The job market is improving, but low labor force participation is still holding us back

August 11th, 2015 at 2:12 pm

Something odd is happening in the U.S. job market.

The rate of unemployment is falling, and doing so pretty quickly (see first figure), to levels approaching the Federal Reserve’s estimate of full employment. That is, the Fed says full employment corresponds to a jobless rate of 5.1 percent and the unemployment rate last month clocked in at 5.3 percent.

Source: BLS

Source: BLS

Underemployment (aka “U6”), a broader measure of slack which counts involuntary part-timers (who want, but can’t find, more hours of work), has been falling even faster than the topline rate. Job growth is trucking along at a nice clip too, with employers adding about 240,000 jobs per month on net over the past year.

All good, right?

So why is the damn labor force participation rate (LFPR) stuck in the mud? And why aren’t we seeing much in terms of wage growth?

On the first point, the LFPR—the share of the population working or looking for work—topped out at around 66 percent before the recession and was last seen stuck at 62.6 percent, the lowest it’s been since the late 1970s. That’s partly a benign function of the aging workforce, as we baby-boomers age out of our working years.

But there’s also a far less benign cause: persistently weak labor market demand that’s led a bunch of working-age people to sit out the job market. One way to see this is to take the retirees out of the picture, as economist Elise Gould does in this post. The share of employed prime-age workers (those between the ages of 25 and 54) is climbing back to its pre-recession level, but it’s still only about halfway there.

Low labor force participation can make the unemployment rate a less reliable indicator than it otherwise would be. If you’re out of the labor force, you’re not counted as unemployed (because you’re not, by definition, looking for work). But if you’re one of those people who could get pulled back into the job market if you saw some welcoming opportunities, then you ought to be counted as contributing to the slack.

This “shadow slack” that doesn’t show up in the unemployment rate has a lot to do (as work by economists Danny Blanchflower and Adam Posen indicates) with the fact that, despite the trends you see in the figure above, wage growth remains mired at around 2 percent. That is, with the un- and underemployment rates falling so much, you’d be well within your rights to expect to see wages accelerating beyond the 2 percent anchor they’ve been pretty much stuck at for about five years.

To show you what I mean, I’ve employed a very simple model of wage growth based on underemployment (see data note below). As you see, the model tracks wage growth pretty well, generally catching turning points.

Source: See data note.

Source: See data note.

However, based on the assumption—one in which I’m pretty confident—that underemployment continues to decline at the rate you see above, this model predicts wages should be growing at a pretty good clip by now, which they ain’t much doing. Chair Yellen considers 3.5% to be the non-inflationary rate of nominal wage growth, which is around where this forecast ends up.

But this out is probably too optimistic re future wage growth because it leaves out the low labor force problem. Adding the labor force to the model (as Posen and Blanchflower found) makes it track recent flat-lining wage growth more closely, and, under the assumption that the labor force rate remains where it is right now, even while underemployment continues to decline, the forecast shows a later and shallower liftoff.

lfwg3

Source: See data note.

These simple models are all speculative, of course. If the job market heats up and more sideliners find work, the LFPR would improve, as would the chances for faster wage growth. But as Yellen herself said last month, “The lower level of the unemployment rate today probably does not fully capture the extent of slack remaining in the labor market–in other words, how far away we are from a full-employment economy.”

That sort of thinking, along with being correct, suggests that if the Fed must raise interest rates, they should do so slowly and carefully, with a close eye on those who still don’t have much to show from the current recovery.

Data note: The wage variable is year-over-year percent change in a combination measure of four wage/compensation series: average hourly wage of non-supervisory workers; Employer Cost Index, average compensation and average wage; and median weekly earnings for full-time workers. The wage series in the figures uses principal components analysis to weight the underlying component series. Copying Goldman Sachs (GS) analysts, I start with their “non-linear wage Phillips Curve” model, which regresses the wage series on underemployment and underemployment squared. For the projection to 2017, underemployment continues to decline at its recent rate until hitting 9 percent, which GS considers the full employment rate for this variable. For the LFPR simulation, I hold the labor force constant at 62.8 percent, its quarterly value since 2014Q2.

 

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7 comments in reply to "The job market is improving, but low labor force participation is still holding us back"

  1. Ben Groves says:

    Sorry, but you make that chart like the Boomers are coming back………….please get it. They are not coming back. There is no “low” LFPR. It simply is deleveraging of the labor market. You can see labor tightness over parts of the country. Lets remember, the government survey is only ONE. The retirement boom is the defining feature of this era since the numbers needed to replace them weren’t gotten.

    With the acceleration of job growth in the last year, the LFPR should be rising on its own and the U-3 should be closer to 5.9% for the 5.4% full employment line. Notice actual openings are stripping excess labor capacity and lowering wages due to higher paid workers retiring. It won’t be to the labor market is very tight and raises kick in over the next decade.

    I am amazed at the stupidity of the blogosphere. They simply don’t get it.


  2. urban legend says:

    Appreciate this analysis very much, especially the recognition of U-6. However, would quarrel with the statement that U-6 has been falling faster than U-3. Over the past year, the decline in the two-month figure (June-July, 2015 vs 2014) is virtually identical at just under 14%. From peak unemployment in March-April 2010, the U-3 drop has been 46% vs 38% for the U-6.

    For some reason, the ratio between the two (U-6 / U-3) has been declining over approximately the last year or two. Speculation as to reason: as online searching becomes more comprehensive and really the only way besides networking to search nowadays, people who did do online checking in the last month for something remotely worth applying for don’t get counted in the labor force under BLS formula because they get put in the same disqualifying category as people who merely checked newspaper want ads. Possible? If so, that would mean U-6 really should be between 9.5 and 9.9 and LFPR should be somewhat higher. In other words, yes, a bit less slack, but still way too much (as reinforced by low wage growth).


    • Odysseus says:

      “people who did do online checking in the last month for something remotely worth applying for don’t get counted in the labor force under BLS formula because they get put in the same disqualifying category as people who merely checked newspaper want ads. Possible?”

      Not possible. The BLS survey asks specifically “Have you *LOOKED FOR* work in the past 4 weeks”. As long as you are sending out resumes – whether paper or electronic – you are counted.


      • urban legend says:

        No, you are wrong. To be counted as unemployed means the person must have actively searched for work in the past month. Here is the BLS explanation for that:

        “Passive methods of job search do not have the potential to connect job seekers with potential employers and therefore do not qualify as active job search methods. Examples of passive methods include attending a job training program or course, or merely reading about job openings that are posted in newspapers or on the Internet.”

        I have gone through periods of what I would call active searching while merely checking online databases and seeing nothing I would qualify for — at least not when there are many others who would meet the requirements without some delayed productivity for getting up to speed. You can only bug employers and so often, or it feels that way anyway. Same for your network contacts. It’s unclear whether that would count as being unemployed and within the labor force under BLS criteria. My suspicion is that this formulation was developed before the online databases became as thorough as they are now, and that may account for the apparent growing disconnect between U-3 and U-6.


  3. Kevin Rica says:

    Jared,

    I hate to quibble — but on what basis did you say:

    “That’s partly a benign function of the aging workforce, as we baby-boomers age out of our working years?”

    Labor force rates have dropped for men in the prime working years of 25-54. For 25-34 year old men, they are down over 4 points; for 35-44 year olds, down 2+; for 45-54 year olds, they are down 3+. They are down marginally for 55-64 year old men. But interestingly, for 65-69 year olds (early Boomers,) rates are UP (can’t retire).


  4. Bob says:

    Why is it that so many con-servatives want to starve people back into the labor force? Apparently the only people we need to pay more to attract are C Suite types.


  5. purple says:

    Home ownership for those under 40 tells the story of what is happening to the US economy. Fist inter-generational decline in living standards in US history.


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