The March non-farm payroll report left investors disappointed by the low level of job creation. Yet the number in the report that may prove the most relevant over the long term was largely ignored — the proportion of the US population currently in the labor force, a number now at 63.8% and close to a thirty-year low.
Over the long term, a country’s economic growth is determined by the rate of increase in the labor force and productivity growth. If fewer people are working, unless there is a surge in new workers or everyone suddenly become more productive, growth slows. This is exactly what has happened over the past dozen or so years in the United States. And to the extent that an aging population continues to retire, lower labor force participation may be an even bigger drag on growth in the future.
Since the onset of the recession in 2008, labor force participation in the United States has dropped by more than 2 percentage points. As the chart below shows, looking further back, since peaking in the late 1990s, the percentage of workers has dropped by 3.4 percentage points, meaning millions of individuals are no longer engaging in regular work.
The decline in the participation rate has coincided with the longer-term deceleration in US growth. Back in the late 1990s, when the participation rate was at its peak, the economy was growing more than twice as fast as recent levels. Between 1996 and 2000, real US gross domestic product growth averaged 4.3%. Since then, GDP growth has averaged a relatively limp 1.6%, with growth never topping 3.5% for any given year. While there are a number of factors that help explain the declining growth rate – including slower productivity growth, slower population growth and the aftermath of the financial crisis – fewer people working is arguably contributing to the slowdown.
So what should investors expect going forward? Since the decline in the participation rate began well ahead of the financial crisis and has coincided with the general aging of the population, I believe the participation rate drop likely has more to do with demographics than with frustrated job seekers leaving the work force.
And with the graying of the US population set to accelerate, and more and more baby boomers set to retire, the downward trend in labor force participation is likely to continue. This suggests that US growth might be slower for a long time and that investors should have modest expectations for how fast the United States, and other developed markets also experiencing a similar demographic trend, can grow over the long term. It’s also an argument in favor of increasing allocation to select faster growing emerging markets.