US Economy is Hamstrung by Shrinking Labor Force

The US stock markets have been struggling since early December when we saw a near-1000-point plunge in the Dow. While the markets quickly recovered to a new all-time high late in the month, it has since been trending lower. Meanwhile, volatility is back with a bang, making investors worry that the trend could be rolling over.


There are many factors that are creating a sense of uncertainty: worries that much of Europe is sinking back into recession, worries that the collapse in oil prices is creating deflation, worries about the strong US dollar, etc., etc.

While these and other factors are weighing on the equity markets, I believe there is another negative at play now: a downward adjustment in the outlook for the US economy. Last week’s advance report showing 4Q GDP rose only 2.6% was a clear disappointment. Perhaps equally disappointing was the Commerce Department’s revision of 3Q GDP to 4.1%, down from the 5.0% previously reported.

There is a growing consensus that the strong GDP growth in the 2Q (+4.6%) and the 3Q of last year was primarily a rebound from the 2.1% decline in the 1Q, rather than a sign that the economy was finally set to surge. The disappointing 2.6% in the 4Q is making many analysts downgrade their forecasts for 2015 and beyond. In other words, maybe 2½-3% growth is all we should expect from this economy going forward. That is the growing feeling, unfortunately.

Assuming that the 4Q GDP number remains around 2.6%, then the economy expanded by only 2.5% last year. For the 22 quarters of so-called economic recovery since 2009, real GDP has increased by a meager 2.3% annually. Historically, since World War II, we’ve grown by nearly 3.5% yearly following recessions.

So what’s wrong with this economy now? Increasingly, analysts are coming back to something I have harped on for years: our shrinking labor force participation rate. It shrank to the lowest level in 36 years (since 1978) in December.


In the late 1990s, over 67% of working-age Americans were in the labor force. As of December, that number fell to 62.7%. As the Congressional Budget Office explained last year, “An unusually large number of people have stopped looking for work” in recent years.

Some people (especially Obama supporters) chalk this up to increased numbers of Baby Boomers who are retiring and leaving the workforce permanently. And this is true to an extent. However, the CBO stated last year that retirees made up just under half of the labor force decline since 2007. What about the other half who have given-up and dropped out?

Before I make my next point, let me state the obvious: President Obama was NOT responsible for the Great Recession and the financial crisis of late 2007-early 2009. Yet the fact is that almost 12 million Americans have left the workforce since Obama took office. That means about six million retired and another six million simply stopped working and stopped looking for work.

Why? Some economists say the vast expansion of food stamp and disability programs are keeping people out of the labor pool. This is unquestionably true! Others say that young people are dropping out, partly because more are going to college and partly because the ones who aren’t are getting crowded out of the job market. Actually, all three have contributed to the problem.

Don’t expect the rate to rise anytime soon, say researchers at the Federal Reserve Bank of Cleveland in a study last year. The Fed expects further declines over the next decade or so. The youngest Baby Boomers are still in their early 50s, the researchers say, so boomers will be dropping out of the job market for years to come.

Sadly, the conclusion may be that our shrinking labor force is now incapable of generating economic growth above 2½-3% annually.

Is there a way to reverse this trend? I doubt it, unless the economy is unshackled from rising taxes and onerous regulations, and our leaders adopt a strong commitment to free trade. Unfortunately that’s a tall order given the current occupant of the White House!

In conclusion, the US economy faces numerous problems today – Europe, deflation, the dollar, over-regulation, etc. But in addition to those issues, I believe the growing reality that our economy is hamstrung by a continued decline in the labor force is another worsening headwind for equities.

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