Simple Arithmetic and the Participation Gap

One week ago Gavyn Davies, columnist for the Financial Times, noted that the labor force participation rate has dropped 2.8 percentage points since 2007.  He explained further that some researchers attribute about half of the decline to demographic change leaving a 1.3 percentage point drop in participation due to the sluggish recovery.  While I strongly disagree with the view that demographic change accounts for half of the decline in participation, that is not the emphasis of this blog post.*

Davies then conjectured that the decline in participation “implies that the genuine amount of slack in the labour market might be about 1 to 1.5 percentage points more than implied by the unemployment rate.”  Presumably Davies, the former head of the global economics department at Goldman Sachs, meant that official statistics report the unemployment rate on a labor force base that is considerably smaller than it would be in a healthy economy.

Where Davies gets this wrong is in the simple arithmetic of his calculation of the shrinking labor force.  Assuming that Davies is correct that the labor force participation rate dropped just 1.3 percentage points due to the weak economy, that decline is 1.3% of an adult U.S. population of 246 million or 3.2 million adults.  The labor force is now measured at about 155 million so the 1.3 percentage point gap in participation translates into a 2.1% drop in the size of the labor force. (about 63% of adults participate in the labor force).  If all of the 2.8 percentage point drop in the participation rate is due to cyclical factors that would mean that the weak economy has shrunk the labor force by 6.9 million adults or 4.4%.

When describing changes in percentage points and comparing one time series to another, analysts should be careful that the base for calculations are consistent. 1% of the adult population represents about 2.46 million people while 1% of the labor force represents 1.55 million people.  The official unemployment rate measures the slack in the labor market conditional on the size of the labor force, not the adult population.  Whether you believe Davies’ numbers or not, its clear that there are between 3.3 and 6.9 million Americans no longer participating in the labor force because of a weak labor market recovery.

*See my previous post explaining that in a healthy labor market participation should be rising not falling for adults age 55+ who are younger (due to the baby boom cohort), have longer life expectancies, longer to wait for Social Security benefits, and women in this age cohort greater lifetime labor force attachment than previous generations.