Labor Market Impact On GDP Growth

The Federal Reserve Bank of St. Louis provides a great deal of commentary on a wide range of economic topics. They recently wrote commentary on the significance of labor market data, and importantly, the influence of the employment to population ratio (E/P) on real GDP. The article notes the sub-par GDP level is being influenced by the reduced level of the E/P ratio, a level last reached in the early 1980's. Specifically they note,

"...the EP ratio is a key input in a standard growth accounting framework. In this framework, real GDP is the product of (1) real GDP per worker, (2) the percentage of the population that is employed, and (3) the civilian population. The first term approximates labor productivity and the second term is the EP ratio. Mathematically, we can transform each of the three components into growth rates and then add them together to produce real GDP growth. Since population growth tends to change very little in the short-to-medium term, the growth accounting framework is useful because it shows why real GDP growth accelerates or slows. Thus, has real GDP growth changed because of changes to the growth of labor productivity, EP ratio, or some combination of the two? One reason why average real GDP growth during this expansion (2.24 percent) has been so slow is that labor productivity growth has been relatively slow: 1.48 percent per quarter (annualized) through the first quarter of 2014. As shown in the graph, the other reason is that the EP ratio is still below the level that prevailed at the trough of the past recession (second quarter of 2009). Since then, the EP ratio has declined by an average of 0.26 percent per quarter (annualized). Until the growth of the EP ratio strengthens, the pace of the economy’s growth will remain quite modest (emphasis added). That is, assuming population growth remains constant, if labor productivity growth doesn’t accelerate, neither will economic growth."

From The Blog of HORAN Capital Advisors

Source: Federal Reserve Bank of St. Louis

As a result, one key question from this economic data point is to ask the question, what is constraining job growth? No one factor is likely contributing to this phenomenon; however, several regulatory factors are likely contributors. The Affordable Care Act and the Act's redefinition of a full time worker as one working 30 hours per week and a proposal to increase the minimum wage to $10.10 per hour by 2016. Businesses have already responded to the increased cost of labor by replacing employees with technology. Several large restaurant chains have introduced tablet computers at tables allowing patrons to order and pay for meals without the need of a server.

Certainly there needs to be a cost/benefit balance in labor regulatory requirements. At the current slow rate of employment growth though, regulations increase labor costs will continue to constrain employment growth and result in a low level of economic growth in the foreseeable future.