Sunday, May 20, 2012

Consequences of a shrinking labor force

WSJ's David Wessel devoted his column last week to why the labor force is shrinking and what this means for the recovery.  The labor force participation rate for men has been trending downward for some time, as a result of youth staying in school longer (and being less likely to take part-time jobs) and older men retiring earlier.  The rate for women had been steadily climbing from 1950 to 2000, but has since leveled off.  It has taken a big drop since the Great Recession.

The big question is what will happen once the unemployment rate starts coming down significantly.  Will workers return to the labor force once opportunities improve?  If so, then we must accept the likelihood that the current 8.1 percent number vastly understates the true degree of excess supply in the labor market.  On the other hand, what if the labor force participation rate does not recover?  In this case the upside of any recovery will be compromised by labor shortages and tax revenues will be permanently reduced, exacerbating government budget deficits even more. 

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