The Curse of a Shrinking Labor Force

One more reason why growth and prosperity may continue to be elusive.

By + More

We don't just have fewer jobs than we used to. We also have fewer people who even want a job.

In 2007, before the recession hit, the percentage of working-age Americans who considered themselves part of the labor force was about 66 percent. It's been falling ever since, and today, it's about 64.5 percent. As a statistical change, that might seem like a modest drop. But a shrinking pool of workers usually signals a long-term slowdown in economic growth, and that could lower living standards for millions of Americans over the next several years.

[See 20 industries where jobs are coming back.]

During recessions, it's normal for some Americans to drop out of the labor force. Some people lose their job and decide to do something else until the economy improves and jobs return. Spouses decide to help out at home for awhile. Students prolong their education instead of looking for work. Some jobless people get so discouraged that they give up job hunting and therefore drop out of the labor force. That clearly happened during the latest recession. At the end of 2007, there were just 369,000 "discouraged workers" who had stopped looking for work. There are now 1.2 million. Overall, nearly 6 million Americans have stopped looking for a job for some reason, and dropped out of the labor force.

When recessions end, the number of discouraged workers and other labor force dropouts usually returns to earlier levels. But economists think that may not happen this time—with serious implications for everybody else. The first problem is that many jobless people were employed in industries that are shrinking permanently, like manufacturing, so those jobs may never come back. Some of those workers will move into other fields, but that will take time. Older discouraged workers, instead of rejoining the labor force, may simply retire earlier than expected, on a pension or on Social Security payments—with a smaller nest egg and lower standard of living than they would have earned by working steadily till the end of their careers. And some younger labor force dropouts may simply end up without work for years, swelling America's underclass.

Demographic trends will also shrink the size of America's employable population. As in other developed countries, America's population is slowly aging, with Baby Boomers retiring at a faster rate than young people are entering the workforce. There's nothing new about that, but combined with other trends, it will help intensify a labor force shift that would have been more subtle without the ravages of the recession.

[See why every worker needs new skills.]

Some labor-force dropouts will rejoin the work force as the recovery evolves, and it will take awhile for an equilibrium to settle in. Research by Bank of America Merrill Lynch, for instance, shows that during the recession, workers 34 or younger withdrew from the labor force at the highest rates, probably because they have the most flexibility to go back to school or move in with parents. And some older workers who have jobs will probably work longer, to make up for the wealth they've lost in the housing bust and the sharp decline in stock values since 2007.

But those trends are unlikely to stop a long-term decline in the labor-force participation rate. Bank of America predicts that the participation rate will tick up slightly over the next few years, then resume a downward trend that's been in place since 2000. This matters because the proportion of citizens who are working or looking for work is one of the biggest factors determining economic growth, and growth is what generates prosperity. It's intuitive: If a larger portion of the population is working, more people have money to spend, which makes businesses more profitable, promotes hiring, and leads entrepreneurs to create even more businesses.

Labor force participation, in fact, is a proxy for the rise—and now, decline—of American economic power. Participation rose from about 58 percent at the end of World War II to about 67 percent at the end of the 1990s. A slow descent began in the early 2000s. The drop during the recession was the sharpest decline of the last 60 years.

[See how to fall out of the middle class.]

On the course that Bank of America predicts, relatively low participation rates will limit economic growth to just 2.5 percent or so for the foreseeable future, which is considerably below the average growth rates of 3.5 percent or so that have typified America's more prosperous days. Lower growth means that the economy won't create nearly enough jobs to reduce unemployment any time soon, with unemployment rates of 8 percent or higher becoming a very uncomfortable norm. That will keep incomes down even for those who do have work, since the supply of workers for many jobs will be much bigger than the demand. Persistently high unemployment also means that tax revenues at every level of government will be lower, forcing cuts in services and higher taxes on those who still have jobs. The impact on many Americans, including those with jobs, will be an ongoing struggle to save money and get ahead.

There could be surprises that produce a more upbeat scenario. More Americans could start their own businesses, generating fresh jobs. Stronger foreign economies and a low dollar could create an export boom that's bigger than expected. Or Washington could rally with new policies that boost economic growth. But it would be a risky bet to bank on that. With jobs so hard to find, Americans are simply finding something better to do with their time.