Ask not what you can do for your labor market

Demographic shifts and an ageing population will keep dragging down the rate of U.S. growth. Time to focus elsewhere.

WE have spent most of this U.S. economic recovery cycle asking, ‘what can we do for the labor market?’ It might be time to ponder, ‘what can the labor market do for us?’

Employment is one of three critical factors that determine economic growth. But throughout this recovery, employment and growth haven’t exactly progressed hand in hand:

  • the unemployment rate has been halved from the 2009 peak, and is 1.2 percentage points lower than the 1980–2006 average (5.0% in September 2016 vs 6.2%); there are 5.4 million more people working today than at the previous employment peak before the recession;
  • GDP growth instead is 1.2 percentage points lower (2.1 during 2010–15 vs 3.3%).
  • The Federal Reserve believes we are “close to full employment”; but growth is disappointing.
Employment reached a new peak, with 5.4 million more people working than before the recession

The employment boost that we enjoyed as the unemployment rate fell from 10% to 5% cannot be repeated. Remember, the speed of GDP growth depends on the pace at which the economy can add to the employment level, to the capital stock, or to productivity.

Over the coming years, employment growth will be driven mostly by the growth in the labor force (people of working age) and by any changes in the participation rate (the share of working age people who hold a job or are looking for one).

What will this mean for growth?

The participation rate won’t help us much.

Let me start with the participation rate; it is a bit of a puzzle, and opinions differ. Here are the facts:

  • The participation rose steeply from the mid-1960s to the late 1980s, as women joined the labor force in greater numbers; it peaked at just over 67% through the end of the 1990s;
  • Then it declined to 66% by 2004, and seemed to stabilize;
  • When the great recession struck, it dropped sharply again to just over 62%.

You can already guess that economists have come up with two competing explanations:

First economist: ‘Look, the biggest decline in participation happened with the recession. Many workers got laid off, and for a few years it was very hard to find jobs. A lot of people got discouraged and stopped looking for work. But this can be reversed. Now that the economy is getting stronger, firms are hiring again. With the unemployment rate so low, employers will be less choosy, and even people who have not worked in a few years will come back into the labor market.’

Second economist: ‘You wish. The problem is that the U.S. population is getting older. And older age brackets have fewer people working: for people age 25–54, the participation rate is 81%; for people age 55–64 it is 64%. As the population ages, the average participation rate drops. It’s simple arithmetic. This is why the participation rate started falling in 2000, well before the recession.’

My colleague Gordon and I don’t trust economists, so in our recent paper we crunched the numbers, using detailed population projections from the Census Bureau and trying out different assumptions for participation of different age groups. For example, as the population ages, we tend to stay healthier for longer, so it is reasonable to assume a greater share of ‘older’ people will be working.

Our conclusion is: in the next few years, we could indeed see some recovery in the participation rate. In the best case scenario it could be as much as 3 percentage points, which would give a healthy boost to growth.

But this would be short-lived. Demographic shifts will eventually prevail, and drag the participation rate back down to just over 62% — lower than today.

So looking into the next few decades, the participation rate will not help us much.

Even in a best-case scenario, higher participation will give only a temporary boost to labor force growth

…nor will employment growth.

The bad news is that population aging is also slowing the rate of growth of the labor force. It already has.

During the last ten years, labor force growth has averaged only 0.5% per year. This compares to 3% per year in the 1970s and about 1–1.5% through the 1990s and most of the 2000s. And new research from RAND also shows that older workforces are less productive on a per-worker basis.

You could look at this in a positive light. There is growing concern that technological innovation could displace jobs. Maybe it is a good thing if we need to create fewer jobs in the first place because there will be fewer people coming into the labor force.

But if you are thinking of overall economic growth, this is not good news at all. It means that one of the three engines of growth will keep sputtering for the foreseeable future.

How big of a problem is this? Well, if labor force growth has dropped from 1–1.5% to 0.5%, that roughly means 0.5–1% less GDP growth, other things equal.

The ‘other things’ are investment and productivity — and the good news is, we can make clear choices to accelerate each. I will tackle this in my next two blogs.