The Shrinking Labor Force Is Scariest Number for America’s Job Market

Wall Street bigwigs, major investors, stock analysts, and economists agree on very little these days. Whether it’s about technical levels, recession indicators, or the yield curve, everyone seems to have a different outlook for the economy and markets. One of the few points of consensus, however, is the fundamental importance of the job market.

It’s not a particularly revelatory stance: A vast majority of Americans rely on employment as their primary income, and when Americans make money, they spend money. Given that about 70% of economic output is generated through consumer spending, if a bunch of people lose their jobs, spending will fall and, in turn, crush the economy.

This is why many economists and analysts focus on the unemployment rate. Surging unemployment is both the hallmark of a recession and a painful event in people’s lives. It hits Wall Street and Main Street equally hard. That’s why many of us think about the job market through the lens of unemployment. When your best friend gets laid off, you rush to their side with ice cream and a pep talk.

Given this focus on unemployment, you may think that economists would have a fairly sanguine view of the current job market. The headline jobless rate is 4.2%, up from record lows set in 2023, but hardly at a catastrophic level. And beyond the uber-popular rate, there are a few other signs of a resilient job market: Layoffs aren’t swallowing corporate America’s workforce, and claims for unemployment benefits have leveled out recently.

Still, there is one number that is just under the hood of these well-watched statistics that represents a serious cause for concern. The official US labor force, which measures the number of working-age Americans actively working or looking for work, is shrinking at a rate normally seen during the depths of economic crises. In fact, the pool of available workers has now stalled for three straight months, the first such streak since 2011.

Labor supply may be an overlooked metric, but it points to a troubling economic chasm. The reasons for this shrinkage point to worrying shifts in America’s job market, and the consequences could be perilous. Over time, a smaller labor force presents a set of pernicious challenges: lower growth, lower tax revenue, and lower productivity.

Turning around this decline requires better economic fortunes and a change in policy, but reversing the trend is necessary to keep the US moving in the right direction.

The issue with a shrinking labor force goes back to a concept from Econ 101: supply and demand. We usually think about supply and demand in terms of shopping, whether sellers have enough toys, TV, or whatever goods they provide to meet the desires of buyers, but these dynamics show up everywhere, including the job market. When it comes to the workforce, the supply side of the equation is you (if you’re working or looking for a job) and your fellow employees, while the demand is businesses that currently employ people or are looking for more employees via open jobs.

When the labor supply falls, the number of workers available to take a job also decreases. This leaves businesses scrambling to find people to staff their positions. While this scenario may seem ideal for the workers whom employers are fighting over, the job-hunting bliss may be temporary. If these struggles are prolonged, then companies operate at less than full capacity, missing out on growth and shrinking the country’s overall economic pie.

The slowdown can also filter over to the demand side of the business — if there are fewer workers to buy things, then companies may slash their production and slow their hiring. For much of the 2020s, the job market narrative has been all about low-wage workers finding pay increases and better positions because of the desperate demand for more employees across the spectrum. If demand drops, this story can reverse. Even with a smaller pool of workers available, contraction on the part of businesses would force higher-skilled workers to accept lower-skilled positions.

A smaller labor force also increases the likelihood that there aren’t enough of a certain type of experienced worker that certain industries need.

Take homebuilding, for example. Harvard University’s Joint Center for Housing Studies has found that the shortage of skilled construction workers — an issue since the housing market meltdown in the mid-2000s — has led to longer project times and unexpected delays nearly two decades later. Not only is this bad for the homebuilders themselves, but it slows down the number of new homes that can be built, leading to fewer opportunities for homebuyers and higher home prices.

This hasn’t been much of a fear for the US over the decades. The supply of workers usually grows as more Americans enter the employment age. Yes, older workers offset this as they retire (or die), but since 2007, the number of new entrants has outweighed those exiting in 63% of monthly jobs reports. That trend has reversed over the past three months as the total number of people in the labor force has declined by 790,000 workers from April to July.

Another way to look at the change in the pool of workers available in America is the prime-age labor force participation rate — or the percentage of people ages 25—54 who are either employed or looking for work. A higher participation rate shows that working-age Americans have enough faith in their job prospects to apply for positions and that businesses are able to meet their employment needs.

The participation rate plummeted during the global financial crisis and stayed toward the lower end of the historical range for much of its aftermath, a sign that people were so discouraged with job prospects that they stopped looking entirely. Fast forward to today, and we’re starting to see some worrying signs again. The labor force participation rate has dropped for four straight months, aligning with the drastic slowdown in hiring.

There are a few big reasons for this shrinking. Perhaps the most significant is the precipitous drop in immigration — evidenced by a 90% drop in border encounters over the past year. The lack of immigration has clearly dealt a big blow to the labor force. Immigration may be a political hot-button issue, but there’s no doubt that the flow of immigrants was a necessary source of workers. Over the past two decades, four of the five strongest years for hiring have coincided with higher-than-average growth in immigrants as a share of the labor force.

The effects of this immigration slowdown are evident in the widening gap between the supply of native-born and foreign-born (immigrant) workers. Over the past four months, the share of foreign-born employees in the labor force has slid nearly one percentage point, the biggest drop on record.

The immigration crackdown and a rough hiring environment are only part of the story. Other long-term trends could be depressing the number of people willing to jump into the workforce. Labor force participation among women has yet to recover from pre-COVID levels given steep childcare costs and return-to-office mandates and the cost of childcare. The participation rate among teenagers 16 to 19 years old has also plummeted over the past few months, likely a product of fewer entry-level opportunities.

This shrinking of the labor supply means that there simply aren’t as many people for American businesses to hire, which can distort other highly followed measures of economic health. Over the past three months, the unemployment rate has barely budged, despite corporate America adding a measly 35,000 jobs a month. Ironically, that seemingly good news is another weird downstream effect of the stalling labor supply. Unemployment is calculated by dividing the number of people who don’t have a job but are actively looking by the number of people in the labor force. A smaller overall labor force can therefore shrink the denominator in that equation, keeping the unemployment rate low while masking weakness in the underlying economy.

As the job market weakens, Wall Street desperately wants a salve for higher unemployment. And if hiring totals decelerate, you’ll likely see some economists hand-wave the data as a symptom of this labor force anomaly.

Neither trend is healthy, though. A short-term relief might be what ultimately holds our economy back for years to come. Crack open your Econ 101 textbook again, and you’ll see that population growth times higher consumption per capita equals growth in GDP. In other words, for the country to grow, we need to grow the number of working people and grow the amount that they spend on homes, meals, and the variety of activities that keep our economic engine running. For every worker we lose in supply, we also lose a motivated spender and a source of revenue. If this impact compounds over the years, we may find ourselves in an economy that can’t shift into a higher gear.

The labor force supply challenge is insidious and complicated. Thoughtful policy can help stem the bleeding from immigration, and a stronger economy could further improve the balance in the job market. For now, neither outcome seems to be on the horizon.

Callie Cox is the chief market strategist at Ritholtz Wealth Management and the author of OptimistiCallie, a newsletter of Wall Street-quality research for everyday investors. You can view Ritholtz’s disclosures here.