Key Job Indicator May Not 'Improve' Much More

The labor force participation rate has inched upward, but may be hitting its limit.

Job offerings in a local newspaper.
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Beyond the 7.9 percent unemployment rate and 171,000 new jobs, many labor market watchers spent Friday talking about 63.8 percent. That's the labor force participation rate for October, and it was up by 0.2 percentage points over September—along with the new jobs, good news for the economy. While economists and pundits have recently been rooting for this number to go up every month, there is reason to think it's approaching its ceiling.

[READ: Employers Add 171,000 Jobs in October]

"We expect it to top out probably in 2015 as the recovering labor market gains momentum," says Sophia Koropeckyj, a managing director at Moody's Analytics. She says she expects the figure to hit 64.1 percent at most in the coming years—barely above where it is now.

That's because a massive cohort of baby boomers is hitting retirement age, meaning that they will soon leave the labor force—the group of Americans who are either working or looking for work. As all of those people drop out, the participation rate will only be able to climb so high.

For all of the bluster over unemployment, the participation rate is crucial because it helps show how meaningful the unemployment rate is.

October's 7.9 percent jobless rate doesn't mean that 7.9 percent of all working age Americans are without a job. Instead, it means that of all people in the labor force, 7.9 percent are unable to find work.

That means that when the unemployment rate goes down, it can be because more people found jobs, but it can also be because fewer people are looking.

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To understand this more, brace yourself for a small math problem: Imagine an economy with 15 residents, ten of whom are in the labor force. Let's say that in September, five of those people were looking for work, putting the unemployment rate at 50 percent. If two of those people found jobs in October, that would cut the jobless rate to around 30 percent (or 3 people looking for work, divided by 10 in the labor force). But if two people instead decided to stop looking, the labor force would shrink as well, and the jobless rate would be around 38 percent (or 3—the number of people now looking for work—divided by 8—the new, smaller labor force). That jobless rate is lower than it was to begin with, but no more people are actually working.

That's where the labor force participation rate comes in. The rate stood at 63.8 percent in October, up slightly from September, but far below 2007's high of 66.4. Before then, the rate had been even higher, hovering above 67 percent around the turn of the century.

That's why the October jobless rate grew from 7.8 to 7.9 percent—410,000 more people reported being employed, but 170,000 more reported being unemployed. That also means that a greater figure, 578,000, reported being in the labor force. And it's also why, despite the growing jobless rate, the October jobs report can still be considered relatively positive.

Because the participation rate fell so far from pre-recession levels, it's common to read post-jobs-report commentaries lamenting its current low level. After all, one reason it fell is because people stopped looking for work because they thought there were no available jobs—a group of workers aptly called "discouraged workers," in econo-speak.

[READ: GDP Outpaced Expectations in Third Quarter]

It's true that when people outside the labor force see the job market improve, they might feel more optimistic and start sending out resumes again. But that only will bring so many people back.

Consider our imaginary 15-person economy again. The five people who were not in the labor force to begin with might be stay-at-home parents or retired, meaning that no amount of economic growth is going to entice them to look for a job.

Furthermore, imagine that two of the people still working are 64 years old. Even if the two workers who left earlier come back to the labor force, those two older workers could be retiring soon.

That's the situation facing the U.S. economy, and it's why some economists say we shouldn't have high hopes for a jump in the labor force participation rate. Baby boomers are just beginning to hit retirement age. Workers have been delaying retirement in recent years—the participation rate for people 55 and over has grown significantly over the last decade, from nearly 34 percent at the start of 2002 to 40.6 percent now—but that huge group of workers will eventually leave the workforce, and quickly. In other words, analysts may soon have to shift how they gauge what has been one of the most-watched job indicators in the recovery.