The Peterson Institute for International Economics recently put out a working paper about the labor force participation rate and it provided a more concrete look into why so many prime-aged workers (aged 25-54) have left the work force. Their departure has had a profound impact on the available pool of workers in the U.S., and, over the years, has reduced the capacity of the U.S. economy to grow. Fewer workers result in people buying less, firms producing less, and the economy growing more slowly. Fortunately, this very unusual trend is now clearly unwinding and this should extend an already near-record economic expansion.
From 1995 until 2017 most countries in the world experienced an increase in labor force participation of prime aged workers. This was not true in the U.S. where the population aged 25-54 that was willing and able to work shrunk. Out of 32 countries studied in the paper, only 8 had a shrinking participation rate, and the U.S. was the second worst performer and barely missed beating out the Slovak Republic in experiencing the worst decline. Today the United States is easily last among the developed countries in the world in terms of the percentage of the working-age population that works; a fact that is true for both men and women.
The decline among women is more surprising because for decades working age women consistently increased in participation rate as more women entered the workforce. This happened not only in the U.S. but also globally. The labor force participation rate for women peaked in the U.S. around the year 2000, but continued to climb in almost every other developed country in the world.
As we know, the U.S. unemployment rate is low. But it would not be nearly this low if all of these participants that left the work force were to return. The paper concluded that if the participation had simply remained unchanged from prior to the 2008 recession, over 2 million more prime-aged workers alone would have been in the labor force. If all of those 2 million had simply remained officially unemployed, the current 3.9% unemployment rate would now be 5.0%.
Some of the causes for the participation gaps are increasingly evident. As I have written about previously, disability insurance claims have increased dramatically in the U.S. In 1999, 4.9 million people were on disability. This climbed to 6.2 million in 2004, and just 10 years later it had soared to nearly 9 million, an increase of almost 50% and nearly double from 1999. This incredible increase happened while the rate of workplace injuries fell sharply. There were a handful of factors which drove the increase, including easier ways for people to qualify for disability insurance, a terrible recession, and the opioid crisis. In all, roughly half of the reduction in labor force participation was explained by the increase in those claiming disability.
The good news is that this trend is finally reversing and the improvement is accelerating. The number of people on disability peaked in 2014 at nearly 9 million. That has since declined to 8.5 million. But the year-over year-decline in 2018 was the largest drop yet in both percentage (1.82%) and people (about 150,000). If the rate of change continues, 2019 might see over 200,000 people re-enter the labor force who were not previously participating. The benefit and tailwind of having extra participants in the labor force at a time with the labor market is very tight and baby boomers are retiring is quite beneficial for the economy as it can help to mitigate wage (and therefore inflation) pressures and thus reduce the need for the Federal Reserve to raise rates. It could have a profound impact on increasing the length of the economic expansion. Moreover, 200,000 more workers is only a fraction of the increase in those who have departed the official workforce, which suggests this may be a tailwind for a number of years.
If the decline in the unemployment rate simply slowed modestly, the expansion might be able to continue for quite a few years with less pressure on inflation. Low inflation and strong economic growth is the goldilocks scenario we have experienced for the past 5 years. The large pool of labor available and coming off disability may be just what the doctor ordered to keep this expansion going.
Charts published with permission from and copyrighted to the Peterson Institute for International Economics