Should we be worried about the falling labor force participation rate?

By Austin Nichols :: February 7th, 2014

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Is the declining labor force participation rate cause for concern? Is it due to fallout from the Great Recession?

Regardless of the recession—or the (lack of) impact of the Affordable Care Act—aggregate labor supply will decline steadily in coming years. Why?

Some workers give up looking for work (meaning they’ve left the labor force) after being unemployed for a long time, and many don’t enter the labor market to start looking because of weak earnings prospects during the painfully slow recovery. That is the story we usually hear.

But the most important factor, which swamps discouraging work prospects and any policy shifts, is the graying of America. As the population ages, people will work less or retire. In fact, we will never again reach the peak labor force participation rates of late 1999 and early 2000, when the Baby Boomers hit their stride. This change has little to do with the economy’s short-term health.

So the real question should be: what share of the observed decline is due to frustration, and what share is due to changing structure of the population?

The darker blue line below is a hypothetical labor force participation rate; it holds the population’s composition (age, race, gender) constant at 2006 levels since 1998, while letting the participation rate vary. It shows that, after the recession, the rate would only have fallen by about one percentage point, rather than the actual drop of more than three percentage points. In other words, the changing population accounted for two-thirds of the post-recession drop.

LFP

But there’s even more to the story. Participation rates for younger workers—those 30 and under—have been falling since the recession. While that drop may set them up to struggle later in life, it’s not unreasonable to assume that most of them will (re)enter the labor force eventually. (Very few 25-year-olds simply disappear from the labor force for 40 years.)

So consider another hypothetical: in addition to holding the population structure constant, the light blue line also holds the under-31 labor force participation rate constant at 2006 levels (while letting the rate for all other ages vary). That scenario would have resulted in a participation rate even higher today than before the recession, driven by increasing participation at older ages (though that's not necessarily a good thing).

In other words, another important share of the recent drop is due to the declining participation of young workers, many of whom should (re)enter the labor market in the coming decade.

So what?

The labor market is undoubtedly still struggling, with high unemployment, very high long-term unemployment, and projections of future job growth concentrated in low-wage, low-skill industries. But the current labor force participation rate decline is largely due to long-term demographic trends, along with short-term malaise likely to reverse itself.

Perhaps the real worry inherent in the current decline is that it reflects a naturally shrinking working-age population that must support a growing retired population in coming decades.

Follow Austin Nichols (@AustnNchols) on Twitter.

3Comments

  1. Paul Mullen  ::  7:30 pm on February 12th, 2014:

    One important factor which I have not seen mentioned is workforce decline due to mental illness. While few want to talk about it, mental illness is common. The National Institute of Mental Health reports that “An estimated 26% of Americans ages 18 and older suffer from a diagnosable mental disorder in a given year.” and “Mental disorders are the leading cause of disability in the U.S”.

    Recession, increases financial stress, and so will severely affect those already prone to mental illnesses. Many will simply be too depressed to go out and seek work. Maybe this is what happened to many of the young people who disappeared from the workforce?

    Since one of the major achievements of the ACA has been to force insurers to include mental health care, I would expect that work days lost to mental illness could decrease significantly in future.

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