A recent article on the Federal Reserve Bank of Atlanta's website by Dave Altig, the Atlanta Fed's Executive Vice President and Research Director, discusses the issue of the declining labor force participation rate and provides us with an explanation for the decline as I will outline in this posting.
This graph from FRED quite clearly shows the decline:
The labor force participation rate peaked at 67.1 percent between the years of 1997 and 2000 and has fallen rather steadily since then to a 17 year low of 64.7 percent. The fall has been most dramatic since the Great Recession; the rate has dropped from 66 percent in 2008 to 63.6 percent in April 2012 as shown on this chart:
Here is a less looked at labor force participation graph showing the participation rate for men:
Male labor force participation peaked at 87.4 percent in October 1949 and has fallen steadily to 70 percent in April 2012, a drop of 19.9 percent.
Here is the labor force participation graph showing the participation rate for women which looks completely different:
Back in the late 1940s when men's participation rate was peaking, only 33 percent of women were in the workforce. Women's participation rate peaked at 60.3 percent in April 2000 and has slowly fallen to 57.6 percent in April 2012, a drop of only 4.5 percent.
Here are two more graphs. The first graph shows the labor force participation rate for those 25 years and older with less than a high school diploma:
This data in this graph shows that the labor force participation rate for these Americans is currently 45.2 percent, down only 6.2 percent from its 20 year peak in October 2008. I found that rather surprising considering that Americans without a high school diploma have generally been considered among the least likely to have regained employment since the end of the Great Recession. That said, it is interesting to see that their participation rate is 18.4 percentage points (or 28.9 percent) below that of the general population.
This final graph shows the labor force participation rate for those 25 years and older with a Bachelor's degree or higher:
The participation rate for these Americans peaked at 81.9 percent in July 1992 and June 1993 and has fallen rather steadily to its April 2012 level of 76.2 percent, just off its 20 year low of 75.6 percent achieved in January 2012. Surprisingly, since the end of the Great Recession in June 2009, the participation rate for more educated Americans has dropped by 1.8 percentage points. While this looks rather unsettling, recall that the labor force participation rate for those Americans without a high school diploma in April 2012 was 31 percentage points lower.
Back to the Federal Reserve's analysis. Many mainstream and non-mainstream journalists have attempted to resolve the issues behind the drop in the labor force participation rate. The author notes that the decline in the headline unemployment rate from March (8.2 percent) to April (8.1 percent) was driven by yet another decline in the labor force participation rate. Why is the participation rate falling and how much impact is this having on the unemployment rate?
Staff at the Federal Reserve have calculated that if the labor force participation rate had remained constant from March to April of 2012 instead of falling, that the unemployment rate would actually have risen to 8.4 percent rather than falling to 8.1 percent.
Why is the labor force participation rate falling? Many people feel that the current job market is so poor that unemployed Americans are simply giving up and falling off the Bureau of Labor Statistics' radar. Mr. Altig notes that at least some of the decline in the participation rate is due to population aging as older workers retire and remove themselves from the workforce. Here is a chart from the article showing the impact of demographic changes on the labor force participation rate:
Since the beginning of the Great Recession, the labor force participation rate has dropped by 2.4 percentage points. The Atlanta Fed estimates that 40 percent of the changes in the participation rate can be accounted for by changes in the age and composition of the population. Since the beginning of the Great Recession, 0.9 percentage points of the decline in the participation rate can be explained away by the aging of baby boomers since the labor force will grow more slowly than the total population aged 16 and older. If we look back at the FRED graph showing the participation rates by educational levels and gender, it becomes apparent that, if indeed Mr. Altig is correct, it is American males with a college degree that are responsible for the lion's share of retirements. As well, since the participation rate fell by 2.4 percentage points, this leaves 1.5 percentage points unaccounted for. It is this 1.5 percentage point drop that may well be due to cyclic unemployment (i.e. higher levels of unemployment during a recession) that is becoming permanent structural unemployment (i.e. jobs that are never regained even during an economic boom).
The Federal Open Market Committee has projected that the unemployment rate would be 7.5 percent at the end of 2013. Mr. Altig proposes the following:
1.) If the participation rate stays at 63.6 percent, the economy needs to create 144,036 jobs per month to reach an unemployment rate of 7.5 percent by the end of 2013.
2.) If the participation rate rises by the 1.5 percent that is unaccounted for by demographic changes, the economy needs to create a whopping 304,260 jobs per month to reach an unemployment rate of 7.5 percent by the end of 2013.
While it certainly would be wonderful if the unemployment rate really did drop to 7.5 percent, a level that is still high by most historical post-recessional standards, I suspect that the FOMC is dreaming in technicolor. By the end of 2013, the world could well be in the grips of another recession; at the very least, it is quite possible that within 18 months, the European debt influenza will find itself well established in the world's economy, negatively impacting employment levels around the world.