Labor Force Participation And The Skills Gap In America

Debate among economists around the drivers of declining labor force participation in the US has intensified. How much of the decline since the Great Recession is from the demographic effects of aging population and how much is due to disillusioned workers giving up on job searches and “dropping out” of the workforce? The answer is not obvious, since the participation rate has peaked around the year 2000 and had started declining years before the Great Recession.

First, a bit of background. The reason for the rise in labor force participation between the early 60’s and the end of the 20th century is mostly due women entering the workforce as well as Americans starting to work longer before retiring. This brought a larger portion of the population into the workforce, increasing the participation rate. But as the baby-boomers began to retire, the participation rate started to decline.

The answer to this question has significant implications for the Fed’s monetary policy trajectory because it is a major determinant of the amount of slack in US labor markets. Decisions on the timing of rate hikes will depend to a great extent on whether the labor market has become sufficiently tight to generate wage pressures. And if companies can draw on a large pool of workers who had left the labor force, it will be a while before wage growth begins to accelerate.

The best way to answer this question of demographic effects on the participation rate is to find a “control” country. It would need to be a nation that has a very similar demographic distribution to the US but had not been as severely impacted by the Great Recession. Scotiabank’s Derek Holt argues that Canada is indeed such a country. Canada’s so-called population pyramid is very similar to the US.
 

Source: Scotiabank

At the same time Canada’s experience with the Great Recession was not nearly as severe. Reasons include Canada’s commodity boom, far less aggressive mortgage lending, a better capitalized banking system, a milder housing boom, less fiscal tightening, etc. The labor force participation rates of the two nations have diverged dramatically after the Great Recession.