Labor Force Growth and Long-Term Trends

Credit & Financial Management Review, First Quarter 2009 by Tokic, Damir

Abstract

U.S. labor force had 1.59% annual growth rate from 1947 to 2007. During the same period, GDP grew at 3.38% annually and the stock market grew at around 7.8% a year. Current predictions are that the labor force growth will slow to around 0.6% a year to 2050. Will that translate into around 1.25% a year growth in the GDP and around 3% a year growth in the stock market until 2050?

"Don't worry, it's been taken care of, as long as there are people, there will be money." Unknown musician/thief during the World War II

The U.S. GDP has been in a clear uptrend from 1947-2007 with an annual growth rate at about 3.38% (Exhibit 1). There were only 10 recessions during the same period during which GDP slightly contracted. How can one explain the consistency and resiliency of the U.S. economy during the last 60 years? Is this growth trend likely to continue for the next 50-plus years?

GDP consists of consumer spending, business investment, government spending, and the net exports. Intuitively, aggregate consumer spending depends on the size of the labor force, the ability of consumer to spend and the desire/need of consumer to spend. The function of business investment is to supply the end consumer with goods and services needed for consumption. Therefore, business investment heavily depends on consumer spending. Theoretically, as long as the labor force grows and as long as new jobs are created, consumer spending is likely to grow, and thereby, GDP is likely to continue to grow as well. Consequently, the labor force growth appears to be is a key variable for future economic growth.

Major economic up-trends

The civilian labor force has been in a major (mostly uninterrupted) up-trend from 1948 to 2007 with an average annual growth of 1.59% (Exhibit 2). The growth has been particularly strong in mid 1960's when baby boomers begin to enter the labor force. Baby boomers had begun the enter the labor force as teenagers, which is evident from the labor force participation rates of 16-19 age group, which was in a uptrend that peaked in late 1970's. Also, more women had begun to enter the labor force, forming another major uptrend that peaked and leveled off in mid 1990's. During the same period, the labor force participation rates for men age 20 or older were in a long-term downtrend. In other periods, including more recently, net immigration has provided additional boost to the labor force growth.

The opportunity to nurture a consistent growth in the labor force has provided the U.S. economy with a solid foundation to grow as well. The primary challenge was to match the growth in the labor force with growth in civilian employment. U.S. economy was successful in creating jobs as evident by the clear uptrend in the civilian employment, which grew at 1.57%/year and nonagricultural payrolls, which grew at 2.14%/year (Exhibit 3). Growing labor force and growing employment ensured steady growth in personal income and personal expenditures, which grew at 7.3%/year and 7.42%/year, respectively. Sales of retail stores grew at 3.72%/year, providing another evidence of consistent strength in consumer spending. Not only consumer had increased ability to spend due to jobs creation, but they also extended their paychecks with credit purchases, as evidenced in 10.27%/year growth in consumer installment credit outstanding.

Business spending/investment kept pace with consumer spending. The index of industrial production has been in a major up trend with an annual growth of 3.39% (Exhibit 4), and so have manufacturing and trade sales with 3.23%/year growth. New orders for durable goods, consumer goods/materials, and non-defense capital goods have been growing at 2.94% / year, 5.56%/year and 6.90%/year, respectively. Merchandise imports have been growing at 10.76%/year, but also U.S. exports have been growing at 8.98%/year.

The relation between the demand for goods/services and supply of goods/services has been evident in inflation indices. CPI all items, CPI less food and energy and PPI have been growing at 3.82%/year, 4.06%/year, and 3.00%/year, respectively, (Exhibit 5), while the monetary base grew at 6.40%/year.

Economic activity related to consumer spending, business investment and international trade resulted in 7.18% growth/year in corporate profits after taxes, which positively affected stock prices where index of most common 500 stocks grew at 7.80%/year (Exhibit 6).

All these previously mentioned variables have been in a major up-trend over the last 50-plus years with highly significant and near-perfect correlations among them with correlation coefficients ranging from .950 to .999. Are these trends likely to continue? First, one needs to understand what happens during the recessions?

What happens in recessions?

Generally, before a recession, consumer confidence and expectations increase signaling that consumer is willing to boost the consumption. At the same time, the unemployment rate drops significantly and the industrial capacity utilization increases to a level where it becomes difficult for production to keep up with consumption without a significant rise in inflation. Thereby, prior to a recession, inflation rises, causing the increase in interest rates. Further, the Fed hikes the Federal funds rate to ease inflationary worries. Eventually, stock market negatively responds to higher interest rates and starts a downfall. Consequently, the consumer confidence falls as well.