One of the great constants in the world economy in the past few decades has been the consistently strong growth in the US labour force. This has given American economic performance a demographic head start compared with other developed countries. Not only has it been the main factor ensuring that US GDP growth has remained well above that in Europe, it has also injected flexibility and dynamism into the US economy. But all of that is now at risk. The US labour force suddenly stopped growing in 2008, and has been falling slightly ever since.

As a result of this sudden disappearance of growth in the labour force, the unemployment rate has fallen by 1.5 percentage points in the past two years. But it is doubtful whether this represents a genuine tightening in the labour market. More likely, the underlying growth in the labour force has been disguised by the fact that potential workers have been discouraged from remaining in the labour market by the shortage of job opportunities. Without this shrinkage in the labour force, the unemployment rate would have risen to more than 11 per cent by now. It is urgent to fix this problem before the labour market atrophies, as it did in Europe in the 1980s.

In the long term, the growth of the labour force is determined by the growth of the population of working age, and by the behaviour of the participation rate. In the US, the growth of the population has generally been about 1-1.5 per cent per annum in recent decades, partly driven by natural growth, and partly by net migration. In recent years, the population growth rate has fallen very slightly (to about 0.9 per cent per annum), but this does not account for the sudden change in the growth of the labour force. 

The factor to blame has been the participation rate. Prior to the late 1990s, this rate had been rising continuously throughout the post-war period, driven mainly by a rise in the number of (mostly) married women who wanted to find jobs. Hence, the labour force grew even more rapidly than the population of working age. However, in the last decade, the participation rate for women has hit a ceiling. The reasons for this are not entirely clear, though we can all speculate about the change in social behaviour which might have caused it. In addition, young people have been choosing to spend longer in education, possibly reflecting the rise in the relative earnings of educated workers. These two factors taken together caused a gradual drop of around 1 percentage point in the participation rate from 1998-2008. (See this analysis.)

Since then, the participation rate has fallen precipitously, by over 2 percentage points in just three years. Long term factors cannot explain this sudden change in behaviour. Since the break in trend occurred exactly when the recession began, by far the most likely explanation is a severe shortage of jobs caused by the depth of the recession. Disenchanted with a lack of job opportunities, people have simply stopped looking for work.

Read More: http://blogs.ft.com/gavyndavies/2012/01/12/americas-incredible-shrinking-labour-force/#axzz1jJYbmbIc