Although conditions in the labor market have improved notably in recent quarters, a significant amount of slack remains, in CBO’s estimation. As discussed in a blog post last week and in our updated budget and economic outlook, CBO anticipates that economic growth will pick up in the next few years. That faster growth will reduce the amount of slack in the economy. Similarly, in CBO’s judgment, ongoing gains in employment will largely eliminate the existing slack in the labor market during the next few years.
Broadly speaking, slack in the economy refers to underutilized productive resources, including business equipment and structures that are idle, houses that are unoccupied, and people who would like to work but are not working (or who are employed but would like to work longer hours). In CBO’s view, the current slack in the labor market consists of several elements, including the following:
- The labor force participation rate is well below what CBO estimates would be achieved if the demand for workers was currently stronger—that is, well below the potential participation rate that reflects the estimated effects both of demographics (such as the age distribution of the population) and of the number of people who have left the labor force permanently in response to the recession and slow recovery;
- The unemployment rate is above CBO’s estimate of the natural rate (that is, CBO’s estimate of the unemployment rate arising from all sources except fluctuations in aggregate demand);
- In combination, the shortfall in labor force participation and the elevated unemployment rate have resulted in substantially lower employment in 2014 than would otherwise be the case; and
- The share of part-time workers who would prefer full-time work is significantly higher than it was before the recession, and the rate of long-term unemployment is still about a percentage point above its average rate during the years before the recent recession.
One important signal that
significant slack remains in the labor market is continued slow growth in
hourly labor compensation. But measuring slack is quite difficult—especially
given the unusual developments in the labor market since the recession
ended—and the current amount of slack could be a good deal larger or smaller
than CBO estimates.
Labor
Force Participation Rate
The labor force participation
rate fell from 65.9 percent in the fourth quarter of 2007, at the beginning of
the recent recession, to 62.8 percent in the second quarter of 2014.
CBO estimates that about ¾
percentage point of the decline since late 2007 represents the extent to which
actual participation is below potential participation because of the
contemporaneous weakness in both employment prospects and in wages. That amount
is only slightly less than the effect CBO estimates for the fourth quarter of 2013,
when the estimated shortfall of the actual participation rate relative to the
potential participation rate was at its largest.
According to CBO’s analysis,
most of the decline in the rate of labor force participation since late 2007 is
attributable to two other factors: First, long-term trends, especially the
aging of the population, account for about 1½ percentage points of the decline.
Second, unusual aspects of the slow recovery of the labor market that led
workers to become discouraged and permanently drop out of the labor force
account for about ¾ percentage point of the decline.
Unemployment
Rate
The unemployment rate stood
at 6.2 percent in the second quarter of this year, roughly 1¼ percentage points
above its level before the recession (see the figure below).
CBO estimates that about ½
percentage point of that increase reflects temporary cyclical weakness in the
economy—much less than the peak effect of temporary weakness, estimated to be
about 4¼ percentage points in late 2009. In CBO’s view, the remaining ¾
percentage point of the increase from the unemployment rate before the
recession stems primarily from two structural factors that have boosted the
natural rate of unemployment to about 5¾ percent currently:
- The stigma and erosion of skills that can stem from long-term unemployment (wherein a person has been jobless for more than 26 consecutive weeks) account for about ½ percentage point of the increase; and
- A decrease in the efficiency with which employers are filling vacancies (probably at least in part as a result of mismatches in skills and locations) accounts for about ¼ percentage point of the increase.
Employment
Shortfall
In the second quarter of this
year, if the unemployment rate had returned to its prerecession level and if
the labor force participation rate equaled its potential rate, about 3¾ million
more people would have been employed, according to CBO’s estimates. The
elevated unemployment rate and the depressed labor force participation rate
account for that shortfall in roughly equal proportions. By comparison, the
shortfall in employment represented about 5¼ million people in the fourth quarter
of last year by CBO’s estimates, reflecting a higher unemployment rate and a
slightly more negative effect of the cyclical economic weakness on labor force
participation. At its peak in 2009, that shortfall was 8½ million people, CBO
estimates.
Those estimates of the
shortfall in employment do not reflect the number of people who have left the
labor force permanently in response to the recession and slow recovery.
However, the estimates do include unemployed workers who would have difficulty
finding jobs even if overall demand for workers was higher. Alternative
measures of the shortfall in employment that treated those or other groups of
people differently might be appropriate for some purposes.
Other
Indicators of Labor Market Slack
Another manifestation of
slack in the labor market is the number of people who are employed but are not
working as many hours as they would prefer. The incidence of part-time
employment for economic reasons (resulting from slack work or business
conditions or a worker’s inability to find full-time employment) remains much
higher than it was before the recession (see the figure below). Consequently,
the Bureau of Labor Statistics’ U-6 measure of underutilization in the labor
market stood at 12.2 percent in the second quarter, down from a peak of 17.1
percent in fourth quarter of 2009 but still well above its value of 8.5 percent
in the fourth quarter of 2007. (The U-6 measure combines the number of
unemployed people with numbers for two other groups of people: those who are
“marginally attached” to the labor force—that is, who are not currently looking
for work but are willing and able to work and who have looked for work in the
past 12 months—and those who are employed part-time for economic reasons.)
Consistent with the trends in the U-6 measure, average hours worked per worker
fell substantially during the recession and remain below their prerecession
level.
Although the rate of short-term unemployment (the number of
people unemployed for 26 weeks or less as a percentage of the labor force) in
the second quarter of 2014 was close to its average rate between 2001 and 2007,
the rate of long-term unemployment was still about a percentage point above its
average rate during that earlier period (see the figure below). The fact that
the elevated amount of unemployment is concentrated among the long-term
unemployed has accentuated concerns that stigma and an erosion of skills may be
hindering their efforts to secure stable work. Although CBO estimates that
those factors have raised the natural rate of unemployment, the agency
nonetheless expects that many of the long-term unemployed who are not near
retirement age will be employed again. CBO’s view reflects recent research that
the long-term unemployed are in many ways similar to people who have been
unemployed for a shorter time. Moreover, the rate at which the long-term
unemployed find jobs, while still quite low, appears to have picked up in
recent months.
Finally, labor compensation (the combination of wages,
salaries, and benefits paid to workers) has grown slowly, another indication
that a significant amount of slack remains in the labor market.
Difficulties in
Measuring Labor Market Slack
Considerable difficulties arise in measuring slack in the
labor market, especially under current circumstances. For example, in
estimating potential labor force participation, CBO has estimated how many
people permanently dropped out of the labor force because of such factors as
long-term unemployment. However, CBO may have underestimated or overestimated
that number, and therefore potential labor force participation could be higher
or lower than the agency thinks. Similarly, CBO’s estimate of the increase in
the natural rate of unemployment relative to what it was before the recession
incorporates the agency’s estimate of the decrease in the efficiency with which
employers are filling vacancies. That effect has diminished gradually, in CBO’s
judgment, as the causes of that dampened efficiency have receded and as workers
have acquired new skills, shifted to faster growing industries and occupations,
or relocated to take advantage of new opportunities. If such adjustments in the
labor market have occurred faster or slower than CBO has estimated, the natural
rate of unemployment would currently be lower or higher, respectively, than CBO
has estimated. A lower natural rate would suggest less upward pressure on wages
for any given unemployment rate, and a higher natural rate would suggest more
upward pressure.
Source: Congressional
Budget Office
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