Despite last month’s poor jobs report, the U.S. labor market is improving.
Job creation is running at the fastest pace since the late 1990s, and there is some evidence that wage growth is finally starting to accelerate, albeit modestly.
However, one key component is missing from the labor market recovery: rising labor force participation. In March, labor force participation declined 0.1% to 62.7%, the lowest rate since the late 1970s.
Why are so few Americans participating in the labor market even as jobs become more plentiful? I see three main reasons.
1. An aging population.
While the Great Recession inflicted significant damage on the labor market, much of the decline in the participation rate can be traced to the simple fact that the population is getting older. Older individuals tend to work less than younger ones. This is why the participation rate has been declining for 15 years. According to a White House Study, from the beginning of 2011 through the second quarter of 2014, the participation rate fell by 1.4 percentage points. Roughly 70% of the decline can be attributed to the aging of the population.
2. Fewer women working.
Male labor force participation has been dropping for decades, but for most of the past 60 years that decline has been offset by a steady rise in female participation. This trend seems to have come to an end. Female participation started to peak in the late 1990s, at around 61%. It plateaued at that level until the financial crisis. Since then, it has been steadily slipping. As of last month, female labor force participation was down to 58.1%, the lowest level since the early 1990s.
3. A mismatch between skills employees have and those employers need.
While a large part of the decline in participation is secular, there is a cyclical component as well. People typically drop out of the work force during, and immediately after, recessions. What is different this time is that those individuals are not returning to the labor force as was the case in past cycles. This is arguably a function of the unique nature of the last recession. Demand for workers has shifted. In many industries, construction for example, demand is still well below the pre-recession peak. Displaced workers also may lack the necessary skills for the new jobs, for example in healthcare.
Other factors may be contributing to the decline as well, including a larger percentage of younger Americans in college and a sharp spike in Americans on Social Security disability. Looking forward, while a stronger labor market should slow, or at least temporarily reverse, some of the decline, demographic trends and structural changes in the labor market suggest that participation rates will remain under pressure.
For investors, this has two critical implications: slower real U.S. economic growth and low rates. If aggregate hours worked grow more slowly because fewer Americans are working, absent a spike in productivity, real growth will be slower. And to the extent real growth slows, nominal growth is also likely to be slower, a trend normally associated with lower interest rates.