By Alex Brazier and Filip Nikolic | A key factor driving up prices in the U.S.? There aren’t enough workers to comfortably maintain the current level of production. As we’ve said before, that’s not because companies are producing an unusually high amount. It’s because production constraints – like the worker shortage – are making it difficult for the economy to operate at the current level of activity.
Unless the worker shortage can be solved, getting inflation down means reducing economic activity to a level that can be more comfortably sustained. In other words, a recession. The problem is: much of the shortage can’t be solved. And where it can be solved it will take time. It’s also not the only production constraint driving up inflation – but it’s a big one, which is why we’ll focus on that here.
All eyes on the participation rate
U.S. unemployment is at a 50-year low. Yet the share of the population that’s in work is still well below where it was when the pandemic began. How come? Because there’s an unusually large number of people who aren’t working and don’t count as unemployed. They’re “outside the labor force”: think students, stay-at-home parents, retirees.
This is reflected in the participation rate – the share of the adult population (16 and over) inside the labor force. That rate fell dramatically in the pandemic as the economy shut down. And many of those who left the workforce then haven’t come back. See the A workforce not recovered chart.
We don’t expect the participation rate to recover much from here. Here’s why…
Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, October 2022. Notes: The chart shows the U.S. labor force participation rate, defined as the share of the adult population (aged 16 and over) that is in work or actively looking for work.
An ageing population
The population has been ageing. As the Growing older chart below shows, the adult population is steadily rising, but an increasing share of it is now over 64: the point at which many people typically leave the labor force by retiring.[i]
That means a bigger share of the adult population is not in the labor force – which explains the downward trend in the overall participation rate since 2010. It also accounts for most of the 1.1 percentage point drop in the participation rate since the pandemic started: we estimate almost 70% of it. See the green line on the Almost all down to ageing chart below.
With the share of the population aged 65+ set to keep rising, we believe the overall participation rate will continue its long-run downward trend from here: other things equal, we expect it to fall on average by around 0.2 percentage points each year.[ii]
Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, Census Bureau, Haver, October 2022. Notes: The chart shows the actual and forecasted growth of the working-age population (ages 16-64) and of the entire adult population (ages 16+).
Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, October 2022. Notes: The orange line shows the U.S. labor force participation rate, defined as the share of the adult population (aged 16 and over) that is in work or actively looking for work. The green line shows how much the ageing population has contributed to the decline in the participation rate since 2008. It is calculated by fixing participation rates for each group and changing the weights as observed in the population data over the chart sample period.
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Covid has made matters worse
The ageing of the population doesn’t quite explain all of the fall in the participation rate since the pandemic started, though. The pandemic has left its mark, too. Some of those aged over 64 do participate in the labor market. But the pandemic has reduced the share that do – taking 630,000 workers out of the labor force.[iii] See the yellow line on the Fewer older workers than usual chart. Why? A forced break from work in the pandemic has likely pushed many into retirement earlier than might have otherwise been case. We think those earlier retirements account for around 20%[iv] of the fall in the overall participation rate since the pandemic started.
Is there any scope for the over 64s’ participation rate to get back to its pre-Covid level? It’s unlikely many will come back out of retirement. More likely, the share of over 64s staying in work will only go back to what it was pre-Covid as the current 55-64s age into that group over the coming decade.
What about the remaining 10% of the fall in the participation rate? That’s explained by the fact that the participation rate of the 16-64s is still a touch below its pre-pandemic level – see the orange line on the chart below. In contrast to the majority of the decline in the overall participation rate, this part could come back as the economy normalizes after the pandemic – but it’s just a very small share of it.
Put all this together and we don’t see much hope of a rapidly expanding labor force in coming months – the economy will need to get used to having fewer people in the labor force relative to the size of the adult population.
That’s one reason why the U.S. economy faces either continued shortages and price pressures, or the Federal Reserve crushing demand down to what a constrained workforce can comfortably produce. Not an easy choice and the crux of why, in our view, the Fed finds itself caught between a rock and a hard place right now.
Sources: BlackRock Investment Institute, U.S. Bureau of Labor Statistics, October 2022. Notes: The chart shows the participation rate for those aged 16-64 on the left, and the participation rate for those aged 65 and over on the right.
Where does that leave U.S. economic growth in the longer term?
Not only is the worker shortage key to understand current high inflation and the difficult choice facing the Fed, it will also be central to the future evolution of the U.S. economy.
Slowing population growth, coupled with an ageing population, will mean the available workforce expands much more slowly in the coming 20 years than it did in the past 20. If the productivity of each worker continues to increase at the same rate, annual GDP growth could average around 1.8% in future, compared to 2.6% in the past.[v] See the Worker shortage = slower growth chart. That’s significant: the U.S. economy has never grown that slowly over a 20-year period since data began in 1920.
This isn’t a problem unique to the U.S. In fact, populations are ageing even more rapidly elsewhere – like China, which may also be less able to compensate that ageing with an inflow of working-age migrants or greater productivity: one reason why we think China is entering a slower growth phase.
Sources: BlackRock Investment Institute, U.S. Bureau of Eonomic Analysis, Bureau of Labor Statistics, Census Bureau, October 2022. Notes: The chart shows the actual and forecasted employment and GDP growth.
[i] The working-age population (which we define as 16-64) typically has a participation rate of around 74%, those aged 65 and over have a participation rate of just 20%. In 2010, 16.3% of the adult population was over 64. That rose to 20.6% in 2019, and has risen further in the past two years to 21.6%.
[ii] This is the average annual impact of ageing over the next ten years, based on Census Bureau population projections shown on the Growing older chart. After that period, as dependency ratio growth slows down, the impact of demographics becomes smaller.
[iii] Right before Covid hit, the share of over 64s that were still working, or actively looking for work, was 20.5%. Now, it’s just 19.4%.
[iv] Based on the decline in the 65+ participation rate in the post-Covid period relative to the decline in the overall participation rate.
[v] In the 40 years prior to the pandemic, employment grew by 1.2%. With each employee also becoming 1.4% more productive on average each year, the U.S. economy grew by about 2.6% per year. Slowing population growth overall, coupled with the ageing population, means the workforce is likely to grow by only 0.4% in the coming two decades. Assuming productivity continues to increase at around the same pace, annual GDP growth over the next 20 years would be perhaps just 1.8%.
