In late 2010, we set an all-time record for the Australian economy: nearly 66% of people aged 15 and over were either employed, or were actively looking for work. To put that in perspective, the labour force participation rate has averaged 63.2% since 1980.

In the past couple of years, participation has started to fall. From a peak of 65.9% in late 2010, the participation rate slid down to 65.1% in December 2012. If we’d kept a stable participation rate, we’d have around 150 000 extra people in the workforce at the moment.

What’s causing the participation rate to fall? Is it that jobs growth has been weak, so people are giving up and stopping looking for work? Or is it that the demographic tide is turning, and baby boomers are starting to retire? Another way of posing this question is to ask: to what extent is the decline in participation ‘cyclical’, and to what extent is it ‘structural’? If it’s mostly cyclical, then you’d expect to see the participation rate within particular age groups falling. If it’s mostly structural, then the participation rates of particular groups could remain the same, but older age groups (that participate at a lower rate, on average) would account for a higher proportion of the population.

The answer, as you’ve probably guessed, is that it’s a bit of both.

Over the past couple of years, the workforce participation rate of young people, aged 15-24, has fallen quite a bit (-1.2 percentage points); the rate for prime-aged workers, aged 25-54 has also fallen (-0.4 ppts). The rate for older workers has been more or less steady, rising by only 0.1 points in the two year period.

Since 2010, the population has aged: the proportion of the adult population that is aged over 55 has risen from 30.9% to 31.7%. The population shares of both young and prime-aged people has fallen commensurately (by 0.5 and 0.3 percentage points, respectively).

By putting all these facts together, we can calculate how much of the fall in the overall participation rate is due to the ageing population, and how much is due to people within each age bracket becoming less likely to participate.

The overall participation rate is just the average of the participation rates of each age group, weighted by the population share of each age group. So the total labour force participation rate (LFPR) at time t is:

formula1

where p is the population share of each demographic group (i).

Using this formula we can separate out the change in the total participation rate into its two components. The change in the participation rate between time t-1  and time t is:

 formula2

In other words, the total change in the participation rate is equal to the change in the participation rate of each demographic group, holding population shares constant, plus the change in population shares, holding the participation rate of each group constant.

The participation rate fell 0.7 percentage points between late 2010 and late 2012, from 65.9% to 65.2%. [fn1] Using the formulae above, I find that, 0.4 points of the 0.7 percentage point fall is due to a fall in the participation rate of particular groups, and 0.3 is due to the ageing of the population.

Here’s my calculation of what the participation rate would’ve looked like without demographic change. In other words, the greenish line shows what the participation rate would’ve been if the population share of each age group had remained unchanged from December 2010, while the black line is the actual participation rate.[fn2]

part rate

If the demographic structure of the country had stayed intact over the past couple of years, the participation rate would be higher than it is now, but still lower than it was in late 2010.

[fn1] Here I’m using the average for October, November, and December of the original, non-seasonally adjusted data.

[fn2] The chart is based on a more granular decomposition of demographic effects, using eight age groups rather than the three broad groups alluded to above. The basic method is the same. Note that these calculations are based on non-seasonally adjusted data. I’ve smoothed them in a fairly crude way.