Why the U.S. labour market is not as tight as it looks

 

From a tightening labour market to inflation acceleration – how far left to go for the U.S. economy? (part 1 of 2)*

Since the Global Financial Crisis (GFC), US labour force participation has declined materially, suggesting a sizeable amount of additionally available labour supply, that is not fully captured in unemployment statistics, and considerable slack in the labour market. Indeed, President Trump has suggested that up to 100 million people not in employment could be put back to work.

35% of the participation decline can be attributed to the ageing demographics effect (“net ageing”), as the baby boomer generation reaches retirement age; a powerful secular trend that will continue to weigh on employment rates over the coming years. But, this blog finds that the shadow labour force (discouraged workers) also accounts for a large part of the shift in employment dynamics, and represents a significant source of transitory slack. If the shadow labour force reverted back to a level equivalent to 2007, participation could be boosted by 50 bps, with 800,000 people added to the workforce. Indeed, if the proportion of unemployed and discouraged workers were both to revert back to 2000 levels, around 2.6 million people could return to work, but this could take years to achieve. While it is plausible that a small potential supply of labour could be additionally found in groups of people currently in education, with family responsibilities or classified as disabled/ill, it is relatively unlikely.

100 million people returning to work is clearly implausible, but considerable slack does remain in the US labour market. Without knowing the true natural rate of unemployment, we cannot know for certain how much of the current ‘underemployment’ rate represents slack, but returning even 3 million Americans back to employment in a swift manner will represent a significant challenge for the Trump administration. Considerable labour market slack remains, and it could take several years to close the gap.

(*Part 2 will address the sensitivity of wages and prices to labour-market slack, and what this means for U.S. inflation and monetary policy.)

The lacklustre US labour-market recovery

Since the GFC, US employment dynamics have shifted considerably. The labour force participation rate has fallen by more than 3%, and has only curbed its decline in the past couple of years (Figure 1). Meanwhile, employment-to-population ratios have recovered only a small part of their 5% declines from the crisis, and still remain a long way from their pre-GFC levels (Figure 2).

Figure 1: Participation rate has collapsed…                                  Figure 2: …as has employment-to-population

Sources: Bloomberg, Worldbank

Despite the official unemployment rate having returned to pre-crisis levels (4.3% in May 2017), the above two measures suggest that there may still be considerable slack left in the US labour market. This blog sets out to explore the extent to which this may be the case.

An ageing population to blame?

Many have been quick to blame the slow labour-market recovery on demographics. One study by the Chicago Fed[1] suggested that around half of the post-1999 decline in the participation rate could be explained by long-running demographic patterns (and they are expected to continue). But is this an oversimplification of the problem?

There are some crude methods to strip out these demographic effects. One could look at the participation rate or employment-to-population ratio, for the 25-54 demographic only (Figure 3). Both data series show that, even when accounting for demographic shifts, (a) there is a significant gap yet to be bridged back to pre-crisis levels and (b) the trend is currently in that direction (back to pre-crisis). Indeed, to Neel Kashkari – President of the Minneapolis Fed and sole dissenter in the FOMC’s March vote – these measures are a clear sign of labour-market slack, and form a key part of his justification for voting against a further Federal Funds rate hike[2].

So, while a large part of the decline in participation is indeed likely due to ageing, other important factors are not always given full due consideration (notably, the effect of discouraged workers leaving the labour force, who could yet re-enter as economic activity picks back up).

Figure 3: A large employment gap yet to be closed

Sources: Macrobond, Bureau of Labor Statistics Current Population Survey

100 million Americans waiting on the sidelines?

In the run up to the US election, Donald Trump repeatedly claimed that there were 100 million people not in employment in the US. It was time to get Americans “off of welfare and back to work”! So who are these 100 million?

The oft-mentioned number refers to the sum of those officially “unemployed” (7 million) plus those ‘not in the labour force’ (95 million). In other words, it is the entire proportion of the US civilian non-institutional population (15+) that is not currently working, equal to around 40% (Figures 4 and 5).

Figure 4: 100m not in employment…                                           Figure 5: …40% of population (15+)

Sources: Bureau of Labor Statistics Current Population Survey.

The number is expectedly large, and has been growing for much of the past decade, but it includes a whole range of non-employed adults; from students to the retired, to those that are disabled or suffering from long-term illness. So it is unrealistic to expect all of these people to get a job. Instead, a detailed dissection of the numbers is essential.

Breaking it down

Figures 6 and 7 show a breakdown of those 95 million not in the labour force, while Figures 8 and 9 show the contribution from each segment to the change in the participation rate between 2007 and 2016. In total, there are five categories that could be driving spare capacity: (1) ageing/retirement, (2) in school or training, (3) disabled or ill, (4) ‘want a job’ (the shadow labour force), and (5) family responsibilities. So let’s take each one in turn…

Figure 6: Breakdown of ‘not in labour force’                                  Figure 7: Breakdown by age group

Sources: Federal Reserve Bank of Atlanta. As at December 2016.

Figure 8: Nine-year participation rate contribution                          Figure 9: Nine-year participation rate contribution

Sources: Record Currency Management, Federal Reserve Bank of Atlanta

  1. Ageing:

Retirement alone accounts for 27 million of those ‘not in the labour force’, and “ageing” represents some 210 bps of the participation rate decline over the past nine years – or 63% of the total change – perhaps unsurprisingly, as the baby boomers approach retirement age. But this number can be misleading; during the same period, it was offset by an increasing propensity to delay retirement until later in life, which actually boosted labour force participation by some 90 bps (Figure 8). Consequently, the net ageing effect in the last decade is closer to 120 bps (Figure 9). This is still the single largest contributor to the participation decline, but only accounts for 35% of it.

The ageing demographics effect is highly unlikely to reverse. 57% of all retirees are already 66+ (Figure 10), while 90% of the net-retirement effect on participation (2007-2016) has been driven by people in this age group. A counterbalancing, “delayed-retirement” effect is indeed at play, with a huge number of Americans now working much longer than past generations did. But this is already accounted for in the above net numbers. And, moreover, the vast majority of the delayed-retirement effect has so far come from the 56-65 demographic, with relatively few from the 66+ bucket delaying enough to offset demographic shifts (Figure 11).

Figure 10: Age distribution of retirees                                           Figure 11: Delayed retirement cannot offset ageing

Sources: Record Currency Management, Federal Reserve Bank of Atlanta

All in all, the data indeed suggest that delayed-retirement trends make future ageing effects less worrying than they would otherwise be. But it would be unrealistic to expect an acceleration in delayed retirement large enough to completely offset the ageing process and drive the participation rate higher. The majority of those who have already retired are not likely coming back, and ageing trends are set to continue for some time (Figure 12).

Figure 12: Ageing trends set to continue for decades

Sources: Record Currency Management, Federal Reserve Bank of Atlanta, U.S. Census Bureau. (Projected percentage based on U.S. Census Bureau rate of increase from 2015.)

  1. In school or training:

An increase in the rate of those in school or training accounts for some 90 bps of the participation decline. There are 13 million now in this category, with the vast majority aged 16-25 (Figure 13); and, unsurprisingly, the majority of the effect on participation also comes from this age bucket (Figure 14).

Figure 13: 16-25s account for most in education…                        Figure 14: …and majority of rise in education rate

Sources: Record Currency Management, Federal Reserve Bank of Atlanta

So could the increase in the education rate be a relic of the GFC, soon to revert as more jobs become available? Also unlikely.

Figure 15 shows that the percentage of 16-to-24-year-olds in school or training has been in a rising trend for quite some time. So the recent increase, since 2008, is not necessarily GFC related; in fact the rate of growth has been slower than pre-crisis. The 25+ age group, on the other hand, did see a disproportionate education-rate rise after 2008; but the absolute effect was small (10-20 bps at worst), and much of this spike has now been unwound, to revert close to the longer-term trend.

Figure 15: A long-term rising trend in the education rate

Sources: Federal Reserve Bank of Atlanta

Ultimately, all age groups have seen a long-term upward trend in school and training, suggesting that much of this change is secular in nature and not likely to revert. It is fair to assume that there will always be a certain proportion of people in education, and this proportion can be expected to rise as technological automation shifts the demand for labour toward higher-skill-based jobs. With this in mind, it is unlikely that the Trump administration can shift a significant proportion of people from education back into work.

  1. Disabled or ill:

People registered as disabled or ill account for 20 million of those not in the labour force and for 65 bps of the 9-year participation decline. While the distribution across age groups is fairly wide (Figure 16), the recent effect from an increased disabled-or-ill rate is largely driven by those aged 51 and over (Figure 17).

Figure 16: A wide distribution of disabled or ill…                           Figure 17: …but recent effect driven by 51+ group

Sources: Record Currency Management, Federal Reserve Bank of Atlanta

In fact, disability rates have been on the rise for some time, for all ages up to retirement age (Figure 18). Some might argue that this could be driven by an increase in fraudulent benefit claims, at a time when it is difficult to find a job. But any increase in fraudulent claims (if true) would be unlikely to amount to a large part of the disability rate effect; and the observed upward trend has largely continued in the past few years, even as the jobs recovery has been underway.

While it may be tempting to suggest that many classified as disabled or ill could be put back to work, 68% of the rise in this group since 2007 has come from the 55-64 age bucket. Whatever injuries they may or may not have, it is surely unlikely that a large proportion of them will come back to work before retiring.

Figure 18: Disability rates have been on the rise for some time

Sources: Federal Reserve Bank of Atlanta

If the rising trend in disability rates could be curbed, and the next wave of 55-64 year olds could revert to a disability rate two percentage points lower (the 2007 level), some 50 bps could theoretically be added back to the participation rate over the course of the next decade. But either way, in the short-to-medium term, the US administration would do well not to rely on getting this group “back to work”.

  1. Want a job (shadow labour force):

Beyond the 7.5 million officially recognised as “unemployed”, there are another 8 million in the “shadow labour force”, an important measure of underemployment. These are people who want a job but are not included in the official labour force. And this group strongly contributed towards the decline in labour force participation, particularly up to 2012 (a 100 bps contribution).

To be considered unemployed by the BLS, a person has to not only want a job but also be (1) available to work and (2) actively seeking employment. Some do not meet these criteria but are still relevant to labour-market slack statistics. For example, if an individual has actively sought work sometime in the previous year but not in the past four weeks, she is considered a “discouraged worker” who is only “marginally attached” to the labour market. She is part of the ‘shadow labour force’.

Various studies have found that the difference between the officially unemployed and others that want a job is not especially relevant; “all tend to search for work or find jobs at a higher rate than others outside of the labor force” (Atlanta Fed, 2017[3]). For that reason, this particular segment is by far the most important. All members of the shadow labour force essentially represent spare capacity in the US economy and, with the right allocation of resources, could theoretically be put to work in times of booming economic activity.

The shadow labour force is dispersed across all age groups, but especially weighted towards younger generations (Figure 19), with the 9-year participation rate effect also spread relatively evenly across all ages. Unlike the previous three non-participation categories, though, the shadow labour force has actually been in decline since 2012 (Figure 9). That is, while many fell out of the labour force into this category during 2007-2012, a large proportion of them have now come back to the workforce.

Figure 20 shows the effect of the shadow labour force on participation from 2007 to (a) 2012 and (b) 2016. In most age groups, half of the effect has already been reversed, as the job recovery has picked up momentum. And, as one might expect, the younger generations appear to be the most likely to be brought back in to the labour force (with older generations perhaps more likely to suffer from the adverse effects of not being in employment for a prolonged period of time).

Figure 19: A young shadow labour force…                                   Figure 20: …that is getting back to work

Sources: Record Currency Management, Federal Reserve Bank of Atlanta

Most encouraging of all, the rate of 16-20-year-olds in the shadow labour force has reversed entirely. At best, this may suggest that the jobs recovery could rapidly filter through, up the age groups, as the demand for labour continues to rise – potentially boosting participation by 50 bps or more. At worst, the younger generation are no longer likely to suffer as much as their predecessors from the acute lack of skills that has plagued those sitting on the side-lines for a prolonged period. And this means that higher rates of employment can now more easily persist, as these youngsters rise through the age groups in the long-run.

  1. Family responsibilities:

Finally, while some have also commentated on the likely contribution of stay-at-home parents to declining participation, this is the factor that least stands up to scrutiny. As Figures 8 and 9 show, reduced family responsibilities have actually contributed to a slight boost to the participation rate over the past nine years, with female participation benefiting the most.

So, this has not been a contributing factor over the past decade. But could it be a source of further labour market supply in the future? While one can safely assume that it will always be necessary for a certain proportion of the population to remain in this segment, there is some merit to the argument that the proportion could, hypothetically, be lower. With 25 million people currently staying at home for family responsibilities, even a 5% decline in this group – spurred by cheaper childcare measures, for example – could lead to more than 1 million joining the workforce. Ultimately though, the prospects of such a huge shift in behaviour are hard to measure and, in order to occur in the next few years, would likely require vast government-subsidy initiatives (of the likes there is no evidence to suggest will transpire) combined with a significant cultural shift on the part of the American people.

The ‘real’ rate of unemployment…

In summary, we have learned that much of the decline in the labour force participation rate since 2007 is unlikely to be fully reversed in the short-to-medium run – there are powerful secular trends at play.

But, equally, some of the decline is transitory. Beyond simply focussing on the official unemployment rate, discouraged workers in particular represent a significant addition to labour market slack. Combining 7 million unemployed with 6.5 million discouraged workers means that around 13.5 million people currently want a job (the ‘real’ rate of unemployment). And, if the shadow labour force was to revert back to a level equivalent to 2007, participation could be boosted by 50 bps, with 800,000 people added to the workforce.

A broader BLS measure of unemployment, known as U-6 (or the ‘underemployment rate’), captures a similar concept to the combination of ‘unemployed’ and discouraged workers described above. While U-3 is the official ‘unemployment’ rate, U-6 also includes: discouraged workers, all other marginally attached workers, and those workers who are part-time purely for economic reasons.

Figure 21 shows that, while the ‘unemployment’ rate (U-3) is now back at its 2007 lows (and only 50bps above its 2000 low), the U-6 underemployment rate remains 50bps above its 2007 level (and 1.6% above 2000). This suggests that plenty of slack remains before the US economy reaches full capacity. And the recent acceleration in the U-6 decline only further substantiates this.

Figure 21: Underemployment is a long way from its 2000 lows

Sources: Record Currency Management, Bloomberg, U.S. Bureau of Labor Statistics. To April 2016.

Taking the argument to the extreme, if we look to the lowest U-3 rate in history (2.5% in 1953) we can estimate a U-6 rate as low as 4% at that time (extrapolated based on a 1.6 ratio, due to lack of historical data). If “full” employment could, hypothetically, mean levels as low as the 1950s, there could be up to 4.5% of remaining slack.

…and the rest

As mentioned above, while it is plausible that a small potential supply of labour could be additionally found in those groups that are currently in education or disabled, it is fairly unlikely. No matter how deep we dig, there really aren’t many more people out there to put back to work!

Even if, under a very optimistic best-case scenario, an additional 10bp increase in the participation rate was generated from reducing the adult education and training rate, and an additional 20bp from bringing disabled and ill people back to work, this still only implies a maximum possible increase from these groups of around 750,000 people.

If a momentous childcare-subsidy programme was put in place, perhaps another 1 million or so could also be added; but, again, the prospects of this sort of cultural shift are very hard to measure.

Reality check: three million, not one hundred

So how many of those 100 million could really go back to work? Although the ‘real’ rate of unemployment is running at around 8.6% (U-6) – or 14 million people – this can never be brought down to zero, in any economy. Using the numbers calculated throughout this paper, Figure 22 summarises some scenarios that could be targeted in the U.S. for increased employment numbers, from the plausible to the not-so-plausible.

Figure 22: 2.6 million on the side-lines, not one hundred

Sources: Record Currency Management, Bloomberg, U.S. Bureau of Labor Statistics, Federal Reserve Bank of Atlanta

Without knowing the true natural (or equilibrium) rate of unemployment, we cannot know for certain how hot the U.S. economy would need to run in order to achieve any of the increased employment numbers in Figure 22. But adding back anything more than 2.6 million extra workers in the next few years (from those not currently employed) would appear to be a highly optimistic target. Even the 2.6 million target may be plausible but is still ambitious; this would mean driving the U-6 underemployment rate back to levels last seen in 2000, at the height of the Dot-com bubble, and could take years to achieve. Moreover, the Trump administration will also have to contend with longer-term demographic trends, which are shifting more and more of the American population into retirement. In short, no matter how aggressive Trump’s stimulus policies, getting even 3 million people “back to work” will be a tall order.

 

———

[1] Aaronson, D., Davis, J. and Hu, L. Explaining the Decline in the U.S. Labor Force Participation Rate. Chicago Fed Letter, No. 296, March 2012. https://www.chicagofed.org/publications/chicago-fed-letter/2012/march-296

[2] Kashkari, N. Why I Dissented. Federal Reserve Bank of Minneapolis, March 2017. https://www.minneapolisfed.org/news-and-events/messages/why-i-dissented

[3] Federal Reserve Bank of Atlanta, 2017. Labor Force Participation Dynamics. https://www.frbatlanta.org/chcs/labor-force-participation-dynamics.aspx

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