Friday, January 20, 2017

The labor force participation rate vs. the unemployment rate

 - by New Deal democrat

This is the third of four installments looking at whether and by how much people get drawn into the labor force as economic expansions progress.  This is part of a broader look at how close we might be to "full employment."

In the first installment, I showed that if we norm for the long term secular trends, both men's and women's participation in the labor force does go up during economic expansions; i.e., as the economy improves, more and more people who aren't interested in working decide that they do want a job.

In the second installment, I showed that wage growth appears to have very little if any value in forecasting or even correlating with increased labor force participation.  If anything, the correlation appears to run the other way:  increased labor force participation correlates with lower real wages at least over the longer term, but not in any consistent way.

Now let's take a look at whether tightness in the labor market as shown by the unemployment rate correlates with an increase in labor force participation.  Because the U-3 rate has a much longer history than the broader U-6 underemployment rate, that is what I am using.  Note also that for purposes of scale (this will be important later) I am dividing the YoY change in the unemployment rate by 4.

Here is the YoY% change in labor force participation for men, +0.3% to norm for the secular declining trend, compared with the unemployment rate (inverted so that a decrease in the rate shows as an increase in the graph). I've split this up into three time series better to show the relationship.  First, here is 1950-64:



In the 1950s, there is no discernible correlation.  But beginning in the 1960s, and all the way up until the present, there does appear to be a significant correlation between a decrease in the unemployment rate and an increase in men's participation in the labor force.

Now here is women's participation, -0.3% through the 1990s to norm for the secular trend of their entry into the labor force during that time.  First, here is 1950-1965:



With the exceptions of the late 1950s-early 1960s, and the recovery since the Great Recession, once again there does appear to be a significant correlation between a decrease in the unemployment rate and an increase in women's participation in the labor force (but note the poor relatinship in the present expansion, which will be dealt with in the last installment).

Remember that I told you to keep the division of the YoY change in the unemployment rate by 4 in mind?  That's because the above graphs suggest that, although it is a very noisy relationship, a back of the envelope estimate is that for every 1% change in the unemployment rate, there is a .25% change in the labor force participation rate for both men and women.

Not only is there a significant correlation between the unemployment rate and labor force participation, but it appears from the above graphs that the unemployment rate *leads* labor force participation by 1-2 years.  This is also shown  when we compare the difference in the YoY change in the two: 

Compared with trend, the LFPR outperforms later in the expansion as the unemployment rate flattens and then begins to rise, while it under performs relative to trend when the unemployment rate begins to turn down early in a recovery.

In the last few months, the unemployment rate has declined to new lows.  That suggests that in the next 12-24 months, the LFPR will increase compared with trend.  If the unemployment rate were to decline another 1% to 3.5%, thereafter we should expect roughly another +.25% YoY increase in the LFPR compared with trend, which translates into a very slight nominal increase.

But this relationship, while important, isn't the end of the story.  Because we still have the issue of retiring Boomers, and we still have the fact that women's labor force participation barely budged for 6 years after the end of the Great Recession.  A year ago I wrote a series on the "child care cost crush." So in the final installment, I will take a look at these issues.