Almost 350,000 American workers dropped out of the labor force in November, according to new data from the Bureau of Labor Statistics. That’s four times the number of net new jobs that month. So although the unemployment rate fell to 6.7 percent, overall the report wasn’t good news.
Here’s what’s even scarier: When it comes to people dropping out of the labor force, the U.S. is probably just getting started. Rather than find jobs, a wave of unemployed Americans is likely to stop looking for work as a result of the expiration of extended federal unemployment benefits on Jan. 1.
Recipients of unemployment benefits are required to actively search for work. With few job openings around, losing that requirement takes away the only reason many unemployed Americans kept searching. A study by economists Henry Farber and Robert Valletta found that unemployment insurance has little effect on people’s readiness to take a job, but it has a big one on people’s decision to keep searching for work.
The view that desperation will force the unemployed to get a job, which seems to drive Republican opposition to extending federal benefits, just isn't supported by the data. And that’s leaving aside the moral problems with starvation as a policy strategy. Moreover, the long-term unemployed who have lost benefits have especially little chance of finding work, research from economist Rand Ghayad shows.
North Carolina cut benefits last summer, and if the results were replicated nationally, then almost all 1.3 million people whose benefits expired at the start of 2014 will drop out of the labor force within months. That would reduce the labor-force participation rate a full 0.8 percentage points, to 62 percent. And since you have to search for work to count as unemployed, the unemployment rate would fall by the same amount, to 5.9 percent.
The end of benefits will be bad news for the economy in two more ways. First, unemployment insurance is highly potent as fiscal stimulus. Ending it will slow growth by 0.2 to 0.4 percentage points this year, according to the Council of Economic Advisers.
Second, the false drop in the unemployment rate will also create a problem for monetary policy. The Federal Reserve has said it won’t consider raising interest rates until inflation rises above 2.5 percent or the unemployment rate dips below 6.5 percent. With November’s labor-force drop and more to come, the U.S. economy will cross the threshold far sooner than the Fed expected -- and because of a measurement problem, not an economic boom.
How will the Fed respond? Policy makers there are probably considering two options. They could lower the unemployment threshold -- a 6-percent goalpost has been discussed in the past as a way of providing extra stimulus. Or they could drop the threshold entirely. Either way, the rash of labor-force dropouts means that a 6.5-percent unemployment rate is no longer consistent with their objectives.
Congress is still considering an extension of unemployment benefits, but the odds of passage look grim. The House of Representatives probably won’t sign on, even just for three months and with reduced benefits.
But don’t let Congress’s dysfunction convince you that extending benefits is at all controversial. It would be one thing if Jason Furman and Gene Sperling, two of the Obama administration’s top economists, were the only ones on board. But they’re not. So are Michael R. Strain and James Pethokoukis of the right-leaning American Enterprise Institute, Reihan Salam of the National Review, and economist Scott Winship, Rep. Paul Ryan’s economic policy adviser.
Last week’s jobs report was shocking. But we’re about to see several more like it -- anemic job creation and sharp contraction in the labor force -- if Congress doesn’t get its act together.
(Evan Soltas is a contributor to the Ticker. Follow him on Twitter.)