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Making (some) Sense of the Labor Participation Rate

In the face of months of steady employment gains, along with some green shoots of wage growth, there's been quite a bit of political baiting and hand wringing over the Labor Participation Rate. Why has it declined, and what does it tell us about the U.S. Economy? After all, we've put up the strongest job gains in 30 years, manufacturing output is at an all time high, and almost every economic metric we study is pointing upwards.

So, how do we reconcile these figures:

employment stat.png

With these figures?

Civilian LPR.png

Well, there are couple of things we can parse. One, note that this trend started in the year 2000, and has trended down ever since. The aftermath of the financial implosion of 2008 clearly accelerated this trend. It also appears that the trend towards lower LPR may have stopped, but more about that later. But let's go back and take a broader look at the employment/participation trends over time. As you can see from the NBER chart below, participation does not seem to be correlated to the overall unemployment picture at all. Also note participation trends by gender.


Now, let's take a look at the picture all in:

LPR All In.png

So what is driving these trends, seemingly at odds with each other? This was given a bit of study by Roger E.A. Farmer, currently Distinguished Economist at UCLA, who observed the following truths:

Participation is a voluntary choice. Unemployment is not.

Participation is not cyclical. Unemployment is.

The secular trend in participation dwarfs the cyclical movement.

In other words, we're witnessing a change in the participation rate due to a new set of factors coming into the labor market. What's driving the downturn? Here's my opinion, and by opinion, I mean this is what I am surmising given my observations, without the aid of empirical data. First, we know that the aging population is causing a shift in participation. This is a powerful demographic trend, although it may turn out to be stickier than in prior times, thanks to people living longer. But the longer it progresses, the more pronounced the effect will be for this segment. But I think the macro trend comes down to this: From 1996 to 2000, the participation rate managed to keep it's head above 67%. That was LPR's finest hour. And that period was also the last time we saw any kind of wage inflation. It's my belief that shortages in filling jobs drove wages up, and incentivized more people to join the workforce. People DO respond to incentives like better pay, and many may have simply made the choice to take advantage of opportunities they didn't have before.

Having said that, there could be dozens of levers working on these statistics. As an example, family formation, at long last, has finally attained the same level as it did pre-crash, after it cratered in the aftermath of the sour economy. That could move the numbers further. Proposed wage increases may have an effect in driving people back to the workforce.

One of the things I've learned when trying to understand these matters, as in the housing meltdown, is that it's never just one or two factors that drive the result. It's often a combination of a succession of factors, each working on it's own “push-pull” effect on the ultimate result, and in a certain order, that give us the outcome. To put it in a Nicholas Talebian way, it's one thing if someone falls down a flight of stairs and breaks their legs. It's another if one breaks their legs and then falls down a flight of stairs. To an after-the-fact observer, causality is elusive.

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