Could There Be A Silver Lining To Declining Labor Force Participation?

by: Scott Krisiloff, CFA

When last Friday's jobs report came out, it was difficult not to notice that the unemployment rate dropped despite a weak payrolls number because of a decline in the labor force participation rate. The participation rate is now back at the same level it was at in the 1970s. This is widely viewed as a bad thing, and there are a variety of reasons that the conventional judgment is fair. However, a declining labor force participation rate could have some positive implications for the health of the labor market as well. That's because a lower participation rate also means incrementally tightening conditions benefiting suppliers of labor (workers), which could help drive prices (wages) higher.

Below is a regression analysis of the labor force participation rate against annualized real wage growth since the 1960s (both on a trailing five-year average basis). In confirmation of the theory, the data implies that there is some negative correlation between labor force participation rate and wage growth. In other words, when there are more people in the labor market (i.e., more competition) wages are pressured. As more people exit the market, the labor market may tighten, which would be a good thing for the employed American worker -- and also probably a good thing for those actively looking for work too, because higher wage growth may result.

Remember that the underlying components of an economy are land, labor, and capital. The "abundance" of labor represented by high unemployment has tipped the balance of the marketplace in favor of those who buy labor (i.e., capitalists). A tightening labor market might start to help tip the marketplace back in favor of labor. This has important implications for those purchasing securities because by buying shares of companies or their debt obligations, we are acting as capitalists by definition. Therefore, a tilt in favor of labor could be a tilt against capital, which might manifest itself in environments that are not as favorable for companies such as contracting margins and inflation. This paradigm can also be helpful in explaining why the economy feels so weak to many Americans and yet the stock market keeps rising. There is a fundamental tension between labor and capital in the economy (what a Marxist idea…).

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.