Labor Force Participation Rate: In or Out?
Judging from the media reaction to Friday's Employment Situation Report, one would suppose the end is near. Yes, 96,000 jobs created is mediocre, but, remember it is August after all. Even in the best of times, August is a slow month. Since 1952 the seasonally adjusted change in non-farm payrolls from July to August has averaged -0.2 percent — in other words, flat month-over-month.
In picking over the report, the pundits have found a new subject of their jeremiads: it is the labor force participation rate (LFPR). In August the rate fell to a seasonally adjusted 63.5 percent — the lowest level in the new century. The hand wringers neglect to mention three facts. First the LFPR has been declining — gradually and then more rapidly since the Great Recession — for over fifteen years. So there is more to the trend than the current weak economy. Second, the labor force historically contracts in August. In the 58 of the last 61 years, the labor force declined (from July to August) on a non-seasonally adjusted basis. When seasonally adjustments are made a decline is observed in 26 of the previous 61 years. In any year it is almost a coin toss whether more workers will opt to absent themselves, than those who will elect to join the labor force, in August. True, the rate of contraction is at the higher end of the historical range; but it is not well above it.
Finally there is a demographic component. Participation rates may be lower simply because the population is aging. This trend is obscured by the way the labor force participation rate is computed.
The current definition of the labor force participation does not reflect the distortions an aging populace can produce. The LFPR is computed by dividing the number of individuals, male and female, between the ages of 16 and 64, who are in the labor force, by the population of people age 16 years and older. Leaving aside for a moment the distinction of being in or out of the labor force, the ratio underestimates the true participation rate.
The reason why is simple: the denominator includes individuals 65 and older. Sixty-five, like 16 or 18 or 30 or 50, is one of those milestone years for most individuals. It is the age by which many people retire, giving up the daily grind to enjoy their remaining years in leisure. Consequently, come 65 a large number of individuals have voluntarily exited the labor force. Their inclusion in the computation systematically biases the result, understating the U.S. population's engagement in the economy.
There is perhaps a historical reason for this computational inconsistency. The Great Depression, the New Deal and then the Second World War, all spurred the federal government's efforts to measure and manage the elements constituting the economy. In 1950, life expectancy at birth for a man was just shy of 66 years. For a man celebrating his 65th birthday in 1950, he could on average expect to celebrate 13 more. Fast forward to 2010: today, the average American man has a life expectancy at birth of 76 years; a man reaching 65 today has a life of another 17 years. The increase in life expectancy may seem glacial, but it suffices over time to significantly increase the proportion of the population over age 65.
From 1950 to 2010, the share of the population 65 and older has increased from 8 to 13 percent. As the general population continues to age, this share will continue to increase. We corrected for this distortion by including only the population age 16 to 64 in the denominator. When this adjustment is made, the labor force participation rate is a healthier 73 percent, down from a July 1997 high of 78 percent.
Alas, even after this refinement, the trend is still one of decline. But as already noted, the rate has been edging lower for some time. The recent slide — since 2007 — is due in part to the economy. But even had the financial crisis been averted and the recession avoided, the LFPR would probably still be declining. Before joining chorus of lamentations, consider there is more at work here inducing workers to be in or out.
Notes on Sources and Methods:
The gray shaded vertical regions indicate recessions as determined by the National Bureau of Economic Research (NBER).
The labor force participation rate (LFPR) is computed using non-seasonally adjusted (NSA) civilian labor force and population data for individuals between the ages of 16 and 64. All labor force and population data was obtained from the Bureau of Labor Statistics (BLS). The light blue line the NSA LFPR; the dark blue line is a 13 month running average of the monthly NSA rates. This provides a seasonal adjustment of sorts to illustrate cyclical or secular trends in the LFPR.
(Source: BLS; NBER; AIFS estimates.)
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