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U.S. employers added a jaw-dropping 528,000 jobs in July, far more than expected, and wages rose more than expected — but the number of jobs or job seekers fell. Where are you all?

The labor force shrank by 63,000 in July despite a population increase of 177,000, the Labor Department said on Friday. The labor force participation rate — the proportion of people working or looking for work — fell by a tenth of a percentage point to 62.1%.

The mysteries of a shrinking workforce and declining labor force participation are among the lingering ailments of the post-pandemic recovery. The labor market has been very strong — so strong that many believe we won’t be in a recession despite two consecutive quarters of negative growth — but somehow that hasn’t pulled a larger percentage of Americans into the labor market .

“I can’t have a client meeting without someone asking me where all my workers have gone. I don’t know, but they’re clearly gone,” Credit Suisse analyst Zoltan Pozsar wrote in a note to clients on Monday.

Harvard economist and former Obama administration adviser Jason Furman Say On Friday, he was “confused” by July’s decline.

There’s another mystery here, an almost puzzling mirror image of Furman. The household survey showed that the number of employed people only increased by 179,000, and the employment-population ratio only increased by 0.1%. If the participation rate hadn’t risen and the overall level of employment had barely grown, where did all these workers come from in July? Just as we don’t know where workers go, we don’t know where they came from.

A Brief History of Recent Workforce

Travel restrictions, business closures and concerns about COVID caused labor force participation to plummet in the spring of 2020. We hit a low of 60% in April but rebounded quickly in the following three months. In the summer of 2020, however, the recovery stalled. Employment rose rapidly in October, but participation did not.

When the vaccine rolls out in the spring of 2021, participation rebounds for a second time, and employment begins to rise rapidly again a few months later. Then we ran into another air pocket, probably related to rising infections and schools staying closed. The reopening of schools and a drop in infections led to a third surge that began in November 2021 and continued through March of this year.

After a peak in March, engagement started to drop again. Notably, job growth peaked in the previous month. Until this month, job growth as measured by the payroll survey was at its slowest pace in more than a year. Part of the decline in participation may simply be a slowdown in job growth.

Another strange thing started in March 2020. While we are still adding jobs, employment levels, as measured by household surveys, are flat. This is the survey the Labor Department uses to construct unemployment rates, participation rates and other demographic data about who is working. It is constructed by asking about the employment status of households. It differs in many ways from wage surveys, which ask businesses, nonprofits, and governments about employment, hours worked, and wages. (You can read the difference between the surveys here.)

Attract the self-employed to the payroll

When you run a household survey alongside a salary survey, you’ll notice a few things. First, household surveys show higher employment levels than wage surveys. This is because it includes agricultural workers, self-employed individuals in unincorporated businesses, unpaid leavers and unpaid domestic workers. Wage surveys only count those on the payroll of non-agricultural establishments (also known as establishment surveys).

Second, you can see that household surveys show that employment growth stalled in March. Businesses have increased employment, but overall employment levels have not.The best explanation for this is that businesses are taking from what financial experts are saying sideline; but instead of hiring people who don’t work, they hire self-employed people. Workers are drawn to the payroll of outside employers by their own businesses. In addition, some people who are exiting the labor force are being replaced by new entrants, maintaining employment levels.

We can see this in the self-employed data in the household report. In July, the number of individual industrial and commercial households decreased by 279,000. On the five-year chart, we can see that self-employment collapsed during the pandemic in the spring and peaked last August. It has been declining rapidly since then, likely because so many workers are moving from self-employment to payroll.

This solves the secondary mystery of where all the workers we add to the payroll come from.

The decline in the labor force participation rate is in chronological order with the flattening of employment levels, suggesting a possible link. Perhaps wage growth alone will not be enough to encourage labor force participation to climb. Employment levels, as measured by household surveys, may be the real driver of participation now. One possibility is that opportunities or rewards for self-employment are shrinking, forcing some workers into the payroll and taking some workers out of the labor force entirely.

real wages are falling

Inflation may also play a role. While nominal wages have been rising, they have not kept pace with inflation. So real wages are falling. This makes it less compelling to give up casual work. Basically, employers are paying workers less for work than before, which means more people who don’t absolutely need work are choosing not to work. If your clients aren’t actually paying you that much, self-employment probably isn’t worth sticking with, so you decide to hang up your boots, so to speak. Or maybe you’re a young person who decides to hold off on finding a paid job until wages increase. In short, the real rate of return to labor has fallen, so some people choose not to put their time into it.

If it sounds absurd to say that people are choosing not to work because of rising prices, remember that unemployment is extremely low and employment levels are almost at an all-time high. More than at any time in recent history, people are more likely to have relationships with people who have jobs, and those jobs now seem very safe. This makes it easier for a small group of people to decide not to work.

Remember, the labor force only shed 63,000 people in July, so we’re not talking about a massive exodus of workers.

The role of seasonal adjustment

Also keep in mind that the labor force participation rate didn’t really contract in July, nor did payrolls increase by 528,000. Before seasonal adjustment, the participation rate improved from 62.5% to 62.6%. The wage figure fell by 325,000. It’s not evil. The headline data you read is seasonally adjusted to remove monthly employment changes, giving us a better understanding of the health of the economy. What the seasonal adjustment in July tells us is that the economy is expected to lose a lot of jobs in July, and it hasn’t lost that many this year. In the non-seasonally adjusted payroll growth chart below, the big drop was in January, and the small drop was in July when payrolls dipped after the holidays. The July employment contraction was the second smallest since a contraction of 314,000 in 1966, behind last year’s contraction of 41,000.

In other words, even ignoring seasonal adjustments, the July report was very strong.

Again, the seasonal adjustment tells us that the labor force participation rate is expected to rise in July, which usually happens this year, and it will. But this year’s increase was smaller than in previous years, so it was a seasonally adjusted decline. The chart below shows the unadjusted labor force participation rate. Every spike is a July.

The combination of falling real wages and very low unemployment raises the opportunity cost of jobs. As a result, the number of workers has not kept pace with population growth, participation rates have fallen, and employment levels have remained flat despite rapid wage growth.

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