Aging population, discouraged workers weigh on labor market size

If the unemployment rate had returned to its prerecession level in the April-June period this year, and if the labor force participation rate equaled its potential rate, about 3.75 million more people would have been employed, according to a new analysis.

Participation in the work force has dropped since the start of the recession because of a combination of the aging population and a slowly recovering labor market that left many workers too discouraged to look for a job, the nonpartisan Congressional Budget Office report shows.

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The CBO said Tuesday that aging workers accounted for about 1.5 percentage points of the drop in the labor force participation rate as it fell to a 35-year low of 62.8 percent this year from 65.9 percent in late 2007.

The labor market's slow recovery, which forced many workers to stop looking for jobs, is responsible for three-quarters of percentage point of the decline, the analysis said.

CBO estimates that about three-quarters of a percentage point represents the extent to which actual participation is below the potential because of a lack of employment prospects along with stagnant wages, Bob Arnold, chief of the CBO’s projections unit in the macroeconomic analysis division, wrote in a blog post on Tuesday.

The participation rate is part of the ongoing slack in the labor market and is a factor in holding back a more robust recovery.

"The elevated unemployment rate and the depressed labor force participation rate account for that shortfall in roughly equal proportions," Arnold wrote.

By comparison, the job market was about 5.25 million people short reflecting a higher unemployment rate and a slightly more negative effect of the cyclical economic weakness on labor force participation.

At its peak in 2009, that shortfall was 8.5 million people, CBO estimates.

"Although conditions in the labor market have improved notably in recent quarters, a significant amount of slack remains," the CBO post said.

CBO anticipates that economic growth will pick up in the next few years.

"That faster growth will reduce the amount of slack in the economy," Arnold wrote in the post. 

Federal Reserve Chairwoman Janet Yellen has said that continued slack makes it very difficult to determine whether the problems with the labor market are structural or cyclical.

The central bank is set to end its massive bond-buying stimulus this fall but is expected, at this point, to wait until next summer to let interest rates rise, mostly because of the labor market's struggles. 

In CBO's view, the so-called slack usually refers to underutilized productive resources and consists of several parts — the share of part-time workers who would prefer full-time work is significantly higher than it was before the recession and the rate of long-term unemployment is still about a percentage point above its average rate during the years before the recent recession.

In combination, the shortfall in labor force participation and the elevated unemployment rate have resulted in substantially lower employment this year than would otherwise be the case, CBO said.

"One important signal that significant slack remains in the labor market is continued slow growth in hourly labor compensation," Arnold wrote.

"But measuring slack is quite difficult — especially given the unusual developments in the labor market since the recession ended — and the current amount of slack could be a good deal larger or smaller than CBO estimates."

The unemployment rate stood at 6.2 percent in the second quarter of this year, roughly 1.25 percentage points above its level before the recession.

CBO estimates that about half of a percentage point of that increase reflects temporary cyclical weakness in the economy — much less than the peak effect of temporary weakness, estimated to be about 4.25 percentage points in late 2009.

The remaining three-quarters of a percentage point of the increase in the unemployment rate stems primarily from two structural factors that have boosted the natural rate of unemployment to about 5.75 percent.

Those factors are the stigma and erosion of skills that can stem from long-term unemployment and a drop decrease in the efficiency with which employers are filling vacancies, probably at least in part as a result of mismatches in skills and locations.