An Unseen Economic Albatross: Labor-Force Dropouts

Huge numbers of Americans are giving up on work

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The unemployment rate is probably the most closely watched economic indicator, but the U.S. economy has become so peculiar that you have to dig a lot deeper to figure out whether the job market is starting to heal.

The December unemployment rate was unchanged at 10 percent, and a tick lower than the October peak of 10.1 percent. As the press has dutifully reported, the big disappointment was the loss of 85,000 jobs in December, when analysts had been expecting a much smaller decline or perhaps even a net gain.

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But the most startling figure in the latest report may be the size of the labor force itself. The government considers the labor force to include everybody who either has a job or is looking for one. So if you get laid off and spend your days hunting for a new job, you count as part of the labor force, even if you’re not earning a paycheck. But if you get discouraged and give up, you don’t count.

The labor force has been shrinking, with a sudden surge in the number of people who have given up on work. In December, 661,000 people dropped out of the labor force, mostly because they’ve been unemployed for a long time and decided they can’t get a job. In November, the labor force shrunk by only 134,000 people. In October the decline was a mere 73,000. The huge December drop reverses a positive trend and signals that more Americans, not fewer, are losing faith in their ability to earn an honest living.

Longer-term data on the labor-force participation rate—the proportion of Americans 16 or older who are either employed or looking for a job—show that the economy is in a deeper hole than headline numbers suggest. The labor-force participation rate in December was 64.6 percent, the lowest level since 1985. The participation rate has been falling steadily for the last year, with the biggest monthly drop occurring in December. If the same proportion of people were in the labor force today as a year ago, an additional 2.8 million people would officially be unemployed. That’s on top of 15.3 million Americans who are out of work and looking for a job.

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These largely unseen labor-force dropouts are probably a bigger drag on the economy than analysts account for. They add up to nearly 3 million Americans—largely in manufacturing, construction, and other blue-collar fields--who used to have a regular paycheck that they spent on cars, appliances, restaurant meals, and everyday items. That spending has dried up and won’t come back for a long time. Many of those disenfranchised workers may also have exhausted unemployment benefits, swelling the rolls of poverty-level Americans eking out a subsistence living.

A shrinking labor force also masks the severity of job-market woes, since the unemployment rate only measures those out of work as a percentage of the labor force. Jeffrey Rosen of calculates that if the labor force had declined in December by a mere 134,000—the rate of decline in November—the unemployment rate would have surged to 10.3 percent instead of holding steady at 10 percent. If the size of the labor force had stayed the same from November to December, the unemployment rate would have been 10.4 percent. By my estimate, if everybody who has dropped out of the labor force over the last year were counted as unemployed—instead of not being counted at all—the unemployment rate would tally nearly 12 percent.

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As the economy recovers—assuming that it does—many of those labor-force dropouts will reemerge, looking for work. That’s going to make it look like the job picture is getting worse, when it will actually be improving. If past patterns hold, the labor force will start to expand as hiring resumes, and people not counted at all in prior employment reports will suddenly count as unemployed. That will make the unemployment rate go up, even as the economy stops shedding jobs in the aggregate and starts adding them. The official unemployment rate could peak at close to 11 percent sometime in 2010.

The ebb-and-flow of this shadow labor force also suggests that a healthy, full-employment economy--last seen in early 2007--may still be years away. As Rosen points out, discouraged workers tend to be the least-educated, lowest-skilled members of the labor force, which means they’ll be among the last to find jobs in a recovery. Since they’re still sitting on the sidelines—and their numbers are swelling rather than declining—it will take that much longer for a fragile economy to grow enough to absorb them. We shouldn’t declare a recovery until everybody who wants a job is at least looking for one.