Sunday, October 4, 2015

Some Unpleasant Labor Force Arithmetic

Words such as "grim" and "dismal" were used to describe Friday's employment report, which featured a payroll employment growth estimate for September of 142,000. Indeed, I think it would be typical, among people who watch the employment numbers, to think of performance in the neighborhood of 200,000 added jobs in a month as normal.

But what should we think is normal? As a matter of arithmetic, employment growth has to come from a reduction in the number of unemployed, an increase in the labor force, or some combination of the two. In turn, an increase in the labor force has to come from an increase in the labor force participation rate, an increase in the working-age population, or some combination of the two. So, if we want to think about where employment growth is coming from, labor force participation is an important piece of the puzzle. This chart shows the aggregate labor force participation rate, and participation rates for men and women:
As is well-known, the participation rate has been falling since about 2000, and at a higher rate since the beginning of the Great Recession. Further, participation rates have been falling for both men and women since the beginning of the Great Recession. It's useful to also slice this by age:
Thus, labor force participation has dropped among the young, and among prime-aged workers, but has held steady for those 55 and older. So, there are two effects which have reduced aggregate labor force participation since the beginning of the Great Recession: (i) participation rates have dropped among some age groups, and have not increased for any age group; (ii) the population is aging, and the old have a lower-than-average participation rate.

Next, we'll go back to the 1980s, as that period featured a major recession, but with a very different backdrop of labor force behavior.
The chart shows the population, aged 15-64 (just call this "population"), labor force, and employment (household survey) for the period from the beginning of the 1980 recession to the beginning of the 1990-91 recession, with each time series scaled to 100 at the first observation. This is a period over which the population grew at an average rate of 1.1%, while labor force and employment grew at average rates of 1.6% and 1.7%, respectively. Over this period, employment could grow at a higher rate, on average, than the population, because of an increase in labor force participation, driven primarily by the behavior of prime-age workers. It should be clear that, over the long run, population, labor force, and employment have to grow at the same average rates - again, as a matter of arithmetic. But, over the short run, employment can grow at a higher rate than the labor force if unemployment is falling, and the labor force can grow at a higher rate than the population if the participation rate is rising.

Fast forward to the recent data.
Over the period since the beginning of the Great Recession, population has grown at an average rate of 0.5%, and labor force and employment at 0.3%. As you can see in the chart, employment has essentially caught up with the labor force, reflected of course in a drop in the unemployment rate to close to its pre-recession level. Year-over-year payroll employment growth looks like this:
For more than three years, employment growth has been sustained, at close to or greater than 2%, year-over-year. And, with labor force participation falling, that growth in employment, in excess of the 0.5% growth rate in population, has come from falling unemployment.

What most people seem to view as "normal" payroll employment growth, 200,000 per month, amounts to a 1.7% growth rate per annum, given the current level of employment. To sustain that into the future, given 0.5% population growth, requires further sustained decreases in unemployment and/or an increase in the participation rate. Are there enough unemployed people out there to generate that level of employment growth? In this post, I showed unemployment rates by duration, indicating that unemployment rates for the short and medium-term unemployed have returned to pre-recession levels or lower. What remains elevated is the number of long-term unemployed - those unemployed 27 weeks or more. Here's an interesting chart:
This shows (with the two series scaled differently to highlight the correlation) the time series of long-term unemployed and the monthly flow from unemployment to not-in-the-labor-force. Clearly, the two time series track each other closely. This is related to a phenomenon labor economists call "duration dependence." During a spell of unemployment for a typical unemployed person, the job-finding rate falls. A person unemployed a few weeks is much more likely to find a job than a person unemployed for a year, for example. Thus, as we can see in the chart, it is likely that a long-term unemployed person does not find a job, and exits the labor force.

So, suppose that about 1 million (roughly the difference between the net increase in long-term unemployment from the beginning of the recession until now) long-term unemployed leave the labor force. This would imply an unemployment rate of about 4.6%. Can unemployment go much lower than 4.6%? Probably not. This means that there is little employment growth left to be squeezed out of the current unemployment pool. So, if payroll employment growth is to be sustained at 200,000 per month, this will require an increase in the labor force participation rate. Could that happen? This next chart shows the flows into the not-in-the-labor-force (NILF) state:
Here, note that the flows into NILF from both employment and unemployment are elevated relative to to pre-recession levels. Further, about 70% of the flow currently comes directly from employment. From the previous chart, it seems clear that the flow from the unemployment state will fall to normal levels as the number of long-term unemployed falls, but that should not stem the reduction in the labor force participation rate, if the high flow continues from employment to NILF. Checking what is going on with respect to flows out of the NILF state:
These flows were high relative to pre-recession levels, but are close to, and moving back to, those levels.

These charts reinforce a view that the fall in labor force participation, post-recession, has been driven by long-run factors, and those factors show no sign of abating. Thus, we should not expect the labor force participation rate to stop falling any time soon, nor should we expect it to change course soon.

Conclusion? With the population aged 15-64 growing at 0.5% per year, if we're getting payroll employment growth of more than about 60,000 per month (that's 0.5% growth in payroll employment per year), this has to be coming from the pool of unemployed people, or from those not in the labor force. But further significant flows of workers from unemployment to employment are unlikely, and the net flows from the labor force to NILF are likely to continue. Thus, employment growth of 142,000 may seem grim and dismal, but labor market arithmetic tells us that employment growth is likely to go lower in the immediate future.


  1. Here's the graph of what the U3 unemployment rate looks like when we use the working age population ages 15-64 as the denominator:

    As you suggest, pretty tight.

    Now here is the broad, U6 underemployment rate, using the working age population ages 15-64 as the denominator:

    Not tight at all!

    1. If we want to measure labor market tightness, the typical approach, that comes from search models of unemployment, is to measure the ratio v/u, where v is vacancies, and u is unemployment. Do that using the U3 measure, and labor market tightness looks like this:

      With the U6 measure it looks like this:

      Or, try insured unemployment, and it looks like this:

      With the first measure, tightness is at about the same level as the most recent peak in 2007. With the second, it's close to the 2007 peak, and with the third it's ultra high relative to anything seen since the JOLTS data came into being. Why would we look at the last measure? Read this post:

      That shows how insured unemployment gives you a stable Beveridge curve. So, I think one could make a case that "not tight at all" does not describe the state of the labor market. Damn tight would be more apt.

  2. Thanks for your reply. I would be more persuaded as to your argument about U6 underemployment if the ratio of openings to actual hires weren't at record levels:

    Using actual hires vs openings shows a substantial amount of slack:

    Why the disconnect between openings and hires? Probably a tug of war about wages being offered.

    1. I can't remember what the number is, but a large fraction of hiring is job-to-job. One unusual feature of the labor market currently, is that there is a lot less movement from job-to-job in the labor market, reflected in low hires and low quits. What we're interested in here are the flows among labor force states - employment, unemployed, NILF, and so it's not clear you want to be interpreting the ratio of openings/hires as reflecting lack of tightness.

      "Probably a tug of war about wages being offered."

      Where do you get that idea?

    2. I got that idea from soaring job openings and stalled hires. This is a market that is failing to clear.

    3. Part of the the point is that it's not useful to think of the labor market, and in particular this labor market, as a "market," in the econ 101 sense. There is heterogeneity, and friction. If the only friction you can think about is sticky wages and prices, you're not going to get very far in explaining what is going on.

  3. "These charts reinforce a view that the fall in labor force participation, post-recession, has been driven by long-run factors, and those factors show no sign of abating."

    One needs a story to suggest this topsy turvy result. Else the coincidence of the decline in participation and the bubble burst is too powerful.

    1. "One needs a story to suggest this topsy turvy result."

      In the past, labor force participation has not been cyclically sensitive, and in this case labor force participation is falling while unemployment is falling at a high rate. So what else could this be but long run factors driving a decrease in labor force participation? If this has something to do with a "bubble burst" why wouldn't this be accompanied by a persistently high unemployment rate?

    2. As well, look at the second-to-last chart. There is a large flow of people currently transiting directly from employment to NILF. They are doing that because a bubble burst 9 years previously?

    3. I'm afraid I'm not smart enough to say what effects a gap down in demand should have in all its details. But I can say that clearly world governments did not due the job necessary to adequately replace demand. Where a large part of what was required was to in a sense "feed" real capital assets with demand so managers would not abandon them. So I cannot say what the second to last chart means in this context. Perhaps someone else can.

      In addition to the towering Coincidence, we have seen a parade of economists' efforts to justify, explain, normalize our miserable condition, starting perhaps with Summers, all seeking to recast the Coincidence as an inevitable long term trend. If because of our persistent action (or inaction) we manage to establish a new equilibrium, ex post this does not mean it is what had to happen.

    4. All of the words in john's post individually mean something, but collectively they mean nothing.

  4. Doc at the Radar StationOctober 5, 2015 at 8:04 PM

    These recent posts from the Atlanta Fed's blog are interesting:

  5. Is there a more detailed age break down- specifically women in their 20s and 30s vs women 40+? Male employment has been falling since the 1950s, while female employment was growing for most of that time and steady from ~2000-2010. Childcare costs started rising in the mid 90s just as women's lfpr stopped rising

    A more recent graph would be nice but stagnant wages for a portion of the population with rising childcare costs could cut the LFPR of a certain age group in this manner- speculation only at this point.

    1. I don't know the data that well, but there's certainly more detail in there by gender and age. I do know that labor force participation has not fallen in Canada. Demographics are similar in Canada, but of course social services are quite different. There may be tax deductions for child care costs as well. One of my labor economist colleagues tells me there are interesting things going on with respect to fertility, particularly as regards college-educated women.

  6. Like Canada, UK labour force participation is strong, rising even. And, like Canada, the UK has similar demographics to the US. It's a mysterious world.