What If We Just Need Fewer Jobs?

Executive Summary

In what had been a decidedly subpar recovery in the labor market, employment growth has strengthened significantly in 2014. With 11 months in the books, job gains are on pace to record their best year since 1999. The stronger pace of hiring has led the unemployment rate to decline 1.2 percentage points over the past year—the largest annual drop in 30 years. Yet, is the recent pace of payroll gains sustainable?

Job growth is a function of both the supply of and demand for labor. With labor force participation having fallen sharply since the Great Recession and growth in the working-age population slowing, growth in the supply of labor, measured by labor force growth, looks to have downshifted in recent years. As a result, the number of new jobs needed each month to keep the unemployment rate steady has also declined. We estimate that from 2015 to 2020, payroll growth of around 65,000 jobs per month should be sufficient to absorb new entrants into the labor force and to exert neutral pressure on the unemployment rate. This marks a notable downshift from a trend of around 150,000 in the 1980s and 1990s, and even the early 2000s when trend employment growth slowed to around 120,000.

Supply, Demand and the Economic Fundamentals Behind Job Growth

Since the Great Recession ended, the labor market has lagged significantly behind other sectors of the economy. After cutting 8.6 million jobs between Dec. 2007 and Feb. 2010, employers had been slow to re-hire as demand has been precariously weak in the wake of the 2008 financial crisis. Five years after the current economic recovery began, hiring has finally shifted into higher gear. Employers have added 2.65 million jobs in the first 11 months of the year, the strongest showing since 1999 with still one month to go before the year’s final tally. The unemployment rate has duly fallen to its lowest level since 2008 as job growth has outstripped labor force growth.

How many jobs does the economy need to add each month to see a further decline in the unemployment rate? A good benchmark is the trend rate of job growth. The trend rate of job growth is effectively the number of jobs needed to absorb new entrants to the labor force without affecting the unemployment rate. Above-trend job gains would reduce the unemployment rate, whereas below-trend job growth would drive the unemployment higher.

Job growth is ultimately a function of the supply of and demand for labor. Although fluctuations in demand are the driving factor of job growth in the short run, the supply side plays a key role in the overall trend in job growth. Labor supply is driven by growth in the working age population as well as this group’s rate of participation in the labor market. Admittedly, the participation rate can be affected by demand conditions in the short run. Over time, however, the labor force participation rate has been dominated by secular trends independent of the business cycle.

Historical estimates for the trend in job growth have centered around 150,000 new jobs per month. 1 This is close to the average number of jobs created per month from 1960-1999 (145,000). 

During this period, however, labor force growth was bolstered by two major secular forces: the demographic effect of the baby boomers joining the workforce beginning in the late 1960s and a cultural shift of rising labor force participation among women beginning in the early 1960s (Figures 1 & 2).

Now these forces have reversed. Over the past 10 years, growth in the population age 16 and over—the working-age population—has slowed to an average of 1.0 percent per year compared to 1.5 percent from 1960-1999. In addition, the labor force participation rate has been trending lower since the early 2000s. The labor force participation rate for women began to level off in the late 1990s and could no longer offset the long-term decline in the participation rate for prime-age men. A few years later, the baby boomers began to turn 65, an age when participation in the labor force—despite inching up in recent years—drops off dramatically.

These secular shifts in participation have been exacerbated by the Great Recession. The labor force participation rate has fallen 3.2 percentage points since late 2007. The participation rate for prime-age workers has showed some early signs of stabilizing, but does not yet point toward the long-awaited cyclical rebound that would lift the overall participation rate. Together with weaker population growth, the rate of labor force growth has slowed in recent years and suggests that the trend rate of employment growth has also fallen, meaning fewer new jobs are needed each month to reduce the unemployment rate.