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January 1, 2013 Summary Points Despite a historically slow pace of job creation coming out of the latest recession, the unemployment rate has steadily declined from its peak levels. A big reason for this is that hundreds of thousands of people have left the labor force and are no longer counted as looking for work. This is a complicated picture that includes “discouraged workers” and others who have sought out an expanding social safety net of unemployment and disability payments. But there is also a mix of longstanding demographic factors and macroeconomic conditions that is shaping labor force participation. Because labor force participation rates are falling, fewer new jobs will be needed in the future versus historical trends to keep the unemployment rate from growing. That is not necessarily a happy story. Furthermore, the quality of those new jobs will determine whether there will be a “lost generation” of workers who struggle to increase their human capital and real standard of living. The two drivers of GDP growth are increases in the labor force and productivity gains. Current trends in these regards point to slower GDP growth over time. However, the good news is that as investors we are not constrained to our home economy, but have opportunities in foreign companies and global franchises based here that should continue to benefit from more rapidly growing labor forces around the world. Through much of 2012 the monthly Labor Department report on employment told a similar story. An average of 151,000 new jobs were created each month, a pace that was well below previous recoveries and also below the historical number needed to provide enough jobs to keep up with the expanding population. Yet month after month the unemployment rate fell, defying most observers’ expectations and intuition. Every month the story was the same. Enough people had dropped out of the labor force so that the percentage unemployed of those working and actively looking for work declined. Labor force participation measures the percentage of people 16 or older who consider themselves working or looking for work. Everyone else is considered “voluntarily” out of the labor force. The path of this percentage since World War II is shown below.
Labor Force Participation 1948-2012
70% 68% 66% 64% 62% 60% 58% 56% 54% 52% 50%
Source: U.S. Bureau of Labor Statistics
The labor force participation rate today is as low as it has been in 30 years standing at 63.6%. It has been falling for over a decade, but the drop of more than 3% since the recession began in 2007 has been particularly steep. What is causing the labor force to shrink? There is no simple answer. To understand the decline, one must first appreciate why the rate was rising after World War II. The second chart shows without question that the increase was entirely due to the evolutionary role of women in the market labor force. While female labor force participation was almost doubling in the 50 years after 1948, male labor force participation was steadily declining.
Male and Female Labor Force Participation 1948-2012
40% 30% 20%
Source: U.S. Bureau of Labor Statistics The major factors driving labor force participation in the 50 years after 1948 were: Women having more market work force opportunities and responding to them (+). An increasing number of older men reaching retirement age (-). A rapidly expanding college population, first of men and then of both sexes. This meant that many simply deferred entry into the labor force (-). Expanding real incomes, allowing people to retire earlier (-). Expanding social safety net programs, allowing some in the population to voluntarily leave the work force (-). The dramatic increase in female labor force participation in the first 35 years of the history was large enough to offset the other forces, and by 1968 began to push total participation higher. By the mid-1990s, however, female labor force participation had peaked and all the forces were working in the same downward direction. Notice that what is not on this list, or evident in the charts, is the important impact of the many recessions the country went through over this 64 year period. The business cycle matters at the margin, but it takes fairly sophisticated statistical analysis to estimate by how much. Such a study was recently performed by Willem 1 Van Zandweghe of the Kansas City Federal Reserve Bank. His conclusion was that half of the dramatic decline in labor force participation since the financial crisis in 2008 was due to the recession and the other half could be attributed to demographic forces that would have been in place anyway.
Willem Van Zandweghe, “Interpreting the Recent Decline in Labor Force Participation,” Federal Reserve Bank of Kansas City Economic Review, First Quarter 2012.
The interaction of demographic trends and labor force participation is further demonstrated in the last chart showing how participation rates have varied through time by age of the worker. The focus of this chart is on male workers to avoid the additional factor of child bearing age for women.
Male Labor Force Participation by Age
(1948 - 2012)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 16 to 24 years 25 to 54 years 55 to 64 years 65 to 69 years 70 to 74 years 75 years and over
Source: U.S. Bureau of Labor Statistics The data is not complete for all age groups because the Bureau of Labor Statistics apparently did not find traditional retirement age workers interesting enough to focus on separately until 1978. But there are a number of observations worth noting in this data: Not surprisingly, peak labor force participation occurs between 25 and 54 years of age, and the trend for this group has been steadily downward for over 60 years. The most dramatic declines in labor force participation are in the 16-24 year group because of increased attendance in higher education and in the 55-64 year group, likely because of increased standards of living and increased social safety net programs allowing for early “retirement.” Labor force participation drops meaningfully with traditional retirement at 65 and declines further with age as shown by the differences in participation for the 55-64, 65-69, 70-74 and above 75 age groups. Over the last 20 years, however, all of these older groups’ participation rates are trending higher, suggesting that better health and greater longevity are encouraging more “senior” workers to stay in the labor force. There is no suggestion in the chart that these trends are greatly affected by the business cycle. This chart shows how complicated a mosaic these labor force participation figures really are. We hear anecdotes about people continuing to work because they cannot afford to retire after the recession and market turmoil. While there are no doubt many such stories, the more common scenario is the productive, healthy worker who asks why he should quit when he expects another twenty or more years of life. As more and more baby boomers retire, labor force participation can be expected to continue downward, but perhaps at a somewhat slower rate as more seniors stay active in the work place.
Beneath these broad trends lie a number of other factors that are important in determining what labor force participation rates are likely to do in the future and what they mean to the economy: Hundreds of thousands of workers have become “discouraged” by their inability to find jobs and have exhausted unemployment benefits. These people could return to the labor force, but the longer they are out of the pool the more difficult it becomes to rejoin. Labor force participation rates of people 16-24 fell more dramatically than other age groups after the 2008 financial crisis. There has been a dramatic increase in Social Security Administration disability claims that began well before the last recession, but accelerated after it. This appears to be contrary to the general trend of healthier Americans who are living longer. All of these factors suggest that even as the economy recovers, labor force participation rates might continue to drift down. If the only objective were to cut the unemployment rate, this would be a good thing. There are, however, several negatives that should concern everyone: People who are out of the labor force involuntarily often times fail to develop important human capital that can serve them in the future. This is particularly true for the 16-24 year-old cohort group who run the risk of becoming a “lost generation” of workers, perpetually behind where they should have been in terms of living standards were it not for the recession. The increasing reliance on disability payments and other forms of the social safety net will likely expand federal and state expenditures well beyond the projections already being debated in the discussions of public finance and debt. New jobs alone are not enough. Low quality jobs that do not build human capital will retard meaningful improvements in the standard of living for many millions of Americans. We should care about this discussion as citizens since it will shape the economic well being of the country for years to come. As investors it is vital to us as well. The two most important determinants of economic growth are technological change and the expansion of the labor force. Developing economies can sometimes enjoy quantum leaps in productivity as they adopt the latest technologies from abroad. Advanced economies like the United States, Japan and Western Europe are already technology leaders in most areas and are therefore likely to experience more gradual gains. History says that for us to enjoy serious growth in GDP, the labor force must also continue to expand. The United States has been blessed historically by immigration and slightly higher birth rates than Europe and Japan, which has allowed us to achieve the most rapid rate of growth among developed countries. But this does not have to continue. Population growth in the U.S. has slowed. There are serious restrictions on immigration today that appear to be limiting the ability of highly trained foreigners to come to this country. If labor force participation continues its rapid decline for any of the above reasons one of the primary drivers for economic progress will be waning. Looking only at the economic headline statistics like the unemployment rate can be deceiving. While the number seems to be indicating progress, the story at the core is weak. For stock markets and other investments to show long-term opportunities, there must be solid growth. The link between GDP and equity market returns is too complicated to be discussed in this Commentary, but we shall revisit the topic in the future. The best news in this story for investors is that top global franchises are not limited by GDP growth in their home countries. But it would be better for all if domestic GDP was vigorously expanding and all companies could benefit. ____________________________________________________
This document is intended for informational purposes only and contains the opinions of Offit Capital. Nothing herein constitutes an offer to sell, or solicitation of an offer to purchase, any securities, nor does it constitute an endorsement with respect to any investment area or vehicle. This presentation is subject to revision, modification and updating. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. This presentation is confidential, and is intended only for the person to whom it has been delivered. Under no circumstance may a copy be shown, copied, transmitted, or otherwise given to any person other than the authorized recipient (unless required by applicable law). © 2013 Offit Capital
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