Written By: Michael Joyce, CFA, CFP

The closely-watched employment report released by the US Department of Labor on Friday, December 6, showed a continual, albeit slow, improvement in employment in the United States.  The unemployment rate declined to 7.0% (down from a peak of 10.1% in October 2009) and non-farm payrolls increased by 203,000 over the past month.

However, there is one segment of the report that showed little improvement and whose continued decline, even as the unemployment rate has shown signs of improvement, remains, in my opinion, a cause for grave concern.  I’m referring to the labor force participation rate. The labor force participation rate is the percentage of working-age persons in an economy who are either employed or unemployed but looking for a job.  The report released on December 6 showed this rate stuck at 63%.  This is close to levels not seen since 1978.

Every college freshman taking Principles of Macroeconomics learns that the unemployment rate falls when an economy grows and rises when economic growth declines. The labor force participation rate, contrarily, tends to ebb and flow with the economy.  When the financial crisis occurred, the labor force participation rate declined just like economics textbooks said it should.  Since then, however, the labor force participation rate has continued to deteriorate even as the economy has improved and the unemployment rate has declined.  The table below shows the labor force participation rate in the United States from 2007-2013.


The continued disintegration of the American labor force participation rate , despite improvements in economic growth, has grave long-term implications if this trend proves to be an indicator of underlying structural economic problems.  First, we can expect that the number of workers retiring will increase as the aging Baby Boom Generation reaches retirement age.  A declining labor force participation rate among younger workers will mean that there will be fewer paying into social security to support the increasing number of retiring Baby Boomers.  Ominously, the only improvements in labor force participation rates over the past few years, have been in those the over the age of 55.

Labor force participation has not continued to decline because of layoffs, which are currently below pre-recession levels.  What has lagged has been job creation and new hiring – especially among small businesses that have traditionally been the engine of job creation.  According to an August 2013 study by the National Federation of Independent Businesses (NFIB), small business owners cite increased regulatory red tape and higher taxes as the two biggest impediments to creating jobs.  These two factors were cited as significantly more influential to labor force participation than were falling sales, competition from larger companies, and the cost of labor.

The shrinking labor force participation rates also hint at long-term structural economic problems.  Even during the recession, many jobs that required skilled workers went unfilled because of a lack of qualified applicants with the proper skills.

The workers who have dropped out of the labor force for economic reasons are primarily engaged in one of two activities: collecting disability benefits or studying in school. Many workers  turned to disability benefits for income during the recession. This has increased the number of disability beneficiaries by 1.8 million since the recession began. These workers will probably remain permanently outside the labor force.  Just 10 percent of SSDI beneficiaries who leave the system do so because their health has improved enough so that they no longer qualify for benefits.  Even fewer workers voluntarily leave disability insurance to work.  According to the trustees of the Social Security Disability Insurance Trust fund, the fund will be exhausted in about three years.

The labor force participation rate merits watching as a harbinger of future economic growth prospects. Unlike those who left the labor force to collect disability benefits, those who left the work force to continue their studies are likely to re-enter the work force at some point.  As long as these students are gaining valuable skills from their studies, this is unlikely to negatively affect the economy in the long term.