Labor Force Participation

So far we’ve focused on whether people can get a job if they want one, but it is also important to ask whether people want a job. We therefore turn from the unemployment rate to the labor force participation rate. Recall that the labor force participation rate is the percentage of the adult, noninstitutionalized, civilian population (adults for short) who are working or actively looking for work. In other words, the labor force participation rate is the percentage of adults who are in the labor force:

In the United States (circa 2014), there are 155.4 million members of the labor force and 247.4 million adult, noninstitutionalized civilians, so the labor force participation rate is

What determines the labor force participation rate? We will discuss two factors.

  1. Lifecycle effects and demographics

  2. Incentives

Lifecycle Effects and Demographics

Table 11.3 shows how labor force participation rates vary with age. Not surprisingly, most young adults are full-time students not workers. Labor force participation peaks in the prime working years, ages 25-54, when most adults are in the labor force. After age 65, most people retire and only a small minority remain in the labor force.

Table :

TABLE 11.3 The Labor Force Participation Rate at Different Ages

Age Range (years)

Labor Force Participation Rate

16-19

44%

25-54

83%

 65+

15%

Source: Bureau of Labor Statistics, 2006.

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Baby boomers are the people born during the high birthrate years, 1946-1964.

Lifecycle effects can interact with demographics to change national labor force participation rates. For example, as more baby boomers reach retirement age, the labor force participation rate will decline. In 2000, 12.4% of the population was 65 years or older, but by 2030 nearly 20% of the population will be 65 years or older. In fact, by 2030 it’s estimated that 18.2 million people in the United States will be 85 years or older.9 Since older people are less likely to participate in the labor force, the aging of the U.S. population will lower the labor force participation rate.

Many economists are concerned because falling labor force participation means lower tax receipts. Of greater concern, tax receipts will be falling just as the demands on Social Security and Medicare rise. The head of the U.S. Government Accountability Office, whose job it is to analyze the long-term financial health of the U.S. government, has said in this regard, “When those boomers start retiring en masse, then that will be a tsunami of spending that could swamp our ship of state if we don’t get serious.”10 We take up these important issues at greater length in Chapter 17.

A natural response to rising life expectancies and better health at older ages is later retirement. The “normal” retirement age is partly a matter of culture and convention but it is also partly determined by economic incentives, especially taxes—a subject to which we now turn.

Incentives

Why do people join the labor force? A few artists (and some professors!) love to work, but most people work because work pays more than leisure. More specifically, the choice to work depends on the difference between what work pays and what leisure pays. The choice to work, therefore, can be influenced by taxes on workers and benefits paid to nonworkers. Taxes discourage work and benefits encourage nonwork. We can see both of these effects in action by looking at how retirement systems in different countries change the incentives that older people have to work.

Taxes and Benefits Figure 11.10 shows labor participation rates for men ages 55—64 in different countries in 1998. In Belgium, only one-third of men in this age range were working, while in the United States only one-third of men of this age range were retired! Why are there such large differences in labor force participation rates? It’s not just cultural differences concerning the right age for retirement.

Labor Force Participation Rates of Older Workers Differ Significantly across Countries (Males aged 55-64, 1998)
Source: OECD Labor Force Statistics.

In the United States, a worker of retirement age who continues working is not penalized.* But many countries penalize workers who work past the normal or early retirement age because many countries do not allow a worker to work and receive the same government pension. For example, in the Netherlands in the 1990s, a worker who worked past the age of 60 lost one year of benefits. The lost benefits can be thought of as a tax on working. Workers who kept working also had to pay payroll taxes on their wages. The net result was that a worker who worked past the age of 60 in the Netherlands earned less money than a worker who retired! In other words, a worker who did not retire at age 60 had to pay to work. If you had to pay to work, how much work would you do?

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Figure 11.11 graphs the labor force participation rate of older men against a measure of the penalty, the implicit tax, on working. Countries with a high implicit tax have a low labor force participation rate.

Male Labor Force Participation Declines the Higher Are Implicit Taxes (Males Aged 55-64)
Source: OECD Labor Force Statistics, 2005. Gruber, Jonathan, and David A. Wise. 1999. Introduction and summary. In J. Gruber and D. A. Wise (eds.), Social Security Programs and Retirement Around the World. Chicago: University of Chicago Press.

Early retirement is beneficial for workers if they want to retire early, but taxing older workers at significantly higher rates than younger workers (sometimes at rates above 100%!) does not benefit the older workers. Pushing older workers into retirement also imposes significant costs on younger workers who must pay higher taxes because older workers are not contributing to GDP.

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Men aged 55-64 are a large share of the population, about 17% in most Western European countries, so the tax on working means that millions of men retire early and draw on their pensions instead of continuing to work and produce wealth. The graying of the population that we mentioned earlier is even more serious in Europe than in the United States—in part because the incentives created by European retirement programs greatly decrease the labor force participation rates of older workers.

Incentives and the Increase in Female Labor Force Participation Incentives have also played a role in the dramatic increase in the U.S. labor force participation rates of women. In 1948, only 35% of women aged 25-54 were in the (paid) labor force. By the mid-1990s, 75% of these women were in the labor force. Figure 11.12 plots U.S. labor force participation rates for women since 1948. Notice that the 1970s brought especially large increases in labor force participation rates.

Female Labor Force Participation Has Increased Rapidly
Source: Bureau of Labor Statistics.

Cultural factors such as the rise of feminism and the growing acceptance of equality for women certainly played a role in rising female labor force participation. But cultural changes do not happen in a vacuum. Changes in the economy such as the move from a manufacturing to a service economy also brought more women to work. Even today, for example, there are almost three times as many male semiskilled factory and machine operators as female operators, but there are more female professionals (lawyers, professors, accountants, etc.) than there are male professionals.11 As the manufacturing sector declined and the service sector rose, there was less demand for machine operators and more demand for professionals. This raised wages in sectors where females had a comparative advantage, thereby drawing more females into the labor force. In turn, the phenomenon of women in the workplace fueled the rise of feminism.

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The growth in women working was especially dramatic in the professions. Figure 11.13 shows the percentage of the first-year students who were female in medical school, dentistry, law, and business programs from 1955 to 2005. From 1955 to about 1970, fewer than 10% of first-year students in the professions were females. Beginning around 1970, however, female participation shot up—more than doubling in all professions in just 10 years and continuing to increase until between 40% to 50% of all students in professional programs are female.

Females Entered Professional Degree Programs in Large Numbers Beginning in the 1970s
Source: Goldin, Claudia. 2006. The quiet revolution that transformed women’s employment, education, and family. American Economic Review 96(2): 1-21.

Why did females start entering professional schools in increasing numbers beginning around 1970? Economists Claudia Goldin and Lawrence Katz have an intriguing and controversial answer—the pill.12

How the Pill Increased Female Labor Force Participation The pill has been called the greatest technological advance of the twentieth century. For the first time in history, the pill gave women a low-cost, reliable, and convenient method of controlling fertility. Condoms can also prevent unwanted pregnancy, but the pill is easier to use, less prone to error, and more reliable. Among typical users, the pill is seven times more reliable than condoms, and among those who always use the pill according to directions, it is 60 times more reliable.

Economists Goldin and Katz argue that the pill lowered the costs of earning a professional degree by giving women greater certainty about the consequences of sex. It takes years of effort to earn a professional degree, and earning a degree while bearing or taking care of a baby is very difficult. Thus, women who wanted a professional degree before the advent of the pill had either to bear the costs of abstinence or risk pregnancy. The pill lowered these costs and increased the incentive of women to invest in a long-term education.

CHECK YOURSELF

Question 11.7

The marginal tax rate (the tax on additional income) for married couples was reduced significantly during the 1980s. How would this affect the female labor force participation rate?

Question 11.8

Some politicians want to raise the age at which people can collect Social Security benefits, likely postponing retirement for many. How will this change affect the labor force participation rate?

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The availability of the pill and the increase in women entering college and professional degree programs do coincide. Although the pill was first sold for contraceptive use in 1960, at that time 30 states banned advertisements for birth control devices and some even banned the sale of contraceptives. It wasn’t until 1965 in the landmark case Griswold v. Connecticut that the U.S. Supreme Court said states could not ban the sale of contraceptives to married couples. Single women could still be prohibited from buying contraceptives until 1972. As laws banning the sale of contraceptives fell, more women bought contraceptives and according to Goldin and Katz, more women began to plan for long-term careers.

Goldin and Katz make a plausible argument for their hypothesis (and they provide more evidence than we discuss here); nevertheless, it would be interesting to know if similar effects happened in other countries as the pill became available. Questions like these are on the cutting edge of economics—perhaps some of you will help to answer them.