It is becoming increasingly clear that reforming federal policies to keep people in the workforce is the primary economic policy challenge of our time. Americans’ future quality of life will depend on our getting this right.
Americans’ standards of living, and indeed our economic power as a nation, are reflections of our productive output. Only that which we produce can be transmuted into desirable things ranging from the goods that we buy and consume privately, to the public goods that we share, to the strength of our defenses in a dangerous world. While a great deal of our public policy debate focuses on how national wealth is distributed, we cannot distribute what we don’t have. More fundamentally, it is our economic output that determines the quality of life Americans can enjoy.
Our economic growth is basically a function of two primary factors: how many Americans are working, and how productive we are during the hours we work. It is straightforward to understand that the more productive we are, the more wealth we will have together. Indeed, a graph of recent annual growth in Gross Domestic Product (GDP) shows that it is generally higher when our productivity grows faster. Thus a good deal of our prosperity comes from Americans learning to work faster, better, smarter and more efficiently. (Note: multifactor productivity incorporates not only labor productivity but also output on capital services; the GDP decline of 2008-09 arose primarily from decline in the latter.)
As striking as the correlation is between productivity growth and total economic growth, employment growth is perhaps even more important. To be productive, Americans must work. Assuming given levels of productivity, the more Americans who are working, the more wealth our society generates. A similar graph comparing recent annual GDP growth with annual changes in total employment renders this relationship inescapable. Our economic output generally rises (and falls) with the numbers of Americans in jobs.
This relationship is why discussions of the economy often focus on the unemployment rate, long defined as the percentage of Americans seeking work who are unable to secure it. In recent years it has become increasingly apparent that the health of the labor market isn’t measured solely by the unemployment rate, but must account for the total numbers of Americans making themselves available for work. A quick glance shows that the growth of this available labor force is a strong determinant of the numbers of those employed.
Indeed, total labor force growth and employment growth tend to move quite closely together. The rare exceptions are years like 2008 and 2009 when unemployment rates suddenly changed.
A quick look at this last graph shows that even though the unemployment rate has recovered from the recent recession, we have reason for continuing concern. Our total labor force – i.e., those available for employment – is no longer growing as fast as it formerly did. If we want to continue to experience improvements in our living standards as previous Americans did, this is something we must fix.
What is behind our sluggish workforce growth? A number of things:
- Americans are spending a higher percentage of our lives out of the workforce collecting benefits from various retirement programs. This is largely because of our inadequate response to demographic change; even as longevity has increased, the age of first eligibility for such benefits as Social Security (62) and Medicare (65) has not. As a result, labor participation among seniors is lower today than it was a half-century ago, even though we generally lead longer, healthier lives.
- Various federal benefit programs are proving to be poorly designed in the sense of applying high marginal tax rates to employment earnings. Basically, this means individuals receive substantial benefits if they lack paying work, but lose them as they receive job income. This results in people making the rational decision to have less work and earnings than they otherwise would. A prominent example is the Affordable Care Act, which has been shown by the Congressional Budget Office and academic economists like Casey Mulligan to be driving many people out of the workforce.
- Other factors are not fully understood. To take but one example, it is widely documented that workforce participation has long been declining among young adult males. We do not have a single, agreed-upon explanation for this persistent participation decline.
Policy corrections to these various causes of labor participation decline will need to be implemented if the United States is to resume the economic growth rates that made us the leading economic power in the world. We simply can no longer afford to have our largest federal retirement, health care and income security programs shifting people out of the workforce who, based on their health, age, skills and general inclination, would otherwise be working. Lawmakers will have no choice but to confront these realities at some point, and would do well to do so sooner rather than later.
It is important to understand that corrections would generally tend to benefit individual program participants. This is because, while the current designs of programs from the ACA to Social Security often induce workforce withdrawal, the temporary inducement often comes at the cost of the individual’s long-term interest. For example, retiring on Social Security at age 62 reduces one’s annual benefits and increases the risk of outliving one’s savings and experiencing poverty in old age. Similarly, those who bypass employment to receive substantial subsidies like those in the ACA often do so at the cost of skill development that would otherwise result in higher wages later.
Only if we surmount our labor force participation challenge will we be able to successfully address other economic policy desires such as higher living standards, lower poverty, and sound federal government finances. For these and other reasons, re-orienting federal policies to keep people in the workforce is likely to remain the pre-eminent economic policy challenge of our time.
Charles Blahous is a senior research fellow for the Mercatus Center, a visiting fellow at the Hoover Institution, and a contributor to E21. He recently served as a public trustee for Social Security and Medicare.
Editor’s Note: This piece was originally published by Economics21 at the Manhattan Institute.