Wednesday, July 30, 2014

What's driving the decline in labor force participation?

One of the distinctive features of the U.S. economy's current expansion phase is that it has been the weakest recovery ever. As the graph above shows, the economy is operating significantly below its long-term growth trend; if this were a typical expansion, the economy would have recovered to its trend growth path long ago. In fact, it's only grown at a 2.1% annualized pace from mid-2009 through mid-2014. Not only is growth slow, but the economy likely has a lot of unused capacity; because of that, national income today is arguably about $1.7 trillion less than what it could or should be. 

The next most distinctive feature of the current recovery is the unprecedented decline in the labor force participation rate, shown in the graph above. Beginning in 2009, some 7 million people of working age have dropped out of the labor force or given up looking for a job. But why? One standard answer is demographics—the baby boomer generation is starting to retire. But demographics don't turn on a dime, they take many years to play out. In contrast, the current and ongoing decline in the labor force participation rate started rather suddenly in 2009. 

It may be a coincidence, but there was a significant change in fiscal policy that occurred around 2009 that might explain the decline in the labor force participation rate: a huge increase in government transfer payments. As shown in the first of the two graphs above, transfer payments (social security, medicare, medicaid, unemployment insurance, food stamps, disability insurance, veterans benefits, subsidies) rose from 17.2% of disposable income in September, 2008, to 20.1% of disposable income by September, 2009. In dollar terms, annual transfer payments rose by $300 billion, almost 16%, in just one year. Since then they have largely kept pace with the growth of personal income, and they are now significantly higher relative to disposable income than ever before. In my book, this ranks as a significant change on the margin that negatively affected people's willingness to work.

With the government paying people more than ever not to work, it should not be surprising to see fewer people willing to work. As the graphs above show, the labor force participation rate began to decline just after transfer payments rose to a new all-time high of 20% of disposable income. In the past decade, transfer payments relative to disposable income have increased by fully one-third, with most of that increase coming in 2008 and 2009. It's worth noting that the economy has not experienced robust growth for at least a decade.

With the government being generous to a fault, many folks apparently have found it easier than ever before to "drop out." 

One reason transfer payments reached unprecedented levels in 2009 was the Emergency Unemployment Claims program that Congress passed in 2008. Never before could people receive unemployment insurance benefits for so long—up to 99 weeks and even more. This program alone accounted for a $90 billion increase in transfer payment spending in the 12 months ended September, 2009. Spending peaked shortly thereafter, however, then declined by a $100 billion annual rate between early 2010 and  the end of last year, when the program expired. It's not contributing to transfer payments any more, but nevertheless they have remained historically very high. One out of every five dollars that consumers have available to spend is coming from the government, with no requirement to work.

Another reason that transfer payments rose is the increase in the number of people receiving social security disability insurance since the end of 2008. The growth in the number of recipients has declined in recent years, however, and has been relatively flat for at least a year or so. There are about 11 million recipients of this benefit, which totals almost $1000 per month on average, bringing the total annual spending to about $130 billion, or just over 5% of total transfer payments. Nothing significant changed with this program in 2008 or 2009, however, with growth in the post-recession years substantially the same as before. So it's not the culprit many think it is.

A 15% increase in the monthly food stamp benefits in 2009, plus a relaxation of the eligibility rules in April 2009, helped fuel a huge, 50% increase in the number of people receiving food stamps since the end of 2008. The average SNAP recipient gets about $125/mo., and the program is currently costing about $70 billion per year. That equates to about 2.8% of current transfer payments. In 2009, the increased spending on food stamps in 2009, relative to 2008, was about 40%, or about $20 billion per year. Not a big factor, but certainly a contributing factor.

Another big reason for increased transfer payments was the ARRA, over 75% of which consisted of an increase in transfer payments, much of which, in turn, came in the form of tax benefits, housing assistance, grants, and expanded entitlements that likely continue to exist.

One more thing: marginal income tax rates have increased in recent years, by a not-insignificant amount, especially due to the implementation of Obamacare, which imposes a 3.8% tax on earned income and another 3.8% tax on unearned income for those considered to be "rich." I know people in California who now face marginal tax rates as high as 74%. That is a powerful disincentive to work.

And as Milton Friedman taught us, "spending is taxation." Every dollar of transfer payments from the government is a dollar that comes from the private sector. More transfer payments drain more resources from the productive sector, and thus contribute to slow the growth of jobs and incomes.

I wish I could identify all the pieces of this smoking gun, but I am reasonably convinced that a significant increase in government transfer payments, combined with higher marginal tax rates, have created, on the margin, important disincentives to work, and that, in turn, is an important driver of the ongoing decline in the labor force participation rate.


PD Dennison said...

I think this explains a lot about the low work participation rate in the US.

It also matches the bigger picture of a US economy that is hindered by big government and a lack of growth policies.

The US continues to become Europe as Europe becomes Japan.

Benjamin Cohen said...

I agree with Scott Grannis on this one.

SSDI and VA "disability" rolls are booming. These people are getting paid to do nothing--except they put a burden on productive Americans.

There are about 12 million Americans getting "disability" payments either through SSDI (8 million) or VA (close to 4 million, and no, they are not injured in battle. That number is 200k at most).

These are welfare abusers of the worst sort.

People have an incentive to "game the system" and invent maladies that are very hard to disprove, such as bad back, bad knees, loss of hearing, PTSD, and so on.

There are enabling cottage industries, in doctors, lawyers and other coaches to help the "disabled" claim the largest benefits possible.

The number of people claiming "disability" dwarfs the regrettable number claiming unemployment.

PC-wise this is a toughie.

Vets are extremely well-organized, and vet service organizations (VSOs) are clued into congressional districts and states.

Carolina Senators should be called "the Senators from the VA."

Nancy Pelosi even told former Bush Secy Defense Gates that "on vets issues, we let the VSOs take the lead."

And the sheer number of SSDI recipients makes them a powerful, if poorly organized, voting group.

We just saw another explosion in the VA budget, in this last go-round about poor service.

Expect to see the VA eat up $2 trillion in next 10 years---and no end in sight.

There is one difference between SSDI and the VA: the VA is financed by corporate and personal income taxes and capital gains taxes, and so that levy falls on heavily on upper-income investors and job creators.

If you want cuts in income MTRs, you should also be examine cuts in VA outlays.

The SSDI is financed by payroll taxes.

IMHO, both SSDI and VA "disability" programs should be pared back by two-thirds.

randy said...

The increased safety net clearly plays a significant role as an enabler for people leaving the workforce. IMO, what's uncertain is whether there would have been sufficient work for marginal participants, even if they had been better incentivised. Productivity gains and technology has changed so much, and the Great Recession exposed a huge number of marginal workers that simply couldn't contribute anymore. That is a large part of the sudden drop, as companies could no longer afford to continue to carry them. Ross Douthat had a good article a while back, that really supports Scott's position mostly, but discusses more subtleties.

"But it’s also possible to argue that as a rich, post-scarcity society, we shouldn’t really care that much about whether the poor choose to work. The important thing is just making sure they have a decent standard of living, full stop, and if they choose Keynesian leisure over a low-paying job, that’s their business."

William McKibbin said...

I concur with Scott's analysis regarding labor participation -- I am an advocate of cutting government spending by not less than 40% immediately (balancing the budget) -- to that end, only uniformed personnel should remain on the government payrolls -- moreover, all military personnel currently deployed overseas should be returned to the US for homeland defense duties on US soil -- government spending is almost all lard -- savage cuts are required to get the US back on track -- and yes, get Americans back into the workforce -- for the record, I do not view the "work" of non-uniformed personnel employed by the government as productive -- in fact, I view non-uniformed government employees as total waste -- again, massive cuts are required in government spending to get the US working again while restoring the Main Street USA economy -- I regret that reorganizing the USA will probably be required to achieve these ends -- if necessary, government cuts should be enforced at gun point -- the president should be closing government buildings and sending everyone home immediately -- 90% of government jobs are waste.

William McKibbin said...

PS: I also believe that Americans should have the guaranteed right and duty to work their entire lives, or until such time as they are fully disabled or able to retire via personal savings -- this would eliminate Social Security and Medicare costs for all but Americans who are fully disabled -- my definition of fully disabled is missing two or more limbs, eyes, or hearing (any combination) -- everyone else would remain in the workforce until they died or became disabled -- we need to keep non-disabled Americans in the workforce their entire lives or until such time as they are disabled or can afford retirement based on personal savings.

William McKibbin said...

PPS: I also believe that personal taxation should be outlawed -- governments need to find some other way of raising money, or simply go away forever -- my idea of less government is very similar to essentially no government at all...

William said...

St Louis Federal Reserve Bank

Velocity of M2 Money Stock


Still declining but at a slower rate in 2nd Quarter 2014. said...

Today's Investor's Business Daily article on same topic--slow growth and weak job market.

Despite Strong Quarter, U.S. Remains in Growth Rut

Unknown said...

"But demographics don't turn on a dime, they take many years to play out."

Actually, they *can* turn on a dime. If you look at a chart of the # of births per year, you'll see that, right after WWII, the # of births shot up dramatically. Look what happened in 1946-47. Those people turned 65 started in 2011. So, as suddenly as those people were born in 1946-47, those people are turning 65 in 2011-12. Probably some retired early when the recession hit as they lost their jobs.

BTW, regarding the long-term GDP growth trajectory, Walter Kurtz has a counter-argument here.

Michaelcl Clarke said...
This comment has been removed by the author.