September 7, 2013

THERE WASN’T much good news in Friday’s monthly labor market report from the U.S. government. Even what seems encouraging — a continuation in August of the slow downward trend in the unemployment rate, to 7.3 percent — actually gets worrying on close inspection. This superficially positive figure reflects the fact that the number of people 16 years old or older seeking work fell by 312,000, while the nation’s employers only hired 169,000 full- or part-time workers. That means only 63.2 percent of the working age population is considered to be in the labor force, the lowest percentage in 35 years.

The shrinkage of the U.S. labor force reflects the U.S. economy’s current weakness — and threatens to perpetuate it. A waning labor force may decrease the country’s potential for growth over the long term; it raises the ratio of dependents (children, retirees) to active producers.

Declining labor force participation is often attributed to an increase in “discouraged workers,” those so frustrated by the lack of jobs that they quit hunting for one altogether. But a May 2013 report by David Kelly and Brandon D. Odenath of JP Morgan Asset Management argues that, “discouraged workers” are a tiny and, since unemployment peaked at 10 percent in October 2009, a declining share of the population.

More important are long-term demographics. The post-1960 surge of women into the labor force, which drove the participation rate to a peak of 67.3 percent in 2000, has crested. Meanwhile, the population is getting older, and thus more susceptible to early retirement, disability and other changes that lead to labor-force exit. According to Kelly and Odenath, there would be 4.2 million more people in the labor force if we still had the participation rate of October 2009 — and aging explains 57 percent of this “missing” cohort.

Government can’t do much about demography (though sensible immigration policy would help). But it could do more to encourage work — beyond the obvious need for sound, pro-growth fiscal and monetary policies. Two areas cry out for reform. Social Security Disability Insurance (SSDI) is a necessary safety net for most of its recipients; but because of a combination of financial benefits and malleable eligiblity standards, it creates a perverse incentive to quit work for some. About 11 percent of labor force shortfall since October 2009 is due to workers going on SSDI, Kelly and Odenath argue.

The current system of disability determinations effectively requires workers to give up looking for work — sometimes for many months — even to be eligible for benefits. Meanwhile, rules and regulations discourage those who do qualify from trying to find suitable work thereafter.

Also in need of reform is the Earned Income Tax Credit, (EITC) a wage supplement for low-wage workers, which has proven to be one of the most effective policy tools yet devised for encouraging work and eliminating poverty. Eligibility for the program is currently focused — appropriately enough — on working parents with children. Single, childless workers can get a maximum of $487 per year, in contrast to more than $3,000 for a single parent of one child. An expanded EITC for single, childless workers would incentivize more of them to look for jobs.

The main cause of joblessness is the slow recovery from an epic recession. But there is a danger that cyclical unemployment will, over time, become structural. Policy-makers need to use all the tools at their disposal to prevent that.