The 7.5% US unemployment rate, at its lowest level since 2008, seems to be telling a story of slow-but-steady recovery after the Great Recession and Financial Crisis. Unfortunately, the bulk of evidence suggests the “real” jobless rate is far higher. As the U-3 rate has fallen, so has the labor force participation rate, or LFPR. If the LFPR were at the same level as when the downturn began, the unemployment rate would be a stunning 11.3%.
Two critical questions: First, how much of the 2.7 percentage point drop in labor force participation since 2007 reflects structural forces rather than weak demand discouraging workers? Second, is the key structural element mostly the aging of the US population or is it the shift of the workforce into Social Security disability?
A new study by Goldman Sachs, partly based on recent Federal Reserve research, offers some reasonable answers. The real jobless rate is probably more like 9%, still dreadful. And here’s why:
1. Blame the baby boomers, at least somewhat. Of that 2.7 percentage point drop, 1.2 percentage reflects demographics — a number GS arrives at by plotting the overall LFPR against a rate that assumes an over-16 workforce not aging. So most of the drop in the LFPR is not due to the boomers.
2. The US isn’t Europe. Economists blame persistently high EU unemployment in the 1980s on the relatively easy availability of long-term jobless benefits. But Goldman doesn’t think the same thing is happening here, or at least nowhere to the extent as in Europe. Since 2007, the number of SSDI disabled worker recipients has risen by nearly 2 million, or 0.7% of the over-16 population.
Yet the rise in SSDI beneficiaries has only modestly outstripped the Social Security Administration’s pre-recession forecasts. Goldman: “Most of the growth in SSDI beneficiaries seems to be due to a larger and older population. … So while we would not rule out a certain amount of hysteresis, we expect it to fall far short of the European experience.”
3. The problem is mostly slow growth. So of that big drop in the LFPR, GS concludes, the remaining 1.5 percentage points — the equivalent of 3.5 million jobs — is mostly related to weak labor demand. (That’s where I get the 9% number.) As shown in a recent Fed study, labor demand shocks can have protracted effects on participation. There are lengthy lags. More typically, a big demand shock causes a sharp rise in the unemployment rate, which then reverses over the next three years. The LFPR falls more gradually and only begins to recover three years after the shock.
But not this time. GS: “The current labor market recovery has been much slower, as the unemployment rate has reversed less than half the trough-to-peak increase more than five years after the shock. The reasons are well known — a private debt overhang, excess supply in the housing market, fiscal headwinds, and spillovers from the financial instability in Europe.” So adjusting for the weak recovery in the labor demand explains most of the LFPR decline.
Going forward, GS expects the participation rate to remain flat. Demographic changes will offset recovering labor demand. (The bank doesn’t mention it, but I would also be concerned about the impact of the PPACA on the quantity and quality of job growth.) Given the GS forecast for GDP growth, we’re looking at a 6% unemployment rate by early 2016. But that improvement will understate the true weakness of the labor market, arguing for more aggressive policy action, particularly for the long-term unemployed.