The Silent Economic Driver: The Labor Force Participation Rate

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The labor force participation rate has a significant impact on the U.S. economy. Image courtesy of the U.S. Senate.

Big jobs usually go to the men who prove their ability to outgrow small ones — Theodore Roosevelt

In recent years, pundits have repeatedly sliced and diced the slow economic growth in the United States. Likewise, politicians continue to complain about the still-high 6.1% unemployment rate.

Both are facts in the current economy.

What isn’t often explored is the link between the two.

Occasionally, pundits may hint at this link when talking about about consumer spending, corporate profits and income inequality. However, although the phrase ‘labor force participation rate’ has been thrown about on the political talk show circuit, it’s not exactly a household term.

And yet, it should be. It’s not the rise and fall of the U-3 unemployment rate that should receive the most attention, but the percentage of the entire population generating meaningful salaries, wages and employment income.

The reason is painfully simple: Consumer spending represents 70% of economic activity in the United States.

If employment isn’t healthy, neither is the economy.

What is the U-3 Unemployment Rate?

The U-3 unemployment rate is the official measurement of the health of the labor market in the United States. The following U-3 definition is from the Bureau of Labor Statistics:

Total unemployed, as a percent of the civilian labor force.

The definition appears reasonable enough, until one understands what ‘civilian labor force’ actually means.

Per Investopedia, the civilian labor force is defined as follows:

A term used by the U.S. Bureau of Labor Statistics (BLS) to describe the subset of Americans who have jobs or are seeking a job, are at least 16 years old, are not serving in the military and are not institutionalized.

Key to this measurement of unemployment is what’s in the denominator of the equation. Or more correctly, what’s not in the denominator.

The pool of individuals from which the calculation is derived only includes “Americans who have jobs or are seeking a job.”

Although excluding youth, military personnel and the institutionalized makes sense, there are literally millions of Americans still unaccounted for. What happens when they are counted?

The Labor Force Participation Rate

When the total number of employed individuals is divided by the sum of the employed and unemployed, the net result is the labor force participation rate. Unlike the U-3 unemployment equation, it includes millions working-age individuals who, for one reason or another, are not looking for work.

After climbing steadily since the early 1960s due to more and more women entered the work force and peaking during the Clinton administration, the labor force participation rate has fallen sharply over the better part of the last two decades, presently sitting at a 36-year low. Although the drop is due to a number of factors, the nonpartisan Congressional Budget Office has estimated that half the decline since 2007 can be attributed to the weak economy.

What Does it All Mean?

As lenders, the very first thing we look at when considering making a loan is the source of repayment.

Yes, we prefer to see good credit and solid collateral, but first and foremost, the individual or business being considered must have reliable income from which to repay the loan. If they don’t, the chances of making the loan hover somewhere between slim and none — and slim left town.

The same concept holds true for spending. Most individuals are rational in their spending patterns, making discretionary purchases when they are comfortable they can afford to do so.

It stands to reason that the declining labor force participation rate has become an anchor on the overall economy, as the growing pool of underemployed and unemployed have little to no discretionary income.

Not coincidentally, at nearly the same time as when the labor force participation rate started downward, average annual economic growth in the U.S. began to slow as well.

Can the Long-Term Economic Trend Be Reversed?

In short, of course it can. Having dealt with small businesses for the past 26 years through the thick and thin of all sorts of economies, I understand that cycles are a natural part of the economic landscape. The bubble economies of 1999-01 and 2005-08 sent shock waves through the system, exacerbating the negative long-term trends that had already begun years earlier.

Consumers will spend more when their income goes up, and as 70% of the economy, they have to be working in order to do so. For the economy to shake this frustratingly slow growth phase, the labor force participation rate must start to rise again. It’s simply not high enough.

How to grow the labor force participation rate is subject to debate. Creating new jobs is certainly part of the equation, as may be incentivizing employers to hire. Dissuading those on public assistance from remaining so beyond the time necessary to get back on their feet is likely yet another key.

Regardless of the methodology, low interest rates and artificial stimuli aren’t the recipe for a healthy, sustainable economy — improving the labor force participation rate is. As Thomas Huxley once said, “Economy does not lie in sparing money, but in spending it wisely.”

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