The Shrinking Labor Force - More Important Than 7.8% Unemployment

by: Howard Richman

Many economists have been confused by the seeming disconnect between the jobs numbers and the unemployment rate in recent reports by the Bureau of Labor Statistics (BLS). But there is a simple explanation. People are leaving the labor force in droves. Although the "sexy" figure in Friday's unemployment report was a decline in the unemployment rate from 8.1% to 7.8%, the more significant number was the decline in the labor force by an enormous 211,000.

But the 211,000 decline in September was paltry compared to the 1,777,000 people who left the labor force in January, according to BLS statistics. At that time, former Reagan budget director David Stockman suggested that we might be experiencing "The Economists' Truman Show." (To find this December-to-January adjustment in the January BLS press release, check out Table C.)

Some observers have even thought that the BLS might be classifying unemployed workers as "out of the labor force," in order to reduce the unemployment rate. After all, if an unemployed person has not looked for work within the last four weeks, he is no longer part of the labor force, and thus no longer classified as unemployed.

Conservative radio show host Rush Limbaugh incorrectly predicted, months ago, that the Obama administration would produce a 7.9% unemployment rate in time to influence the election. He was wrong: they produced a 7.8% rate.

I ran some simple linear regressions and found that it no longer takes 195,000 jobs (i.e., non-farm payroll employment) per month to keep the unemployment rate from rising - the rule of thumb that most economists have been using, based upon the data from 1948 to the present. For the last 10 years, it has just taken 43,000 jobs because potential workers are not being attracted into the labor force like they once were.

The two recessions of the 21st century have caused the demand for U.S. labor to decline, as we have lost manufacturing jobs to our mercantilist trading partners (i.e., the countries that maximize exports and keep out imports in order to steal their trading partners' industries). The U.S. has lost 1,781,000 manufacturing jobs since the last recession began in January 2008; 610,000 of them since Obama took office.

As the graph illustrates, a decline in the demand for labor from "Demand for Labor 1" to "Demand for Labor 2" causes the number of employed workers to decline from point "a" to point "b", with resulting unemployment equal to q1 minus q2. Then, over the months after the recession, wages gradually drop to point "c" at which point all of the workers who are willing to work for the wage w2 find jobs, and those who are not willing to work for that wage, exit the labor force. At wage w2, unemployment returns to its natural rate.

Unfortunately, the scariest statistic in the BLS report was the second straight month of manufacturing decline after a hiatus during which a few of the jobs lost during the last recession were recovered. We could be about to experience another worldwide recession, which could lead to another massive hemorrhaging of U.S. manufacturing jobs and another repetition of the chart above.

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.