While the June employment report had its pros (payrolls) and cons (wages), one number attracted attention: the increase in the labor force participation rate, which rose from 62.7 to 62.9, as more people returned to the labor force, in the process sending the number of unemployed workers higher by half a million.
That said, the move was modest, and as Goldman writes in a Q&A note looking at the participation rate, month-to-month changes in the participation rate are quite noisy, with the standard deviation at 0.14pp over the last 10 years.
the participation rate simply moved up in June near the top end of the 62.3%-63.0% range that has prevailed since early 2014. Over this period, the cyclical participation tailwinds have offset the impact of the structural headwinds, of which a ¼pp trend decline due to aging is the most important contributor.
Whatever the reason behind the monthly increase, a more troubling trend is the ongoing secular decline in the participation rate, especially in the context of other developed economies, where despite economic difficulties, the number of people who end up in the labor force has been rising, a stark contrast with the US. Here is GOldman’s view on what is going on here:
Q: The prime-age participation rate is still well below pre-crisis levels. How unusual is the US performance over the last decade from an international perspective?
A: Pretty unusual, especially for prime-age women. The female prime-age participation is still 0.4pp below the 2007Q1 level in the US while it has actually risen in all the other large advanced economies in our sample and by 4.3pp on average (Exhibit 2, left panel). It appears that the social trend of rising female participation in the US came to an end in the 1990s but is probably still ongoing elsewhere (see here for an analysis of the rise in German female participation). As a result, the US female prime-age participation rate is now 4.5pp below the weighted ex-US average and only trailed by Italy’s. Our forecast incorporates a continued moderate cyclical increase in female prime-age participation in 2018H2 and 2019.
Despite a recent pick-up, the male prime-age participation rate has fallen 2.2pp since 2007Q1 in the US vs. only 1.0pp on average in the other DMs (Exhibit 2, right panel). The US male prime-age participation rate is now more than 3pp below the weighted average and nearly 7pp below the Japanese rate.
Of course, regular readers are familiar with this phenomenon which we have covered for the better part of the past decade. But what remains elusive is the answer to the question why is this taking place?
According to Goldman the answer is two-fold: junkies and prisoners, or as Goldman puts it, “the US opioid and incarceration issues … each explain roughly one-sixth of the US prime-age male participation underperformance, or one-third combined”, or in other words, a third of the US participation problem is the result of increasingly more males becoming opioid addicts and ending up in prison as a result, or independently.
Here is Goldman’s full discussion on this troubling issue, which as much as the FBI would like, can not be blamed on Putin or Russia.
Q: What drives the long-run decline in US prime-age participation?
A: Both global as well as US-specific demand and supply factors. Global demand-based factors, especially the impact of technology and trade on less-educated workers, have arguably played an important role. Global supply factors, including increases in family income (from work or transfers), have likely also lowered labor supply across many DMs.
But the US stands out along three other supply dimensions. First, higher rates of painkiller use, including opioids, and middle-age mortality suggest that more severe health and drug-related problems have contributed to lower US participation (Exhibit 3, left panel). Second, the US incarcerates a much larger share of its population, and people with criminal records face severe challenges in re-entering the workforce (Exhibit 3, right panel). Third, while exposure to trade and technology was likely similar to other developed economies, a weaker US policy response—namely, less supportive retraining and job-search assistance—might have made the impact on participation more costly.
Q: The US prime-age male participation rate is now more than 3pp below the average in other DMs. How important are the US opioid and incarceration issues quantitatively in explaining the US gap?
A: Quite important, but not sufficient on their own. Our literature review implies that the two issues each explain roughly one-sixth of the US prime-age male participation underperformance, or one-third combined.
Using estimates of the causal impact of incarceration on employment from Mueller-Smith, we estimate that around 0.5pp of the 3pp US prime-age male gap results from the relatively high share of the population with a felony record.
Using the estimated cross-county relationship between opioid prescription rates and prime age participation rates from Krueger and the assumption that two-thirds of the regional variation in prescription rates reflects local medical supply factors rather than labor market conditions, we estimate that the relatively high US opioid use rate also drives roughly 0.5pp of the 3pp US male prime-age gap.
Q: The incarceration and prescription opioid rates have declined modestly in recent years. Does this imply that the drag from these issues on labor force participation has peaked?
Probably not, because the labor market effects likely operate with important lags. While the incarceration rate peaked 10 years ago, it will likely take many years before we see a corresponding decrease in the number of former prisoners, mostly because prisoners tend to be young, with a median age in the mid-30s.
Prescription opioid rates have also declined modestly since 2012 according to CDC data. However, CDC data also show a shift to heroin and other illegal opioids and a continued rise in the number of drug-related deaths (Exhibit 4, right panel).
While a discussion of whether the phenomenon of the depressed participation rate due to a voluntary exit from the labor force, whether through incarceration or developing an addiction is far beyond the scope of this article, it brings up an ominous point: all those mostly young workers who exit the labor force and become institutionalized wards of the state in some capacity, effectively relinquish any hope for a viable, lucrative and satisfying career. This is also perhaps the primary reason behind the chronic US productivity problem, which has prevented the US economy from growing at capacity, and resulted in stagnant wages for the past decade.
Which reminds us of another perversion of the welfare state where an incentive quirk pushes more people to end up in a lower income – and productivity – bracket instead of motivating them to strive for proper middle class status: recall that as we described in “When Work Is Punished: The Tragedy Of America’s Welfare State“, the net take home between wages and welfare for most minimum wage Americans is as high as that of an ordinary household making $69,000.
This means, that once many Americans fall into the comfortable “welfare trap” that encourages lower wages, it holds back many otherwise ambitious workers from pursuing more productive work that results in higher wages. A similar trap is sprung on those Americans who, for one reason or another, end up in jail or as drug addicts, in both cases preventing them from returning as productive members of society.
Unfortunately, until there is an honest discussion about either the perverse motivations of the US welfare state, or what it is that forces so many Americans to resort to behavior that lands them in prison, or become addicted – and by an honest discussion we do not mean blaming Putin – the US participation problem will only get worse.
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Author: Tyler Durden