by Calculated Risk on 5/03/2014 06:05:00 PM

Another note on the labor force participation rate:

From Goldman Sachs chief economist Jan Hatzius:

• Since the start of the Great Recession in late 2007, the labor force participation rate has fallen by more than three percentage points, including a sharp drop in April back to the late-2013 lows. The extent of the decline has surprised many economists, ourselves included. What accounts for it, and will it continue?

• The first question is relatively easy to answer. Using an approach similar to that of a recent Philadelphia Fed study, we can show that the decline reflects a combination of 1) more retirements, 2) more disability, 3) higher school enrollment, and 4) more discouraged workers.

• The second question is more difficult, but we believe the answer is no. The most important reason is that the big increase in retirements in the last three years looks far less “structural” to us than generally believed. Many people seem to have pulled forward their retirement because of the weak job market. This leaves correspondingly fewer retirements for future years, and it means that the impact of retirements on participation is likely to become much less negative.

• The other drags on participation are also likely to abate or reverse. Inflows into disability insurance are now slowing sharply, consistent with past cyclical patterns. The school enrollment surge has started to reverse as young workers are finding better job opportunities. And stronger labor demand is likely to pull many discouraged workers back into the job market.

• If participation does stabilize or rise a bit, the decline in the unemployment rate should slow even if payroll growth stays at the sturdy levels seen in recent months. This is one key reason why we believe Fed rate hikes are still far off.

CR Notes:
1) Here is the referenced Philadelphia Fed study:

Analyzing people’s reasons for not participating in the labor force provides a relatively clear idea of the causes of declines in the labor force participation rate. The number of disabled persons has been steadily rising; retirement had not played much of a role until around 2010, at which point it started to make a large impact on the overall participation rate. In particular, the decline in the participation rate in the past one-and-a-half years (when the unemployment rate declined faster than expected) is mostly due to retirement. Furthermore, nonparticipation due to enrollment in school has been another significant contributor to the secular decline in the participation rate since 2000.

There is no question that more workers dropped out of the labor force due to discouragement during and after the Great Recession and that there are more discouraged workers now than before the recession. These facts clearly reflect the continued weakness of the U.S. labor market. However, it is not clear whether the overall participation rate will increase any time soon, given that the underlying downward trend due to retirement is likely to continue.

Several studies try to separate “cyclical” factors from “structural” factors when explaining the behavior of the participation rate. However, the foregoing analysis casts some doubt on the usefulness of such labeling. For example, the label “cyclical” often implies — whether implicitly or explicitly — that declines in the participation rate explained by “cyclical” factors will reverse as the economy improves. However, this presumption may not hold. In particular, the decision to retire is clearly affected by cyclical factors, but this decision is unlikely to be reversed.

2) Here are the most recent projections from BLS economist Mitra Toossi: Labor force projections to 2022: the labor force participation rate continues to fall. The participation rate is projected to decline for the next couple of decades.

3) Headlines that blare Workforce Participation at 36-Year Low as Jobs Climb aren't helpful. A large decline in the participation rate has been expected for some time, and those that keep saying "the participation rate is at a multi-decade low" are not contributing to the discussion. There is a question of how much of the decline is related to demographic trends (retirement, more young people staying in school are two key trends), and how much is cyclical - but some key recent research now supports my view that a majority is demographics.