What’s it: Labor force refers to the share of the working-age population currently employed and those actively looking for work. The working-age population usually refers to those aged 16 to 64 years. However, in some countries, the definition may be different. For example, in Indonesia, it refers to those aged 15 and over.
The labor force represents the supply of labor and affects a country’s potential output. We also use it to calculate several economic indicators, such as the labor force participation rate and the unemployment rate.
Composition of the labor force
In general, the labor force consists of two general groups:
- Employed persons
- Unemployed persons
Employed persons are individuals who are working. This category includes part-time workers, temporary workers, and full-time workers. Those who have jobs and get paid but are sick, on leave, on vacation, and in training also fall into this category.
Unemployed persons are individuals who are currently unemployed but are actively looking for work. They may be recent graduates, individuals changing jobs, unemployed workers, and returning to actively seeking work. As long as they haven’t found the right job but are actively looking for work, they fall into this category.
The labor force excludes working-age individuals who are not actively looking for work. Examples include students, housewives, retired persons, and individuals who care for children or other family members. Likewise, with discouraged workers, they stop looking for work. So, we exclude them in the labor force calculation.
Factors affecting the labor
- Population growth. It depends on the birth rate and death rate. A high population increase adds to the workforce.
- Participation rate. The higher the labor force participation rate, the greater the number of workers available to meet business demand.
- Net immigration is the difference between the number of immigrants and emigrants, that is, the number of individuals of working age who enter and those who leave a country. Thus, positive net immigration increases the labor force.
- Age composition of the population. In some countries, such as Japan, the elderly population dominates. Meanwhile, in developing countries, such as Indonesia, the working-age population dominates. The younger the population composition, the greater the number of the workforce.
- Labor mobility. When mobility is high, unemployed workers quickly find new jobs. It reduces the likelihood that they will become discouraged and stop looking for work.
- Economic conditions. Changing economic conditions also affect the size of the labor force. A recession might make people stop looking for work.
Labor mobility
Highly skilled and highly educated workers are usually more mobile. They can respond quickly to changing business needs, and they are easy to adapt and upgrade their skills when changing jobs, which allows them more flexibility.
When workers are more mobile, they will find it easier to find new jobs when fired. They also didn’t take long to change jobs. Also, they have more flexibility to negotiate wages. This is important to avoid feeling discouraged when looking for a new job.
Conversely, when immobile, workers are more likely to stop looking for work. They see their skills as incompatible with the demands of the business and find it difficult to renew them.
Farm labor is an example. Their education and skills are low. As agricultural mechanization progressed, the demand for their services decreased. Some of them are unemployed and unable to switch to other sectors, such as manufacturing. Finally, they stop looking for work and fall into the category of structural unemployment.
Why labor force data is important
The labor force represents the supply of labor for the production of goods and services. Its quantity and quality affect economic output. The larger the labor force, the greater the economy’s productive capacity.
Meanwhile, the quality of the labor force refers to the skills and knowledge inherent in workers. Quality determines its productivity. Even though the labor supply does not change, they can produce a greater output when they are more productive.
A diverse workforce is also essential for innovation. Diversity presents a variety of perspectives, which is important in some industries, such as technology.
Calculating the unemployment rate
We use labor force data to calculate the unemployment rate. In this case, we are using the total labor force as the denominator. Meanwhile, for the numerator, we use the number of unemployed workers. The following is the unemployment rate formula:
- Unemployment rate = Number of unemployed workers/Labor Force
Government policy focuses on the unemployment rate. Other macroeconomic objectives include full employment, low inflation, sustainable economic growth, and an equilibrium balance of payments.
The economy is at full employment when the unemployment rate is at its natural level. When that happens, real GDP equals potential GDP.
However, the economy often revolves around full employment. When below full employment, the unemployment rate is high, which usually occurs during an economic recession. Conversely, when above full employment, the unemployment rate is low, but inflation pressures are high.
The government then uses several fiscal and monetary policy instruments to influence the unemployment rate. Both affect economic activity and job creation.
When the economy operates far below full employment, such as during a recession, the government adopts expansionary policies to stimulate economic growth and production activity. If successful, it will create more jobs as the business increases production.
Conversely, when the unemployment rate is lower than the natural rate, the economy overheats due to high inflation rate pressures. Although the unemployment rate is low, high inflation harms the economy and can lead to hyperinflation.
To overcome this condition, the government adopted a contractionary policy to moderate the inflation rate. Economic activity weakened, and businesses began to reduce their production levels and the number of workers. Finally, the unemployment rate returned to its natural level.
Calculate the labor force participation rate
The labor force participation rate measures the percentage of the labor supply available to produce goods and services. To calculate it, you divide the total labor force by the working-age population.
- Labor force participation rate = Total labor force/Total working-age population
The presence of discouraged workers influences the statistical interpretation and can lead to biased conclusions on the unemployment rate. Therefore, you should use the labor force participation rate and unemployment rate data together.
A declining unemployment rate does not necessarily indicate an improving economy. That may be due to an increase in the number of discouraged workers rather than an increase in employment. Discouraged workers do not fall into the unemployment category because they are not looking for work. Thus, when we leave the labor force, we no longer categorize them as unemployed. This explains why, in some cases of recession, the unemployment rate is still low.
Measure potential GDP
The labor force is a source of long-term economic growth. They represent the supply of labor in the economy. Thus, when their number increases, it increases long-term production capacity.
Apart from the quantity side, the quality of the workforce is also essential to sustain long-term growth. As workers become more productive, they can produce more output using the same input. Education, training, and technological advances are among the factors that affect the quality of labor.
Economists use labor force data to measure a country’s potential output growth (potential GDP). Together with capital, the labor force forms the production function as in the Solow growth model. Specifically, the potential GDP growth rate is defined as :
- Potential GDP growth rate = Growth in technology + Growth in labor + Growth in Capital
This model posits that the potential GDP growth rate can be broken down into three key components:
- Growth in technology: Advancements in technology and innovation can significantly enhance productivity, allowing workers to produce more goods and services with fewer resources.
- Growth in labor: As discussed earlier, an expanding and skilled labor force contributes to potential GDP growth.
- Growth in capital: Investments in physical capital, such as machinery and infrastructure, can also increase productivity and economic output.
