-4-things-that-

  6. benleet   May 11, 2012 at 11:39 pm

    Private sector employment has stopped since 2000, or in July 2000 there were more private sector jobs than today, almost 12 years later. http://data.bls.gov/pdq/SurveyOutputServlet
    Mr. DeLong talks of a "high pressure economy" creating participation rates that are "once in a generation". He's wrong, 1988 to 2008 the labor participation rate was over 66%. It peaked in Jan. 2000 I think at 67.3%. Now it is 63.8%.

    I spent 30 minutes writing a comment on this topic, and I will submit it here also:
    This article does not do justice to the decline in labor participation story. Briefly here is the real story:
    There has been a fall-off in participation over the past 30 years. The "working age population" grows, and out of the working population a portion join the workforce, and a smaller portion find employment. That's the story. Lately a smaller portion are joining the workforce, and an even smaller portion are finding work.
    The key data about this story is found in this BLS web page, Employment status of the civilian noninstitutional population, 1940 to date: http://www.bls.gov/opub/ee/emp...
    Simply compare the rate of "civilian non-institutional population" growth between 1980 to 1990 ( it was 11%), and 1990 to 2000 (it was 9.5%), and with the rate 2000 to 2010 (it was 10.8%). Then take the rate of entrance into the labor force, respectively for the 3 periods, the periods showed growth of 16%, 11.2%, and 8.5%. Ergo, the portion joining the labor force is declining, the rate has dropped almost in half. Big question: why? The answer in this essay is unconvincing. The answer is that private sector employment was 111 million in July 2000, and it has not increased at all in 12 years.
    Now compare the rate of employment growth for the three periods. Respectively they show: 18%, 12.7%, 1.6%. And if you take it to 2011, the employment growth number goes negative.
    — this is the crux of the matter. A real disaster in employment.
    I wrote about this at http://benL8.blogspot.com, August 28, 2011, http://benl8.blogspot.com/2011...
    — but I recommend you pass on reading it. My first shot at this problem is a confusing mess.