Labor force participation skewing unemployment numbers

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This piece originally appeared on U.S. News & World Report’s website

Between January 2008 and January 2012, the labor force participation rate dropped by 2.5 percentage points (from 66.2 percent to 63.7 percent). Here’s the thing about that decline in the labor force participation rate: it has kept the unemployment rate lower than it otherwise would have been, since most of the decline was due to people dropping out of (or not entering) the labor force because of weak job prospects. However, when job prospects pick up substantially and these sidelined workers start entering or re-entering the labor market as job seekers, that will keep the unemployed rate from coming down as fast as it otherwise would have.

One aspect of the February jobs report that got significant attention was the fact that the labor force participation rate increased by 0.2 percentage points to 63.9 percent—the largest gain in almost two years. Is this a signal that the “missing workers” (people who dropped out of or never entered the labor force over the last four years because of weak job prospects) are starting to return?

It is too soon to infer much from the February increase, since these figures are fairly volatile month-to-month. And in fact, I’m not in the camp of people who believe the pool of missing workers are going to come flooding back any time soon. I think it’s safe to say that these missing workers are not going to be drawn back into the labor force in large numbers until job prospects are strong enough that they won’t face months of fruitless job search. Though there have been recent improvements, today’s labor market is still an unbelievably difficult place to be a job seeker—the unemployment rate is 8.3 percent (higher than the highest unemployment rate of the last two recessions,) the ratio of unemployment workers to job openings is 3.9-to-1, and the median length of time today’s unemployed workers have been unemployed and actively seeking work is nearly five months. It goes without saying that this is not the kind of labor market that draws people in.

A recent report by economist Dean Maki at Barclays Capital entitled “Dispelling an Urban Legend” got a lot of attention by opposing the widely held belief that the decline in the labor force participation rate in recent years has caused the unemployment rate to understate weakness in the labor market and that when the missing workers enter or re-enter the labor force it will cause the unemployment rate to understate improvements.

What is his opposition based on? Well, the text of the report claims that he finds that the majority of the decline in the labor force participation rate was not due to workers dropping out of (or not entering) the labor force because of weak job prospects (i.e. not because of weak aggregate demand), but instead it was due to structural factors (in particular, baby boomers retiring and long-term trends toward declining labor force participation within key groups in the labor force).

However, while the text claims one thing, the actual data presented in the report show another—the report shows that, according to his model, far less than half of the decline in the labor force participation rate over the last four years was due to structural factors (in particular, Figure 5 in the report shows that just 0.9 percentage points of the 2.5 percentage point decline in the labor force participation rate between January 2008 and January 2012 was due to structural factors).

Again, even by his own method of calculating the structural decline in the labor force participation rate—which is certainly an overestimate because it fails to take into account long-term trends toward increased educational attainment, which push up the labor force participation rate—he finds that well over half of the decline in the labor force participation rate in the last four years was because of weak aggregate demand for workers. His model shows that without this weakening of aggregate demand over the last four years, the labor force participation rate in January would have been 65.1 percent instead of 63.7 percent. Just to provide a sense of the potential impact of a decline that large—if the workers making up that drop were instead in the labor force and were unemployed, the unemployment rate in January would have been 10.2 percent instead of 8.3 percent.

As I said earlier, I believe that the missing workers aren’t going to enter or re-enter the labor force until they are confident they will find a job in a reasonable time frame. A key (if buried) message from the Barclays Capital report is that most of the decline in labor force participation over the last four years was due to weak aggregate demand, so if these sidelined workers don’t enter or re-enter the labor force soon, it is because of policy choices Washington is making not to boost aggregate demand.