The Hot New U.S. Labor Market

Why unemployment can stay low

Only a few years ago, the economic consensus was that the natural rate of unemployment--the level below which inflation was bound to accelerate--was somewhere around 6%. Yet joblessness has been 5% or less now for 29 straight months, and inflation has declined steadily through the 1990s, hitting a 12-year low last year.

What accounts for this amazing coincidence of modest joblessness and modest inflation? In a recent study published by the Brookings Institution, economists Lawrence F. Katz of Harvard University and Alan B. Krueger of Princeton cite several developments that suggest unemployment, currently at 4.2%, can stay relatively low without sparking inflation and upsetting the economic apple cart.

The most obvious development is demographic--the aging of the labor force. Because young workers are inexperienced and uncertain about their job choices--spending more time looking for work and changing jobs more often than others--they suffer relatively high unemployment. Thus, both overall joblessness and the so-called natural unemployment rate tend to be relatively high when the proportion of youths in the labor force is large, and to fall when the proportion shrinks.

As it happens, the youth contingent has been shrinking in size for some time. Since hitting a peak of nearly 25% in the late 1970s, the labor-force share of people 16 to 24 years old has fallen to 16% in recent years (chart). The shift since the mid-1980s alone, according to the study, has lopped nearly half a percentage point from the overall unemployment rate.

Another factor is the doubling of the adult population in prison since 1985--with 2.3% of the male labor force behind bars at last count. Assuming a fair number of these inmates would be counted as unemployed if they weren't locked up, Katz and Krueger figure that increased incarceration has lowered the jobless rate by around 0.17 of a percentage point since the mid-1980s.

More significant may be the growth of the temporary-help industry, whose share of employment has jumped from 0.5% in the early 1980s to over 2.2% today. Not only do many people who would otherwise be unemployed now work as temps as they look for permanent jobs, but the availability of temp agencies allows employers to fill vacancies more easily and, in some cases, to minimize wage pressures by keeping the new hires on temp payrolls. The two economists think such changes could have cut joblessness in the past 15 years by as much as four tenths of a percentage point.

Are such developments likely to lead to a high-employment economy in the years ahead? Katz and Krueger are hopeful. While incarceration policy could change, they point out that the shift toward an aging workforce that lowered unemployment in recent decades won't reverse over the next decade. And they think that the labor market improvements fostered by the temporary help industry are likely to endure.

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