The Greek government announced they will hold a referendum this Sunday for the electorate to decide if they wish to reject or accept a set of measures that will unlock a final disbursement of funds from their second financial bailout programme. The country is technically now in arrears on a €1.5bn repayment due to the International Monetary Fund (IMF) on June 30 and the second bailout programme actually ended on the same day, but these complications are not insurmountable should the Greeks vote “yes” to belatedly accept the reforms-for-financial-aid-package. Voting yes will also pave the way for a third bailout programme which is likely to include various forms of debt relief. A “no” vote will continue the recent gridlock and will likely hasten an eventual Greece exit from the Eurozone (Grexit). Thus, Sunday’s referendum is ultimately about staying in or getting out.
The government will campaign for a “no” vote and in his address to the nation, Greek Prime Minister Tsipras explained that should the Greek electorate turn down the package that was offered to them, he would have the political legitimacy to go back to the negotiating table to ask for more favourable terms from the creditors (the IMF, ECB and the European Commission, collectively known as the “institutions”). However it is far from clear, indeed somewhat unlikely, that the institutions will accede to additional demands from the Greeks. Germany will have to put the size and terms of any new bailout package to an already hostile Bundestag; Spain may see similar demands made by non-centrist opposition parties at their General Election due at the end of this year; and the Irish who took the austerity pill and successfully emerged from their own bailout programme will feel short changed. Furthermore, Italy and France have lagged on structural reforms and may have few incentives to now raise the pace should easier terms be offered to Greece.
A no vote will therefore be negative for the Eurozone and highly negative for the Greeks who are likely to try to struggle on with capital controls, no additional funding from any external source (apart from humanitarian), a dysfunctional if not bankrupt banking system and stagnant if not negative economic growth. Eventually they may choose to default on other remaining loans, including a repayment of €3.5bn due to the ECB on July 20, and a parallel currency may start to emerge. The latter may take the form of IOUs issued by the government which if tradable, as they must be if they are to be convertible into goods and services, will quickly depreciate in value vis-à-vis the Euro. Grexit may eventually follow.
That said, we do not see a return to the high financial and real economy stress that we witnessed in May 2010 or in June 2012. For the rest of the Eurozone, what matters is that contagion is limited, and in particular that depositors and investors do not fear that the Greek experience could be repeated in other Eurozone countries. Policy makers will not want to stop a recovery that is starting to take root and which, Greece turbulence aside, looks sustainable. We take seriously the ECB’s promise that “the Governing Council is determined to use all the instruments available within its mandate” to protect the Eurozone economy. Hence a no vote is likely to bring the ECB pre-emptively into play; this will not be license from the ECB for investors to take risk whatever the outcome, but a reassurance that they will curtail very negative outcomes in financial markets that may stop or reverse the Eurozone’s economic recovery. A Greek exit would also provide further impetus to fiscal integration among Eurozone countries.
One final point – we expect a relief rally in the event of a yes vote. It will certainly be a more emollient outcome than a no. But this will not end the Greek crisis once and for all. PM Tsipras will very likely have to resign and a new government will be formed. There will still be issues surrounding the terms of a new deal, as well the ability of the new government to implement and deliver. The drama will roll on. Stay tuned.
This statistic, which I’ll abbreviate LFPR, is critically important because it’s one of the two key economic variables which can drive the US potential growth back toward the “old normal” (the other is productivity). Recall from Oh Great, Now This that GDP growth = growth in hours worked + growth in productivity. “Growth in hours worked” I simplified for the long-term as working age population growth + the change in LFPR. Productivity is languishing at 0.7-0.8, and working age population growth is almost certainly going to be under 1% over the next seven years, which leaves the participation rate as a potential swing factor. In my last post I glossed over LFPR specifics because it’s complicated. This week, I want to actually dig into the nitty gritty of the LFPR, because whether or not this economic trend can rebound remains an essential determinant of appropriate monetary policy over the short term, and obviously potential growth over the long term.
So, how realistic is a potential bounce in the LFPR, or better yet, a reversal of the trend (see chart 1 above)? The consensus seems to be that at least some of the decline is cyclical, and the trend will therefore reverse as the economy improves. However, after spending quite a bit of time on this subject, a reversal looks doubtful to me. The cyclical drivers seem miniscule compared to the impact of demographic and social realities. If anything the downward trend is set to continue.
The LFPR is the percentage of the population 16 years of age and older who are either working or actively seeking work, as calculated by the Bureau of Labor Statistics (BLS). Every two years, the BLS publishes a labor force forecast which combines their outlook for the LFPR, together with the Census Bureau’s population projections*. This cross-sectional analysis is useful in isolating the demographic effects:
There are two dynamics at play: 1) the participation rates for each age cohort are changing through time, and 2) the babyboom population bulge is moving through the age cohorts downward as time passes.
Two massive shifts in LFPR by age are apparent: first, amongst 16-24 year-olds, the rate has been falling, and the trend is forecasted to continue (yellow). Perhaps it’s obvious, but this trend is a result of increased pursuit of education at the secondary, tertiary and graduate level, as well as increased attendance in summer programs. In general, this is perceived to be a positive development for the economy and it doesn’t seem plausible to assume the country takes a step backward in educational attainment to the benefit of our labor force participation. The second major shift in LFPR by age cohort is the dramatic increase in participation amongst those aged 65 and older (green). Clearly the retirement age, out of necessity or out of desire, is increasing.
Matching up the LFPR by age cohort to the dynamics of the actual number of people in each cohort, we can reconstruct the expected dynamics of the aggregate LFPR to see which effect (the increasing retirement age or babyboom population bulge) is more influential. It turns out that despite a generous extrapolation of retirement age increases, the shear number of retiring babyboomers (red) dwarfs the effect of retirement age creep. The weighted average LFPR shrinks (blue), even though the LFPR for older cohorts is still growing. Younger workers entering the labor force later — sometimes much later– exacerbates the effect. So, it appears accurate to say that the demographic effect on the LFPR is real, significantly negative, and unlikely to reverse.
The exercise of matching up population projections together with LFPR projections by age cohort is effective in isolating the demographic effect on the headline LFPR, but doesn’t say much about why the granular LFPR trends and extrapolations look the way they do. For that, we turn to some punchy analysis first carried out by Shigeru Fujita at the Philadelphia Fed, which he recently updated**. When the BLS compiles their survey data, there are three reasons respondents can give for their non-participation in the workforce: retirement, disability, and other. Using the actual survey datasets at the respondent level, Fujita is able to further divide “other” usefully into three more categories: “not working but want a job,” “do not want a job: in school,” and “do not want a job: not in school.” Fujita presents the change in Labor Force non-Participation Rate (1 – LFPR) since the 2000 peak due to each of these five reasons, displayed in Charts 2 and 3. This analysis, though simple, is striking in its clarity.
First, the contribution to the decline in LFPR from retirement and disability combined is substantial, at 2.8 percentage points or roughly 60% of the 4.5% decline. Naturally, this includes the demographic affect of ageing babyboomers illustrated by the cross-sectional analysis above. Our intuition suggests that people don’t typically become un-retired or un-disabled, particularly in light of the relatively strict definition of “disabled” the BLS employs. Fujita takes this a step further and calculates the historical probability of a retired or disabled worker reentering the labor force, and the numbers are low: on the order of 1.5% in a given month for either.
Secondly, Fujita’s breakdown of “other” reveals that individuals who are not working by reason of attending school contributed a further 1.4 percentage points to the LFPR decline. Given that we do not expect the secular shift toward increased educational attainment to reverse, combining this effect with disability and retirement brings the total explanation for the decline in LFPR to 93% “unlikely to reverse.”
There are two final critical takeaways from the Fujita analysis. First, those labor market non-participants that fall into the “not working but want a job” category, who should reasonably be considered marginally attached to the labor force and clearly a source of potential bounce-back in LFPR if they return, peaked at only 0.6 percentage points contribution to the decline. Additionally, that peak was in 2012, and since then nearly half of the slack has been worked off, despite the aggregate LFPR continuing to decline. Secondly, the change in those who “do not want a job: not in school” have actually added to the LFPR on the margin in the post-crisis period. This surprising finding suggests that able-bodied individuals have been sucked back into the labor force for economic reasons, and this effect has been insufficient to halt the slide in LFPR. As the economy continues to recover, if anything, the reversal of this effect could further diminish the LFPR.
In summary, the work of the BLS illustrating the demographic impact on LFPR, coupled with Fujita’s innovative presentation of the raw survey results, seems to demonstrate that the overwhelming majority of the decline in the Labor Force Participation Rate is unlikely to reverse. Whether we call that “structural” or not seems irrelevant. Even if the secular trend toward more schooling abruptly halts, the downward trend in LFPR should continue until the babyboomers are completely across the retirement threshold (another decade out). If the retirement age stops rising, the downward trend in LFPR will worsen. If these conclusions leave you scratching your head or in disbelief, I encourage you to read the three papers (URLs below). Implications for monetary policy in the US are critical, namely that hikes need to happen, but potentially terminate at a lower rate than the market anticipates.
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