Last week’s employment report showed the U.S. unemployment rate falling to 3.6%, a multi-decade low. With little room for the unemployment rate to fall lower, many economists are growing increasingly concerned with the availability of labor supply and, in turn, the prospects for near-term economic growth.

Sustainable economic growth is fueled by equilibrium between demand and supply – as demand increases (alongside wage inflation, tax cuts and general asset price appreciation), supply must rise as well. Should this relationship deteriorate, inflation may materialize, which, at today’s juncture, could complicate the Fed’s accommodative stance on monetary policy. As a result, limited labor supply calls into question the potential for continued U.S. economic growth.

As the unemployment rate continues to fall, investors have turned their attention to the labor force participation rate (LFPR), the percentage of the civilian population, aged 16 or older, working or looking for work, as an alternative source for additional labor supply. As it currently stands, the LFPR is roughly 3.6 percentage points lower than the pre-financial crisis peak of 66.4%, driven mostly by the retirement of the “baby boom” generation.

Given that the economy continues to grow and the labor market continues to tighten, it may be tempting to assume that cyclical factors have continued to depress the LFPR. Unfortunately, this does not appear to be the case. As shown below, the “cyclical” effect on the LFPR has more than dissipated. In fact, based on current estimates, the LFPR is roughly 20 basis points higher than it would be otherwise thanks to cyclical factors – the cyclical effect is boosting, rather than dampening, the LFPR.

This factor, combined with a rapidly falling unemployment rate for persons with only a high school degree and an overabundance of unfilled job openings, suggests that the economy is starved of high quality labor. As a result, even if the LFPR grinds higher, the long-term growth potential for the U.S. economy remains limited and, as a result, revenue growth should slow and rates should hold steady.

Labor supply is severely limited

Labor force participation rate decline since 2007 peak

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Source: BLS, J.P. Morgan Asset Management. The cyclical effect is the decline in labor force participation due to the fact that unemployment is high relative to the starting point of this analysis, which was 4.6% in January 2007. “Other” represents the drop in the LFPR that cannot be explained by age or cyclical effects. Data are as of May 10, 2019.