Free Exchange: The Missing Millions

Rising disability claims may explain America’s shrinking labour force

IN THE early 1980s the distressing persistence of high unemployment in Europe was labelled “Eurosclerosis”. Some now wonder whether “Amerisclerosis” is the right word to describe America’s labour market. It is true that unemployment has slowly dropped from a peak of 10% in late 2009, to 7.3% at present. But this decline overstates the health of the jobs market.

The labour-force participation rate, the share of the working-age population either working or looking for work, has plunged from 66% in 2007 to 63.2% in August, a 35-year low. If those people who have simply dropped out of the labour force were classified as unemployed, the headline jobless rate would be much higher.

This drop in the participation rate is striking by international standards, too. Among 34 (mainly rich-country) OECD countries, only in Ireland and Iceland did participation rates fall farther between 2007 and 2012. In Italy and Britain, where unemployment rates have risen by a roughly similar amount as in America, labour-force participation rose (see left-hand chart).

Many economists believe much of this decline in participation is structural. They argue it reflects increased college enrolment by the young, the approach of retirement for the baby-boomers and a levelling-off in women’s participation after rapid post-war increases. That is doubtless part of the story, but it does not explain everything. Participation rates have declined sharply for “prime-age” men and women between 25 and 54, and risen slightly for those aged 55 and over. By contrast, participation has generally risen for prime-age women in other OECD countries, and risen or fallen only slightly for men.

Cyclical factors are also at work. The unemployed may give up looking for work after long spells of unemployment. Bart Hobijn of the Federal Reserve Bank of San Francisco says that in much of Europe, jobless benefits, which generally require recipients to keep looking for work, are more generous and last longer than in America. That may explain why participation rates there have not fallen. In America, he says, workers are more likely to go back to study or stay at home. The so-called U-6 unemployment rate, which includes those who want jobs but haven’t looked lately or have given up, and those who work part-time because they cannot find full-time work, rose more in the past five years than the official unemployment rate.

In a 2011 paper* Mr Hobijn and three co-authors noted that many of those reported as newly unemployed have in fact been out of work for months but have not previously been recorded as unemployed, probably because they have taken a break from the job search. The authors reckon that these “fringe” workers are much more prevalent than in previous cycles. The big question is whether such workers will start looking for work again in time. The signs are worrying. If you look at U-6 unemployment over just the past two years, rather than the past five, it has fallen faster than official unemployment. That suggests many of the people on the periphery of the labour force have now left it entirely. One explanation for that may be government benefits that affect incentives to look for work.

DI why

More generous unemployment benefits tend to elevate participation rates since workers must be looking for work to qualify. With disability insurance (DI), however, the opposite applies: to qualify applicants must generally demonstrate that they cannot work. In theory, disability and unemployment should not be correlated–and from 1966 to 1985 they were not, according to a new study prepared for the Brookings Papers on Economic Activity by Olivier Coibion and two others. But in 1984 DI eligibility criteria were eased so that applicants could qualify based on a combination of conditions rather than just one. Since then, highly subjective conditions such as back pain and mental illnesses have grown to account for most DI beneficiaries, and claims have become more correlated with unemployment (see right-hand chart). That strongly suggests that many workers find a way to qualify for DI when other benefits have been exhausted.

Between 2007 and 2012 the number of applicants for DI shot up from 11.2 per 1,000 working-age people to 14. Unpublished research by Mary Daly of the San Francisco Fed, Richard Burkhauser of Cornell University and Brian Lucking, a graduate student, estimates that this rise in applications equates to 2.6m people. Depending on how many of those applicants are eventually awarded benefits, this could explain between 31% and 59% of the decline in participation among 16-to-64-year-olds.

These results suggest that if it were not for people receiving disability insurance, reported unemployment would be far higher. Although DI recipients may initially have climbed because the economy was weak, their numbers will almost certainly not decline when it strengthens again; only 4% of beneficiaries return to work within 10 years. The proportion of working-age adults on DI has risen from 1.3% in 1970 to 4.6% in 2013. The impact on participation rates may be cyclical at first and then become structural.

Europe may have useful lessons here. In the 1970s DI became more generous in the Netherlands, and case loads exploded. Had the increase in disability numbers shown up in unemployment instead, the Dutch unemployment rate, which was 6% in 1980, would have been 13.4%, according to a 1992 report by Mr Burkhauser and two co-authors. The crushing expense of DI eventually forced the Dutch government to make reforms about a decade ago, primarily by making employers bear more of the expense of employees who end up on the system. Since then, case loads have dropped. America, whose DI trust fund is expected to run dry in 2016 on current trends, should show similar resolve.

Click here to subscribe to The Economist

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at