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Canada Beats the U.S. on Workforce Participation. Why?

The Flags Unlimited facility in Barrie, Ontario, Canada.

Photograph by Brent Lewin/Bloomberg

The Flags Unlimited facility in Barrie, Ontario, Canada.

Economists and non-economists alike have been struggling to understand why so many people have been dropping out of the U.S. workforce. See here, here, and here, for example. JPMorgan Chase (JPM) economists Silvana Dimino and Michael Feroli bring an intriguing new piece of data to the discussion today: Canada.

As they note, labor force participation has fallen much more slowly in Canada than in the U.S., standing at 66.4 percent in Canada, vs. 62.8 percent in the U.S. As recently as 2002 the two countries’ levels were about equal. The economists run through potential explanations and reject most of them.

Demographic differences? No. Aging accounts for essentially none of the discrepancy in participation rates. Definitional differences? Also no. Slowness of the U.S. economic recovery? No again–the two economies have recovered at roughly the same pace.

The culprit, Dimino and Feroli suggest, is that the U.S. suffered a steeper downturn in participation in the Great Recession, and institutional factors have kept the U.S. rate from rebounding to normal. The two institutional factors they cite are disability benefits and means-testing in the tax code.

The U.S. disability rolls grew 5.3 percent in 2010 from a year earlier, apparently in part because some people went on disability to support themselves financially. Recent growth in the rolls has been slower. The problem is that once someone goes out on disability, he or she is unlikely to return to work. The JPMorgan Chase economists cite that as an example of hysteresis—the tendency of a system to get stuck in its new state.

Means testing could be a culprit as well, they suggest, citing recent work by the Congressional Budget Office. The idea of means testing is to phase out government benefits as incomes rise. While that saves the government money, it discourages people from working more–each extra dollar they earn decreases what they get in benefits. “It is hard to envision that this caused the decline in participation, but it may be serving to ossify the decline caused by the shock of the Great Recession,” they write. In Canada, they say, it appears the discouragement of work caused by means testing is smaller.

Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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