The Labor Department’s Employment Situation report for April contained a mix of good news and bad news. The good news was that America’s economy added a net total of 288,000 nonfarm payroll jobs. The bad news was that our civilian labor force shrank by 806,000 workers, with the labor-force-participation rate (LFPR) dropping to 62.8 percent. Prior to late 2013, the LFPR had not fallen that low since 1978.
All told, labor force participation has now declined by 3.2 percentage points since the start of the Great Recession (in December 2007) and by 2.9 points since the end of the recession (in June 2009). For that matter, it has declined by 4.5 points since hitting an all-time high of 67.3 percent in early 2000.
As I’ve discussed before, economists are still debating how much of the post-2007 decline reflects structural factors related to long-term demographic trends and how much of it reflects cyclical factors related to the severity of the recession and the weakness of the recovery. A new Goldman Sachs report shows that the four key factors have been (1) a sharp uptick in retirements, (2) an increase in people receiving Social Security Disability Insurance, (3) higher rates of school enrollment, and (4) a larger pool of discouraged workers who’ve simply quit the labor force.
Scanning that list, many people would classify the first three factors (retirement, disability, and schooling) as structural and the last one (discouragement) as cyclical. Yet when Goldman’s analysts reviewed the relevant data, they found “evidence that all four drivers of the decline in participation — and not just discouragement — have an important cyclical component. Specifically, the inflows into retirement, disability, and schooling have been far higher in recent years than structural factors alone would suggest.”
With that in mind, the Goldman researchers project that America’s LFPR should stabilize, and might even rise, as the economic recovery continues:
The most important reason is that the big increase in retirements in the last three years looks far less “structural” to us than generally believed. Many people seem to have pulled forward their retirement because of the weak job market. This leaves correspondingly fewer retirements for future years, and it means that the impact of retirements on participation is likely to become much less negative.
The other drags on participation are also likely to abate or reverse. Inflows into disability insurance are now slowing sharply, consistent with past cyclical patterns. The school enrollment surge has started to reverse as young workers are finding better job opportunities. And stronger labor demand is likely to pull many discouraged workers back into the job market.
Let’s hope they’re right. The decline in labor-force participation has contributed to a drop in the employment-to-population (EP) ratio, which fell from 62.7 percent in December 2007 to 59.4 percent in June 2009, and reached as low as 58.2 percent at various points in 2010, 2011, and 2013, before rising to 58.9 percent in April 2014. Why is the EP ratio so important? As St. Louis Fed economist Kevin Kliesen explains:
The key reason, in short, is that the EP ratio is a key input in a standard growth accounting framework. In this framework, real GDP is the product of (1) real GDP per worker, (2) the percentage of the population that is employed, and (3) the civilian population. The first term approximates labor productivity and the second term is the EP ratio. Mathematically, we can transform each of the three components into growth rates and then add them together to produce real GDP growth. Since population growth tends to change very little in the short-to-medium term, the growth accounting framework is useful because it shows why real GDP growth accelerates or slows. Thus, has real GDP growth changed because of changes to the growth of labor productivity, EP ratio, or some combination of the two? One reason why average real GDP growth during this expansion (2.24 percent) has been so slow is that labor productivity growth has been relatively slow: 1.48 percent per quarter (annualized) through the first quarter of 2014. As shown in the chart, the other reason is that the EP ratio is still below the level that prevailed at the trough of the past recession (second quarter of 2009). Since then, the EP ratio has declined by an average of 0.26 percent per quarter (annualized). Until the growth of the EP ratio strengthens, the pace of the economy’s growth will remain quite modest. That is, assuming population growth remains constant, if labor productivity growth doesn’t accelerate, neither will economic growth.