The Big Idea

A plateau in labor force participation

Stephen Stanley | January 26, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Last year was an interesting one in the labor market. Payroll job growth slowed but remained far stronger than generally expected entering the year. The unemployment rate, derived from the separate household survey, bottomed out early in the year at 3.4% and rose modestly to finish at 3.7%. The main reason for the backup in the jobless rate last year was a stretch of unusually sharp labor force growth. A look at the detailed numbers suggests that labor force participation may be close to its highest sustainable levels, which means that we should not depend on this factor continuing in 2024.

Broad trends

Once a year in January, the Bureau of Labor Statistics makes an adjustment to the levels of population, labor force and employment to true up their working-age population figures with the latest Census Bureau population estimates. Unlike most benchmark revisions, BLS does not bother to adjust prior data. That leaves a discontinuity every January in the levels of key parameters in the household survey data. The ratios, like the unemployment rate and the labor force participation rate are usually not affected much, however, as each aggregate is often simply scaled up or down by a similar amount.

In any case, the point is that any comparison of these data needs to start with the January levels as a base. From January through December 2023, the working-age population rose by 0.8%, the labor force expanded by 1.0%, and the household survey gauge of employment increased by 0.6%. The differences yielded a one tenth of a percentage point advance in the labor force participation rate, a one tenth of a percentage point decline in the employment-to-population ratio, and a three tenths rise in the unemployment rate.

Adjusting for demographics

The marginal advance in the labor force participation rate over the course of 2023 is more impressive than it appears at first glance. As the population ages, an increasing proportion of the working age population is in their retirement years. The working age population is defined by the BLS as 16 and over, so there is no age cap. In fact, the demographic trend exerts a downward impetus of roughly three tenths of a percentage point a year on the aggregate labor force participation rate (LFPR). Comparing the overall realized LFPR to a calculated rate that holds the age composition of the labor force constant highlights the decline as a rising proportion of the population ages into categories with lower labor force participation (Exhibit 1).

Exhibit 1: Labor force participation: actual and age-constant

Source: BLS, Santander US Capital Markets calculations.

The age-constant LFPR had ascended to close to an all-time high late last year before falling back in December.

Diving deeper

A less precise but simpler way to control for shifting demographics is to focus on the “prime-age” LFPR, which covers ages 25 to 54. This measure recovered from the depths of the pandemic and by early 2023 had substantially exceeded pre-Covid levels (Exhibit 2). In fact, the readings in mid-2023 were the highest since 2002.

Exhibit 2: Labor force participation ages 25-54

Source: BLS.

Over the past few months, the prime-age LFPR has pulled back a bit, but it was still up by four tenths in December from the January 2023 level and remained higher than the pre-pandemic highs. My view is that prime-age labor force participation is pretty much tapped out. Perhaps we could see a small increase in 2024, possibly returning to near the peak 2023 levels, but it is hard to envision the gauge breaking out to levels not seen so far this century.

That leaves the wings of the population, young workers and older ones. For ages 16 to 24, labor force participation trended down for a very long time, presumably reflecting a rising proportion of high school graduates going to college rather than getting a job, and then leveled off about a decade ago (Exhibit 3). More recently, the rate had returned to pre-pandemic levels by the end of 2022 and gyrated throughout 2023, diving in the spring and summer and then rebounding somewhat in the fall before dipping again in December.

Exhibit 3: Labor force participation ages 16-24

Source: BLS.

Unless long-term preferences toward college are changing, there is no particular reason to expect much more of an uptrend in the LFPR for young workers. We may get a few tenths of a rise, but it is hard to envision much more than that. It is also worth noting that this age group represents only about 15% of the working-age population, so it would take a big swing to move the needle for the overall LFPR. For example, a one percentage point increase in the LFPR of this young cohort would only lift the overall LFPR by 15 basis points.

Turning to the other extreme, the LFPR for the 55 and over age cohort. This group was most affected by the pandemic, as older, more vulnerable workers left the workforce to protect their health. By November 2023, the LFPR had returned almost all the way back to the pre-pandemic peak before dipping in December (Exhibit 4).

Exhibit 4: Labor force participation ages 55 and over

Source: BLS.

Panning out further, this group is impacted by the same aging trend that is affecting the overall LFPR figures. As the giant Baby Boomer cohorts aged in the 2000s and 2010s, the 55-64 group represented an increasing share of the working-age population until just a few years prior to the pandemic. However, it has now begun to decline noticeably, as a greater proportion of the Baby Boomers hit 65. A decade ago, the 55 to 64 group and the 65 and over group were similar in size. Now, the size of the 65 and over bracket is 1.5 times that of the 55 to 64 group. And even within the 65 and over classification, the average age is and will continue to rise, as lifespans extend and more Baby Boomers move into their 70s and 80s. While it would not be shocking to see the 55 and over LFPR add a few tenths of a percentage point in the short term, it seems almost certain that it will be falling over a long time horizon, as more Americans reach retirement age.

Conclusion

If the labor force participation rate in 2023 had been steady instead of rising modestly, assuming that the household measure of employment did not change, the unemployment rate would have ended the year nearly 20 basis points lower than the actual 3.74% reading. Put differently, nearly two-thirds of the rise in the jobless rate from its 2023 low to the December level was accounted for by the expansion in the labor supply.

If the labor force participation rate had fallen in line with the long-term demographic downtrend, then the unemployment rate would have slid into the low 3%’s, perhaps even challenging 3% for the first time in 70 years.

If we cannot count on a repeat performance from the LFPR in 2024, then it will be tougher for the unemployment rate to back up further unless or until the economy and the labor market weaken more dramatically. This is one reason, along with an expectation that net hiring will remain solid in the near term, that I see the unemployment rate holding in the 3.5% to 4% range that has prevailed for two years until at least mid-2024.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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