On 6 November, the Bureau of Labor Statistics released its latest job report with an unemployment rate at 5% for October. This jobless rate is already considerably lower than its historical average (5.8% between 1948 - 2015), being even back to its ‘long-run’ level according to the Congressional Budget Office’s estimate, and yet the decline in unemployment shows no sign of slowing down (see Figure 1).
Figure 1. Unemployment rate and Congressional Budget Office estimate of the natural rate of unemployment.
While some forecasters see the unemployment rate stabilising at about 5% (Federal Reserve Bank of Philadelphia 2015), other forecasting models see the unemployment rate prolonging its steady decline – reaching 4% by mid-2016 (Brookings 2015).
So, does unemployment still have a long way to fall? How far off is the 40-year low of 3.8% reached in April 2000?
In a recent paper (Barnichon and Figura 2015), we argue that the record low of 3.8% was not only due to the booming labour market of the late 1990s, but also to a secular decline in desire to work among non-participants (individuals outside the labour force). Without the decline in desire to work, unemployment would have been closer to 4.3%. And today, desire to work is close to its April 2000 level, placing substantial downward pressure on the unemployment rate. While the unemployment rate remains elevated relative to April 2000, this is because some areas of the labour market, in particular the job-finding rate, has yet to fully recover from the 2008-2009 recession. But as recovery in the labour market continues, we think that the unemployment rate has substantial room to fall below 5%.
To measure desire to work among non-employed individuals, we exploit a question asked consistently by the Bureau of Labor Statistics’ Current Population Survey since 1967: "Do you currently want a job now, either full or part-time?". This question allows us to construct a measure of non-employed individuals' desire to work over 1967-2015, plotted in Figure 2. The share of nonparticipants who want to work has been declining secularly over the past 30 years, with a particularly strong decline during the second half of the 1990s. Importantly, as of September 2015, the share of ‘want a job’ non-participants is close to its 2000 level.
Figure 2. Fraction of non-participants who report ‘wanting a job’ (4-quarter moving average)
A low share of non-participants who want a job has important consequences for the aggregate unemployment rate, because people who want a job behave differently from people who do not want a job. Using matched Current Population Survey microdata to measure worker transitions between labour market states, we find that a non-participant who wants a job enters the labour force (i) often and (ii) mostly through unemployment, while a non-participant who does not want a job enters the labour force (i) rarely and (ii) mostly through employment. Because of this difference in behaviour, a decline in the fraction of ‘want a job’ non-participants lowers the unemployment rate. We develop a stock-flow accounting framework to quantify this effect, and we find that the decline in non-participants' desire to work since the mid-1990s lowered the unemployment rate by about 0.5 percentage points (see Figure 3, middle panel). This is a large effect – in comparison, the widely studied ageing of the baby boom generation lowered unemployment by 0.7 percentage points since the early 1980s (see Figure 3, top panel).1 Interestingly, taken together, demographics and desire to work among non-participants (see Figure 3, bottom panel) appear to account for most of the low-frequency movements in unemployment, as captured by the Congressional Budget Office estimate of the natural rate.
Figure 3. Effects of composition changes on the aggregate unemployment rate
Notes: Upper panel – effect of population ageing (‘demographics’). Middle panel – effect of changes in the share of ‘want a job’ non-participants. Bottom panel – effect of changes in demographics and the share of ‘want a job’ non-participants. The dashed line is the Congressional Budget Office’s estimate of the natural unemployment rate.
Our results then allow us to speculate about possible future values for the unemployment rate at the next business cycle peak. The ‘long-run’ forces that drove the unemployment rate to a 40-year low of 3.8% in April 2000 – ageing and a lower desire to work – are still present today, but are masked by a low job-finding rate that is still 18% below its pre-recession peak of 2006 and more than 25% below its 2000 peak (Brookings 2015b). Bringing workers' job-finding rate back to its 2000 level and holding the share of ‘want a job’ non-participants at its current level imply an unemployment rate at 3.8%. Perhaps more realistically, bringing workers' job-finding rate back to its 2006 level would imply an unemployment rate of 4.5%, suggesting that the unemployment rate still has substantial room for improvement.
Now, our findings raise an important question: What caused the decline in non-participants' desire to work in the second half of the 1990s?
We argue that changes in the provision of welfare and social insurance during the mid-1990s welfare reforms, likely explain at least some of the decline in desire to work among non-participants in the 1990s and the low level today.
To make this point, we estimate a model of non-participants' propensity to want a job, in which desire to work can depend on individual characteristics, the family structure, as well as the different sources of income, both at the individual and at the family level.
Our estimates imply that changes in the provision of (i) welfare insurance and (ii) social insurance (mainly disability) explain a large share of the decline in the share of ‘want a job’ non-participants. This finding suggests a possible role for the major ‘welfare to work’ reforms of the 1990s – the 1993 Earned Income Tax Credit expansion and the 1996 reform of the Aid to Families with Dependent Children programme.
To identify the causal effects of (i) the expansion of Earned Income Tax Credit and (ii) the Aid to Families with Dependent Children and other reforms, we build on Eissa and Liebman (1996) and Eissa and Hoynes (2004) and use a difference-in-difference strategy that exploits the facts that households without children receive little Earned Income Tax Credit or Aid to Families with Dependent Children and other benefits and were little affected by the reforms. We find that the welfare reforms did lower desire to work substantially among some nonparticipants.
In other words, the welfare reforms pushed some non-participants further away from the labour force. Thus, while the ‘welfare to work’ reforms are generally considered to have been successful in bringing many nonparticipants into the labour force (Blank 2002), our results imply that their effect may have been more subtle than previously thought. For some non-participants, the reforms appear to have had the opposite of the intended effect.
Barnichon, R and A Figura (2015), "Declining Desire to Work and Downward Trends in Unemployment and Participation", forthcoming NBER Macroeconomics Annual 2015.
Blank, R (2002), "Evaluating Welfare Reform in the United States", Journal of Economic Literature 40(4): 1105-1166.
Brookings (2015), forecast, available at http://www.brookings.edu/blogs/jobs/posts/2015/09/30-unemployment-projected-to-remain-steady-in-september-barnichon.
Brookings (2015b), forecast, available at http://www.brookings.edu/blogs/jobs/posts/2015/09/30-unemployment-projec....
Eissa, N and J Liebman (1996), "Labor Supply Response to the Earned Income Tax Credit", The Quarterly Journal of Economics 111(2): 605-37.
Eissa, N and H Hoynes (2004), "Taxes and The Labor Market Participation of Married Couples: The Earned Income Tax Credit", Journal of Public Economics 88: 1931-1958, August.
Federal Reserve Bank of Philadelphia (2015), forecast, available at https://www.philadelphiafed.org/research-and-data/real-time-center/surve....
Perry, G (1970), "Changing Labor Markets and Inflation", Brookings Papers on Economic Activity: 411-441.
Shimer, R (1998), "Why is the U.S. Unemployment Rate So Much Lower?", NBER Macroeconomics Annual 13: 11-61.
1 Since older workers have a lower unemployment rate than younger workers, an older population will have a lower aggregate unemployment rate. The ageing of the baby boom generation has been proposed to explain the inverse U-shape movement in unemployment since the early 70s (e.g. Perry 1970, Shimer 1998).