The US employment report for February contains further evidence that, on the surface at least, the American labour market is returning to normal. The unemployment rate of 8.3 per cent is 1.7 percentage points below its peak in October 2009 and private sector employment has risen by a healthy 2.1 per cent in the past 12 months.
Yet consumer pessimism about job prospects remains almost as bleak as it was in the darkest hour of the recession. If the labour market is really improving as much as the official data imply, no one seems to have told middle America.
Ben Bernanke, chairman of the Federal Reserve, is also puzzled. Last week, he pointed to the fact that the jobs data have improved much more than they should have done, given the relatively weak growth rate of real gross domestic product in recent quarters. The link between changes in the unemployment rate and real GDP growth is captured by “Okun’s Law”, named after John F. Kennedy’s economic adviser, Arthur Okun.
This law, which celebrates its 50th birthday this year, has held up rather better than most economic relationships. However, it does not explain the recent decline in the unemployment rate.
Real GDP has grown by only 2.5 per cent per annum since unemployment peaked. This is close to the trend growth in productivity. Using Okun’s Law, this implies that there should have been no decline at all in unemployment during the economic “recovery”. In the past 12 months alone, the unemployment rate has fallen about 1.3 percentage points more than implied by Okun. So what is going on?
Employment gains have certainly been strong in recent months. But over a longer period, the most credible explanation for these puzzles is that the labour force has been growing much less strongly than normal. The participation rate, defined as the sum total of employed plus unemployed as a percentage of the relevant population, has actually fallen from 65 per cent at the height of the recession to 63.9 per cent now.
Normally, it would be expected to rise during a recovery, as previously disaffected workers are drawn back into the jobs market. This time, potential workers seem to have drifted away from the labour market, and not come back.
The labour force has therefore “downsized” itself in line with the economy. Part of this is due to demography and particularly to the rise in the proportion of workers who are near retirement age. They often choose to retire early. But it also seems to be due to the exceptional depth of the recession, which has persuaded many workers that there is no point in actively seeking work.
The shrinkage of the labour force, part voluntary and part involuntary, leaves the potential output of the economy lower than it was before and may explain why Americans do not perceive this recovery in the labour market as a genuine one.
It is a major relief that the labour market is now clearly improving. But the financial crash of 2008 continues to cast a very long shadow on America’s economic potential.
The writer is chairman of Fulcrum Asset Management and a founder of Prisma Capital Partners