What’s it: Labor force participation rate is the labor force’s proportion to the working-age population. The labor force consists of working-age individuals who are currently employed and those who are not yet employed but are actively looking for work. Meanwhile, the working-age population refers to individuals between the ages of 16 and 64.
This statistic is useful for analyzing the labor market, especially when you pair them with the unemployment rate. When the economy thrives, the participation rate increases as the prospects for employment and wages improve.
Calculates the labor force participation rate
Calculating the labor force participation rate is relatively easy because it only requires arithmetic operations. You calculate it by dividing the labor force by the working-age population. To get a percentage, you then multiply the result by 100. The following is the formula for the labor force participation rate.
Labor force participation rate = (Labor force / Working age population) x 100
The definition of the working-age population may differ between countries. It usually refers to those aged 16-64 years; however, some countries may use the aged standard of 15 years or more as in Indonesia.
Meanwhile, the labor force includes the working-age population (16-64 years) and:
- Currently working. This category also includes those who have jobs but are on leave, on vacation, sick, in training, or self-employed.
- Actively looking for work. This group consists of recent graduates or those who are currently moving to other jobs. Unemployed workers and returning to actively seeking work also fall into this category. The definition of “actively seeking work” varies between countries. Some countries define it as people actively looking for work in the past four weeks.
The labor force excludes the working-age population who are not actively looking for work. They include:
- Individuals who take care of the household
- Individuals who are chronically ill
- Discouraged workers
Discouraged workers refer to individuals who become dispirited and stop looking for work. They find it difficult to find work due to factors such as inadequate education and skills. Or, they lack confidence because of discrimination, too-old age, or shrinking employment. They became discouraged and decided to stop looking for work.
Interpreting labor force participation rate
A high work participation rate means that many people are working, or at least, diligently looking for work. That’s likely during a prosperous economy. Jobs are abundant because businesses are asking for more workers to increase production. As a result, people are relatively easy to find new jobs.
Conversely, when participation is low, people may become discouraged because it is difficult to find work. This usually happens during difficult economies, such as an economic recession. Businesses cut production and labor. Thus, unemployed workers find it more challenging to find new jobs.
Why is the labor force participation rate important
In general, labor force participation rate statistics are useful for:
- Measure the composition of labor supply in the economy. The government usually divides the labor force into categories such as gender, age distribution, residence, jobs, education, and economic sector.
- Project future labor supply. Governments often project population numbers by age category, considering factors such as the current population, birth rates, mortality rates, and net migration (immigrants minus emigrants). From the working-age population projection data, you can use the figure for the labor force participation rate to project the future labor force. Then, you can use the projected labor force data to calculate a country’s potential GDP.
- Formulate employment policies. For example, the government uses it to determine future education budgets.
- Understand the labor market behavior of various population categories. For example, you can analyze the variation in participation rates between age groups, education, or residence (rural vs. urban).
The labor force participation rate as a complement to the unemployment rate indicator
Along with the unemployment rate, the participation rate gives you a better insight into labor market conditions. By looking at trends in these two indicators, you can consider the impact of discouraged workers on unemployment statistics.
As I stated earlier, discouraged workers are those who stop looking for work. Economists categorize them as hidden unemployment along with underemployed workers.
During a severe recession, the unemployment rate may fall as many discouraged workers stop looking for work. Likewise, as the economy expands, the unemployment rate may still be high as discouraged workers reenter the labor market but have yet to find new jobs.
Both situations contradict the standard view, where the unemployment rate is high during a recession and low during expansion. However, a change in the number of discouraged workers might produce a different number from this general view.
So you should look at the participation rate along with the unemployment rate. Thus, you better understand whether unemployment is decreasing because of an improving economy or an increase in discouraged workers.
The relationship between the labor force participation rate and GDP
The labor force participation rate is useful for projecting the labor force, an indicator of labor supply in an economy. Higher participation rates mean more labor supply in the economy. With a larger supply of labor, the economy can produce more output.
Economists use labor force data to calculate potential GDP. Apart from using the production function, another approach to calculating it is to add up the labor force’s growth rate and the rate of growth in labor productivity.
Factors affecting the labor force participation rate
The labor force participation rate decreases or increases depending on the following factors:
- Business cycle. For example, during a recession, it is more difficult for people to find new jobs. Fewer employment opportunities because businesses cut output. The supply of labor becomes more abundant than the demand for labor. Long unemployed individuals may become pessimistic and stop looking for work.
- Population growth. An increase in population provides a larger supply of labor. The population increase depends on factors such as birth rates, death rates, immigration, and emigration.
- Education and expertise. Higher-educated individuals are more likely to participate in the workforce than people with less education. They are more flexible in switching from one job to another. Conversely, those with more or less expertise may be discouraged when they are fired.
- Technology advances. Technologies such as automation reduce labor absorption. Some skills are becoming obsolete and irrelevant to demand in the labor market. Finally, those who are unemployed are reluctant to actively seek work.
- Not economically active. Those who are currently working quit and are no longer actively looking for work for reasons such as continuing higher education, taking care of a household, or entering retirement age.
Effects of the business cycle on the level of labor force participation
When the economy expands, the participation rate usually increases. During this period, economic growth was strong and provided more jobs. Prospects for employment and salaries are improving as businesses intensify the use of their productive capacity.
More employment opportunities encourage those who have stopped looking for work to continue filling out applications. When they reenter the labor market, the number of labor force increases.
Conversely, when the economy is in a phase of contraction or recession, the participation rate decreases. Income and job prospects are bleak. As a result, more unemployed people choose to stop looking for work. So, we exclude them from the labor force list.