Friday, December 11, 2015

Does Lower Labor Force Participation Mean the 5% US Unemployment Rate is a Phony Number?

Some have argued that the current 5% unemployment rate is a phony number because the labor force participation rate has fallen so much.

But there is nothing in Austrian school economics that says employment markets don't clear over the long-term. To be sure, there is significant  unemployment when there is a shift from the boom part of a central bank created business cycle to the bust phase, as explained by Austrian business cycle theory. But that is not something that lingers forever. The readjustment after the boom phase can take longer because of unemployment insurance, but that is about it. Non-business cycle factors, such as minimum wage laws or the prevention of market wages to adjust to the downside to changing circumstances can also be impediments to "full" employment, but there is no Austrian theory that suggests the Fed, itself, is fighting a losing battle to prop up unemployment.

1.Because it doesn't have to have to fight such a battle for the market to return to full employment (Though it does.). Markets clear.

2. To the degree that the Fed is currently expanding the money supply, it is distorting the structure of the economy and where employment is, but it is not a  case that it is somehow failing to "get the economy going." I repeat, markets clear including employment markets.

Thus, we need to look for other answers to why the participation rate is falling. Goldman Sachs and the Federal Reserve Bank of San Francisco have offered up what seem to me to be pretty reasonable theories (And please don't attack their findings by ad hominem-type attacks on the institutions. Yes, GS and the SF Fed are evil institutions, but that doesn't mean every report they put out is wrong. If you find an error in their thinking great. If you are just going to hurl ad hominems-type, you are evil.)

 From a new Goldman Sachs study:
What about the 3.6pp decline in the labor force participation rate since 2007? While it’s true that the unemployment rate would be much higher if participation had remained stable, we now believe most of the decline since that time should be considered structural. By far the largest contribution to the decline in participation has been an increase in retirees—mostly a natural consequence of the aging of the workforce. Rising disability rates—a trend mostly driven by demographics—and a tendency for young people to remain in school have also played a role.The remaining cyclical component is a relatively modest share of the labor force, and broadly captured by the U6 unemployment rate, in our view.
From the San Francisco Fed:
First is the aging of the population. The baby boomers are entering retirement and people are living longer. Remember, the participation rate counts everyone over 16, so my happily retired parents count as “out of the labor force,” even though, in their 80s, few people would still be working. Second is that younger people aren’t working as much as they used to. But this is partly because many have extended their education or gone back to school, and fewer are working when they’re there. Third is an increase in people deciding they’d rather have single-income families (Bureau of Labor Statistics 2007–2014). For whatever reason, they’ve traded a second paycheck for spending more time at home, whether it’s for child care, leisure, or simply that it’s a better lifestyle fit. Each of these groups is made up of people who are not working, but doing so for personal or demographic reasons. As their numbers swell, it will, obviously, push the participation rate down.
As for the area of concern, we’re emerging from the deepest, longest recession since the Great Depression. And it’s true that a lot of people did give up looking for work. A key indicator is the somewhat unfairly named “prime-age males” cohort, who are 25–54. This group has historically been a constant in the American workforce, but in the wake of the recession, its participation fell sharply. However, as the labor market has improved, that number has largely stabilized over the past two years, as has the overall participation rate.
The last factor to consider is whether there are people who will reenter the labor force and pull the participation rate back up. The “marginally attached” for instance, a group made up of people who are ready and able to work and who’ve searched for jobs in the past year but who aren’t currently looking. The assumption would reasonably be that this group is poised to return to the labor force. First off, these numbers have come down a lot, falling by over 12% in the past year alone. In addition, my staff has found that, over the past few years, their reentry rate back into the labor force has actually fallen. When you combine this with the aging workforce, it looks unlikely that participation will rise. This is supported by other research from both within and outside the Fed System (Stephanie Aaronson et al. 2014 and Krueger 2015). Overall, the evidence suggests that, even with a quite strong economy, we won’t see a significant number of people come back into the fold.
(GS and SF Fed studies via  James Pethokoukis)



  1. But if were a case of people staying out of the work force entirely voluntarily, not because they chose to because of prevailing conditions then wages would be going up as the supply of people to fill positions decreased. If there was a boom for employment wages would increase even faster.

    Another thing to consider is when the jobs aren't there people who lose their jobs near retirement age retire. Those who are in their 20s stay in school. Either loans, TA, fellowship, research grant, whatever.

    1. So assuming this is the case, what is your theory as to why employment markets don't clear?

    2. Maybe I am misunderstanding, but shouldn't the clearing mechanism be price? Wages are stagnant to down. Labor hours purchased are also stagnant to down in the data I've seen. That would indicate the employment market is clearing as best as it can in light of government mandated minimum wages and other costs coupled with alternatives of welfare, social security, disability, and other non-workforce options.

      If we are really in an employment boom, then prices should be increasing, which would serve to draw people out of non-workforce options. Instead these reports say people are going for non-workforce options. For example, why go to grad school full time on loans or make $10K as a teaching assistant if there are $50,000+/yr jobs waiting?

    3. So, again, assuming your view is correct (though I don't believe it is), what is your theory as to why there are no $50k jobs?

    4. I thought the question was why would the participation rate indicate the unemployment rate is misleading of the health of the economy? IMO the data suggests people are finding employment somewhere if they lower their price far enough. Problem is that price is too low for many so they exit the labor force for other options. This pricing doesn't suggest an employment boom. Low unemployment rate sure, because people either take the lower paying jobs or leave the workforce.

      I am at an intersection of our three data points. Low participation, low unemployment, decreasing or stagnant wages. It also makes sense with the other data points of increased retirement, more students, etc.

      Why do we have this condition is another question. I don't mind taking a stab at it. It is that the sum economic distortions coming from government and the central bank. So there are booms some places but not others. Business creation is dampened. Population growth is another issue. For wages to increase job growth has to out pace that. Data indicates it isn't. That's my best take at the why.

  2. I am sure that the retirement of the Boomers plays a big part. However, there seems to be a disconnect between the lower LFPR and the fact that federal tax receipts are setting records. Where is all this tax money coming from? Is it simply higher rates on the existing workers? Or is it primarily capital gains taxes on the FED-upped equity markets?

    1. Tax receipts always set records unless there is a recession and/or a tax cut.

  3. I suspect some of the lack of participation is driven by student loan deferment after graduation. Also, there seems to be a greater tolerance by parents to allow their 20-30 something children to live at home. Possibly as a way of keeping them around as Social Security has undermined the incentives for children to care for their parents.

  4. Free markets clear. Unfree markets with distortions applied in accelerating measure can be kept from clearing. From observation we know markets can only move to clear 1) at a certain pace and 2) to the extent the mechanisms they rely upon to clear are not thwarted.

    Pace: Consider the pace at which labor demand curve distortion happens vs. supply curve response happens. For example, the artificial subsidy to shale industry capital investment comes from money the Fed prints instantly with a keystroke. Oil executives hear the Fed announcement, count on that financing, and alter their investment models and decisions almost immediately, creating demand for labor with strokes of their pens. Meanwhile, getting a university degree and/or meaningful work skills and experience in the shale oil drilling sector can be a 5-10 year process for people.

    The Fed’s rate of distortion of the structure of production via money printing/credit expansion occurs faster (days) than labor markets can adjust (years). No surprise that a lack of suitable education, skills, and experience is exactly the complaint we hear from employers today while jobs go unfilled.

    Mechanisms: The government is sabotaging all the core mechanisms whereby supply meets demand. Whence all new jobs? Entrepreneurs. Yet public schools institutionally crush key entrepreneurial values in children like original thinking, non-conformity, individualism, capitalism. Employment laws, regulations, taxes, and burdens like Obamacare are heaped onto the shoulders of any would-be entrepreneurs. Minimum skill requirements have soared as an entrepreneur must not only be defiant of the commercial status quo in order to please customers but also simultaneously obediently submissive and/or shrewdly cronyist in order to please government.

    In high-skill jobs, the government now cartelizes most of the biggest industries like health care, finance, telecommunications. This artificially constrains the supply of these "good" jobs. Yet these are the largest industries with the most consumer demand able to fund the most jobs. These are the white collar jobs a college-bred workforce has been exclusively prepared for. In low-skill jobs, the government outright bans uneducated, inexperienced people from working via wage price controls and occupational licensing.

    Thus an outsized number of displaced workers are forced to compete for the remaining artificially constrained supply of jobs, turning to more marginal industries doing work they are either overqualified or underqualified for. At the bottom end of these oversubscribed jobs, wages are dipping below the level at which shifting to government assistance, getting paid to do nothing, makes more economic sense, so people increasingly take that option. The government is effectively herding people out of the work force.

    While mounting Fed printing expands distortions in labor demands across industries, the government simultaneously deploys its guns and jails to broadly undermine market response mechanisms, constricting the high end, smashing the low end, and stifling organic growth in the middle. This collaborative, multi-pronged labor market attack is occurring so fast, so broadly, and so heavily, on an escalating degree, the labor market can’t respond fast enough or adequately enough to clear.