Declining Desire to Work and Downward Trends in Unemployment and Participation

Previous articleNext article FreeDeclining Desire to Work and Downward Trends in Unemployment and ParticipationRegis Barnichon and Andrew FiguraRegis BarnichonCREI, Universitat Pompeu Fabra, and CEPR Search for more articles by this author and Andrew FiguraFederal Reserve Board Search for more articles by this author CREI, Universitat Pompeu Fabra, and CEPRFederal Reserve BoardPDFPDF PLUSFull Text Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinked InRedditEmailQR Code SectionsMoreI. IntroductionThe US labor market has witnessed two remarkable secular trends in the last 30 years. First, the unemployment rate declined secularly after the early 1980s, prompting policymakers to adjust downward their estimate of the natural rate or NAIRU (Non-Accelerating Inflation Rate of Unemployment), as shown in figure 1. Second, a decline in labor force participation has brought down the participation rate to a level not seen in 30 years (figure 2).Fig. 1. Unemployment rate (UR) and CBO estimate of the natural rate of unemployment, 1967–2014.View Large ImageDownload PowerPointFig. 2. Labor force participation rate (LFPR) and CBO estimate of the potential LFPR, 1967–2014.View Large ImageDownload PowerPointHowever, considerable uncertainty remains about the underlying reasons for these trends. While the aging of the baby boom generation has often been cited as a possible factor,1 it is not clear that demographics alone are responsible for these trends. This uncertainty is best illustrated with the recent lively debate about the “cyclical” or “structural” nature (i.e., persistence) of the low participation rate observed today.2This paper argues that a key, but so far little studied, aspect of the secular changes witnessed by the US labor market is the presence of time-varying heterogeneity across nonparticipants (individuals outside the labor force), that is, changes in the composition of the nonparticipation pool. We document a strong decline in desire to work among nonparticipants in the second half of the 1990s, and we show that that decline is a major aspect of the downward trends in unemployment and participation over the past 20 years.The Current Population Survey (CPS) has been measuring individuals’ desire for work consistently since 1967, allowing us to construct a measure of nonemployed individuals’ desire to work from 1967 to 2014. We find that 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.A downward trend in the share of nonparticipants who want a job has consequences for the aggregate unemployment and participation rates, because people who want a job behave differently from people who do not want a job. Using matched CPS microdata to measure worker transitions between labor market states, we find that a nonparticipant who wants a job enters the labor force (a) often and (b) mostly through unemployment, while a nonparticipant who does not want a job enters the labor force (a) rarely and (b) mostly through employment. Because of this difference in behavior, a decline in the fraction of nonparticipants who want a job lowers both the unemployment rate and the participation rate. We develop a stock-flow accounting framework to quantify this effect, and we find that the decline in nonparticipants’ desire to work since the mid-1990s lowered the unemployment rate by about 0.5 percentage point (ppt) and the participation rate by 1.75 ppt. This is a large effect: in comparison, the widely studied aging of the baby boomers lowered unemployment by 0.7 ppt and participation by 2.5 ppt over the same time period. Taken together, population aging and variations in the share of “want a job” nonparticipants can account for the bulk of the low-frequency movements in unemployment since the late 1960s.We conclude that a better understanding of the characteristics of individuals outside the labor force is crucial to understand the trends in unemployment and participation, and in the second part of the paper, we explore possible explanations for the decline in nonparticipants’ desire to work in the second half of the 1990s.Looking across different subgroups, the decline in the number of nonparticipants who want to work is due mainly to prime-age females, and, to a lesser extent, young individuals. Moreover, the decline is mainly a low-income and non-single household phenomenon (with virtually no decline in desire to work among single households), and is stronger for families with children than without.We estimate a model of nonparticipants’ 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. We use time fixed effects so that our coefficient estimates depend on cross-sectional variation, and we use our estimates to predict changes in desire to work since the mid-1990s.Our estimates imply that changes in the provision of (a) welfare insurance and (b) social insurance (mainly disability) explain about 50% of the decline in the share of “want a job” nonparticipants. This finding suggests a possible role for the major welfare reforms of the 1990s —the 1993 Earned Income Tax Credit (EITC) expansion and the 1996 reform of the Aid to Families with Dependent Children (AFDC) program—which precisely affected low-income households with children.We then use a difference-in-difference strategy to try to identify the causal effects of the EITC expansion and the AFDC reform on low-income mothers. The strategy exploits the fact that households without children receive little EITC or AFDC benefits and were therefore little affected by the reforms. The difference-in-difference estimates attribute between 50 and 70% of the decline in mothers’ desire to work to the welfare reforms. In other words, the welfare reforms pushed some nonparticipants further away from the labor force. Thus, while the “welfare-to-work” reform—designed to strengthen the incentives to work and to bring welfare recipients into the labor force—is generally considered to have been successful in bringing many nonparticipants into the labor force (Blank 2002), our results imply that the effect of the reform may have been more subtle than previously thought. For some nonparticipants, the reform appears to have had the opposite of the intended effect.Although the existence of different degrees of desire to work among nonparticipants has been previously documented (Hall 1970; Clark and Summers 1979), the existence of a secular trend in desire to work and its effects on the participation and unemployment rates are, as far as we know, novel. Moreover, the effect of nonparticipants’ characteristics on the aggregate unemployment rate measure underscores the difficult issue of the appropriate definition of unemployment and the distinction between the “unemployment” and “out of the labor force” classifications (Clark and Summers 1979; Flinn and Heckman 1983; Jones and Riddell 1999).To quantify how the decline in desire to work affects unemployment and participation, we build on a large literature, going back at least to Darby, Haltiwanger, and Plant (1986) that studies the flows of workers in and out of unemployment.3Finally, the possibility that changes in the provision of social transfers can affect desire to work and thereby the aggregate unemployment and participation rates echoes Juhn, Murphy, and Topel (2002) and Autor and Dugan (2003) who argue that the growing attractiveness of disability benefits relative to work increased the number of individuals outside the labor force.Section 2 documents the decline in the fraction of nonparticipants willing to work, section 3 quantifies how the decline in nonparticipants willing to work affects the unemployment and participation rates, section 4 discusses the robustness of our results, section 5 explores the possible reasons for the decline in desire to work, and section 6 concludes.II. Fewer People Want to WorkIn this section, we show that the fraction of nonparticipants who report “wanting to work” has displayed substantial secular movements, with a particularly strong decline during the second half of the 1990s.A. “Do You Want a Job Now?”To measure the extent to which nonemployed individuals are interested in working, we use data collected by the Bureau of Labor Statistics (BLS). Since 1967, the Current Population Survey (CPS) has been consistently asking the question “Do you currently want a job now, either full or part time?” to nonemployed individuals outside the labor force, also called “nonparticipants.” We use the answer to this question to separate nonparticipants into two groups; nonparticipants who want a job, denoted Nw and nonparticipants who do not want a job, denoted Nn.Since the phrasing of the CPS question did not change from 1967 to 2014, we can construct a consistent time series of the share of nonparticipants who want to work from 1976 to 2014; that is, the ratiomt≡NtwNtw+Ntnwith Ntw and Ntn the respective number of “want a job” and “not want a job” nonparticipants. For the period covering 1967–1975, we tabulated the data from successive BLS Employment and Earnings publications, and for the period covering 1976–2014, we used microdata from the CPS.Figure 3 shows that the fraction of “want a job” nonparticipants (mt) displays an inverse U-shape pattern over 1967–2014,4 with a particularly strong decline in the second half of the 1990s.5 Interestingly, the behavior of the Congressional Budget Office (CBO)’s estimate of the natural rate—one estimate of the long-run level of unemployment—displays a pattern that is similar to that of mt, a point to which we will later return.6Fig. 3. Fraction of nonparticipants who report “wanting a job” (solid line, four-quarter moving averages) and CBO estimate of natural unemployment rate (dashed line), 1967–2014.View Large ImageDownload PowerPointB. “Want a Job” versus “Not Want a Job”While the trend in the share of “want a job” nonparticipants is striking, for it to be of any consequence for the aggregate labor market, people who want to work must behave differently from people who do not want to work.To evaluate whether this is the case, we match the CPS microdata from 1994 to 2010 to measure and compare the transition rates of nonparticipants who report wanting a job (denoted Nw) with the transition rates of nonparticipants who report wanting a job (denoted Nn).7Figure 4 shows a representation of the labor market with three states—employment (E), unemployment (U), and nonparticipation (N)–, and reports the average monthly transition rates out of nonparticipation (either to E or U) for “want a job” nonparticipants (Nw) and “not want a job” nonparticipants (Nn).Fig. 4. Average monthly transition probabilities out of nonparticipation for nonparticipants who want a job (Nw) and nonparticipants who do not want a job (Nn), 1994–2010.View Large ImageDownload PowerPointWe can see that someone who wants a job behaves very differently from someone who does not want a job.First, someone who wants a job (Nw) is very likely to enter the labor force in the near future (λNwU+λNnE=.62, where λAB denotes the average transition rate from state A ∈ {E, U, Nw, Nn} to state B ∈ {E, U, Nw, Nn}). In other words, someone who wants a job is at the margin of participation. In contrast, someone who does not want a job (Nn) is unlikely to enter the labor force in the near future (λNnU+λNnE=.05) and is thus “far” from the participation margin and from labor force activity.Second, a “want a job” nonparticipant is much more likely to enter the labor force through unemployment than through employment (λNwU>λNwE), but this is the opposite for a “not want a job” nonparticipant: someone who does not want a job is much more likely to enter the labor force through employment (λNnE>λNnU). These two differences in behavior between “want a job” and “not want a job” nonparticipants—the fact that λNwU−λNwE>0 and λNnE−λNnU>0—will later prove crucial when we consider how changes in the share of “want a job” nonparticipants affect the unemployment rate.To dig a little deeper, we study whether a difference between “want a job” and “not want a job” nonparticipants continues to exist once nonparticipants enter the labor force. Table 1 compares the transition rates of recent (entered a month ago) labor force entrants with the transition rates of other labor force participants (who entered the labor force more than a month ago).8 We can see that recent labor force entrants have much higher transition rates back to nonparticipation. However, although “want a job” and “not want a job” nonparticipants display very different transition rates into participation (figure 4), the difference is much less marked once these individuals are inside the labor force. Table 1 shows that their job-finding rates are similar and that their labor force exit rates are somewhat comparable. Interestingly, a former “not want a job” (Nn) is more likely to leave the labor force than a former “want a job” (Nw).Table 1. Transition Rates of Labor Force EntrantsTransitionsUNENUEEU(UNw + UNn)(ENw + ENn) .44.16 Former Nw(.33 + .11)(.08 + .09).20.08 .57.27 Former Nn(.25 + .32)(.03 + .24).22.03Other.19.02.27.01 (.13 + .06)(.01 + .01) Note. Average monthly transition rates computed 1994–2010. Former Nw refers to a participant who was a “want a job” nonparticipant one month ago, former Nn refers to a participant who was a “not want a job” nonparticipant one month ago, and other refers to other labor force participants.View Table ImageC. The Fraction of “Want a Job” across Demographic GroupsLooking at different demographics, a decline in the share of “want a job” nonparticipants can be seen among prime-age females, prime-age males, and young workers. However, in terms of the number of individuals affected by the decline, the decline is mainly a prime-age female, and to a lesser extent young worker, phenomenon.First, similarly to figure 3, figure 5 plots mit, the fraction of “want a job” nonparticipants for four demographic subgroups (denoted with the subscript i): Prime-age male 25–55, prime-age female 25–55, younger than 25, and over 55. In all groups except for old workers, mit displays an inverted-U shape, rising in the 1970s and declining in the second half of the 1990s.9Fig. 5. Fraction of nonparticipants who report “wanting a job” by demographic group: male 25–55, female 25–55, younger than 25, and older than 55. Four-quarter moving averages, 1969–2014.View Large ImageDownload PowerPointHowever these percentage point declines hide large differences in the number of individuals affected by the decline in desire to work. Between 1994 and 2001, the number of prime-age females willing to work declined by 930,000, of young individuals by 680,000, and the number of prime-age males declined by “only” 250,000. Thus, the decline in desire to work is predominantly a (a) prime-age female, and (b) young individuals phenomenon. This difference between groups was not apparent in the behavior of the share of “want a job” nonparticipants because that measure does not capture differences in participation rates across groups. In particular, since prime-age males have a very high participation rate, there are few prime-age male nonparticipants, so that the decline in mit is a phenomenon that affected only a very small share of the prime-age male population. This is not the case for prime-age females and young individuals.III. Declining Share of “Want a Job” and Movements in Unemployment and ParticipationGiven the marked differences in labor market behavior between “want a job” and “not want a job” individuals, movements in the share of “want a job” nonparticipants may affect the aggregate unemployment and participation rates. In this section, we use a stock-flow accounting framework to quantify these effects.We make two points. First, the share of “want a job” nonparticipants is an important aspect of the inverse U-shape behavior of unemployment between the early 1970s and the early 2000s. Second, the decline in desire to work in the second-half of the 90s is related to the currently low level of participation in the US.A. Some AccountingOur starting point is a labor market described by four labor market states: employment (E), unemployment (U), nonparticipant who wants a job (Nw), and nonparticipant who does not want a job (Nn).As in the “Ins and Outs” literature (e.g., Shimer 2012), we assume that the labor market can be described by a Markov chain of order 1,10 so that the number of employed Et, unemployed Uu, “want a job” nonparticipants Ntw, and “not want a job” nonparticipants Ntn satisfies the system(1)(EUNwNn)·t=Λt(EUNwNn)twithΛt=(−λEU−λENw−λENnλEUλENwλENnλUE−λUE−λUNw−λUNnλUNwλUNnλNwEλNwU−λNwU−λNwE−λNwNnλNwNnλNnEλNnUλNnNw−λNnU−λNnE−λNnNw)tand where λtAB denotes the hazard rate of transiting from state A ∈ {E, U, Nw, Nn} to state B ∈ {E, U, Nw, Nn}.We can then use (1) to express any stock variable, for instance the unemployment rate ut = Ut / (Et + Ut) and the participation rate lt = LFt / Popt with the population Popt=Et+Ut+Ntw+Ntn, as functions of the (present and past) worker transition rates {λt−jAB,∀j>0}. For the United States, such functions are particularly simple because the magnitude of the worker flows are so large that, at a quarterly frequency, the labor market is very well described by the steady state of system (1).11 As detailed in the appendix,12 the steady state of system (1) then gives us an accounting identity that allows to express the unemployment rate ut and participation rate lt as functions u(.) and l(.) of the 12 contemporaneous hazard rates {λtAB}.Then, it is easy to write ut and lt as functions of the transition rates out of employment (E), unemployment (U), and nonparticipation (N, including all nonparticipants, Nw or Nn) with(2){ut=u({λtAB})lt=l({λtAB}),A,B∈{E,U,N}where the N-U and N-E transition rates, denoted λtNU and λtNE, are weighted averages of the two transition rates out of Nw and Nn(3){λtNU=mtλtNwU+(1−mt)λtNnUλtNE=mtλtNwE+(1−mt)λtNnEwith the weight mt given by the share of “want a job” nonparticipants.Since nonparticipants who want a job behave very differently from the nonparticipants who do not want a job (in particular, λNwU≫λNnU), changes in the fraction of nonparticipants who want a job will affect the transition rates out of nonparticipation through (3) and thus the unemployment and participation rates through (2).B. Quantifying the Effect of Lower Desire to WorkA Taylor expansion of the accounting identities (2) around the mean of the hazard rates (λtAB≃λAB) and a little bit of algebra with (3)13 gives (see the appendix http://www.nber.org/data-appendix/c13601/appendix.pdf for more details) that the effect of a change in the fraction of “want a job” nonparticipants on the aggregate unemployment rate, denoted dutm, is given by(4)dutm=βNU[(λNwU−λNnU)−λNUλNE(λNwE−λNnE)](mt−m)with m the average fraction of “want a job” nonparticipants, and βNU > 0, the coefficient of the first-order Taylor expansion of ut with respect to λtNU.The effect of a decline in desire to work on the aggregate unemployment rate is a priori ambiguous. On the one hand, as captured by the first term on the right-hand side of (4), a decline in the share of “want a job” nonparticipants lower the average NU transition rate since “want a job” nonparticipants are more likely to join unemployment than “not want a job” nonparticipants (λNwU−λNnU>0), and this lowers the unemployment rate. On the other hand, as captured by the second term on the right-hand side of (4), a decline in the share of “want a job” nonparticipants lowers the average N-E transition rate, since “want a job” nonparticipants are more likely to join employment (λNwE−λNnE>0), and this increases the unemployment rate. In practice however, a lower share of nonparticipants who want to work unambiguously implies a lower unemployment rate. The two hazard rates out of nonparticipation, λNU and λNE, are of similar magnitudes and λNU / λNE ≃ 1, so that the sign of the effect of a change in m on the unemployment rate is given by(λNwU−λNwE)︸>0+(λNnE−λNnU)︸>0>0which is unambiguously positive for two reasons: (a) a nonparticipant who wants a job enters the labor force mainly through unemployment (λNwU−λNwE>0), and (b) a nonparticipant who does not want a job enters the labor force mostly through employment (λNnE−λNnU>0).To quantify the effect of changes in the fraction of “want a job” nonparticipants on the labor force participation rate, we proceed in the exact same fashion and calculate dltm from a relation similar to (4). Contrary to the unemployment rate, a decline in mt has an unambiguous effect on the labor force participation rate. Since a lower fraction of “want a job” nonparticipants lowers all transition rates out of nonparticipation, a lower fraction of “want a job” nonparticipants implies a lower labor force participation rate.C. Controlling for Demographic HeterogeneityBefore proceeding with the decomposition results, we generalize our approach to control for changes in demographics.We do so for two reasons: First, changes in demographics are known to have large effects on the behavior of the unemployment and participation rates, and we want to put the effects of declining desire to work in the context of the contribution of demographics. Second, to the extent that declining average desire to work could be explained by changes in the demographic structure of the nonparticipation pool, we want to control for the demographic composition of the population.We divide the population into K = 8 demographic (age and sex) groups, denoted by subscript i ∈ {1,…,K}.14 The approach to identify the effect of lower desire to work is exactly as described in the previous section, except that all variables now have a subscript i. As described in the appendix,15 we can then aggregate across groups to estimate the effects of (a) demographics, and (b) desire to work among nonparticipants on the aggregate unemployment and participation rates by using the definitions{ut=∑i=1Kωituitlt=∑i=1KΩitlitwith ωit the labor force share of group i and Ωit the population share of group i.D. Decomposition of the Unemployment RateWe start by analyzing the behavior of the unemployment rate.Figure 6 plots the contributions of (a) demographics (top panel), and (b) the fraction of “want a job” nonparticipants (middle panel) to movements in unemployment. To help put results into perspective, we also plot the CBO estimate of the natural rate (dashed line) as a proxy for trend unemployment.Fig. 6. Effects of composition changes on the aggregate unemployment rate (U). Upper panel: effect of demographics. Middle panel: effect of changes in the share of “want a job” nonparticipants. Bottom panel: effect of changes in demographics and the share of “want a job” nonparticipants. The dashed line is the CBO estimate of the natural unemployment rate. For clarity of exposition, the series are level shifted with their mean set to the mean of the CBO natural rate. The plotted series are four-quarter moving averages, 1967–2014.