CBO: There’s more slack in the labor market than you thought

February 14th, 2017 at 4:58 pm

[co-authored with Ben Spielberg]

OTE readers know that in the quest for full employment, we pay a lot of attention to the extent of slack in the labor market (and btw, our next podcast episode will focus on this concept of labor market slack—what is it, how much is there, etc. We know…we can hardly wait, too!). One way economists try to gauge this concept of slack is to compare the actual value of labor market indicators to the theoretical value of where they’d be at full employment.

So when a recent CBO revision pretty significantly raised the budget office’s estimate of the potential labor force, we took notice: their revision suggests there’s more slack in the job market than they previously thought.

What is “potential labor force?” It’s CBO’s estimate of what the labor force would be if the economy were at full capacity and the unemployment rate was at its “natural rate” (the lowest rate consistent with stable inflation). In order to project budget outlays and receipts, CBO needs to guesstimate various quantities in the economy, like employment, the labor force, unemployment, and average compensation. They’re often revising such estimates, as they should when new info comes upon the scene, and in their latest revision, they tweaked up the size of the 2016 and 2017 potential labor force by almost one million for this year, or 0.6% of the total. CBO’s incorporation of race (and hence the rising share of the population that is Hispanic) for the first time and increases in educational attainment were two of the revision’s main drivers.

The following figure shows actual and potential labor force participation rates, which we’ll call LFPR and LFPR* (the rates are just the actual and potential labor force as a share of the working-age population). The gap between the two has diminished as the job market has tightened, but it has yet to close.

Source: CBO, our analysis (see data note)

So what does that mean for labor market slack? While there’s no single, reliable indicator that can tell us that, we have found Andy Levin’s total employment gap to be a useful composite of three measures: unemployment, involuntary part-time employment (IPT), and labor force participation. Following Andy’s method, we compare each measure to its estimated potential at full employment.

The unemployment rate—which for many economists is “all she wrote” when it comes to evaluating slack—is just about equal to CBOs “natural rate,” so if that’s all you were looking at, you might think we were at full employment. But IPT is still elevated, and, given CBOs LFPR* upward revision, there’s more room for improvement there, too. The figure below plots Levin’s slack measure before and after the CBO revision, which raised last month’s result from 1 percent to 1.6 percent (an increase of over 800,000 full-time-equivalent-jobs worth of slack).

Source: Andy Levin, our calculations

Caveats abound. Every one of the potential measures has a large confidence interval around it (see here for what we mean re the “natural rate” of unemployment). For years now, economists have been trying to figure out how much of the decline in the LFPR is a function of the aging workforce and how much is a function of insufficient labor demand, and such estimates are always speculative.

But many economists use these data to calibrate their models of the labor force, and we wanted to make sure that everyone was aware of this revision. It suggests that, while we continue making steady progress towards full employment, we’re not there yet.

Data note: CBO does not publish their estimate of LFPR*. They do publish the numerator–LF*–and they use a smoothed version of the BLS 16+ non-institutional population to calculate the rate (smoothing is necessary because the BLS often updates the population weights). Using BLS’s adjustment factors, we created our own smoothed series of the 16+ population, and thus our version of CBO’s LFPR*. Also, we interpolated CBO’s annual labor force estimates to make them monthly.

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3 comments in reply to "CBO: There’s more slack in the labor market than you thought"

  1. jcb says:

    I know that economists worry about the inflationary effects of falling below the “natural” rate of unemployment, but do they also worry about the inflationary effects of rising above the “natural” rate of profit? Just askin….

  2. urban legend says:

    But don’t we know, virtually to a fact, that in the prime working age (25-54) age group unaffected by voluntary retirements, there is still a two point employment rate deficit compared to early 2007 (3.6% compared to early 2000) and nearly a two point deficit against 2007 for the LFPR (three points against the peak in 1999), and that nobody has come up with a plausible explanation for defections in that age group? We know that except in the Southern European countries beset by forced austerity, other major countries have recovered and even moved beyond their pre-Great Recession heights. Why should the U.S. lag if not for insufficient demand continuing due to insufficient incomes for 95% of Americans and low government spending relative to the need?

    Indeed, I believe nobody has come up with a plausible explanation why we should not consider the peak results in 2000 a more realistic view of potential labor force, overall employment and full-time employment than 2007, which was at the height of the Bush II era shedding of manufacturing jobs. Athough the earlier massive shift of women into the work force no longer could be expected to push up LFPR (or E-pop) at light speed, there is no reason to think the phenomenon would not have continued even at a much slower pace. Moreover, especially in Southern states with low LFPR and E-pops that pulled down the national rates, cohorts of better educated young adults with more modern outlooks have been replacing older, less educated and less modern-in-outlook older adults in the 25-54 age group.

    Look at the Northern tier of mostly middle class and well educated states like the Dakotas and Minnesota, where last I knew LFPRs and E-pops respectively had reached well into the 70s and high 60s, for a real view of where we should be aiming with national policy. It may take quite awhile for Tennessee to match Minnesota in education and income levels, but it should be moving in that direction over the coming decades.