By Brett House and Pierre Yared
FORTUNE -- Many Americans still aren't working. Friday's monthly jobs report for February is better than most expected. On a deeper level, however, it underscores a lot of what we've seen in previous months: An ever-smaller share of able-bodied, working-age Americans have jobs. The 2008 financial crisis dented demand for labor, but this decline in employment started years earlier. The U.S. employment-population ratio peaked in the late 1990s and has slid downward ever since.
Rather than blame recession-era doldrums, this long-run trend reflects a supply side-problem -- too few people have the right incentives to work or to acquire the needed skills to do so. The current obsession with raising the Federal minimum wages won't fix this situation. On its current path, the U.S. is headed toward a work-free and poorer future.
The New York Federal Reserve recently argued that things aren't as bad as the raw employment data imply; that as the U.S. population ages, we end up with relatively more people on the older end of the 15-to-64-year-old spectrum of normal working ages. Older workers are less likely than their younger counterparts to be employed -- their skills become obsolete, their family responsibilities intensify, they become less mobile, their expectations become more rigid, and accumulated wealth and government entitlements provide increasingly strong disincentives to work. Adjusting for these factors, the New York Fed contends that the decline in employment numbers is exactly what we should expect to see as baby boomers age.
That may be true, but that explanation doesn't change an uncomfortable fact: A shrinking share of the population is tasked with keeping the economy growing.
According to the White House, we shouldn't worry because jobs are just so last-century anyway. Responding to a Congressional Budget Office forecast that Obamacare by 2024 could induce some 2.5 million people to reduce their working hours or leave jobs they retain mainly for health care benefits, Presidential Spokesperson Jay Carney suggested that reduced employment would be good for better work-life balance: More family time and less stress.
In fact, we are heading toward a future of too little work and virtually no balance. As Americans age, we face a vicious cycle where workers will be taxed at ever-higher rates to support an expanding pool of dependents. Higher tax rates could further dampen incentives to work, the tax base could shrink, the employment-population ratio could keep falling, and long-term growth could founder.
This isn't a problem that the Fed's large-scale bond-buying program can fix. Low interest rates are designed to boost short-run demand -- not change long-term incentives to work.
Granted, it is possible to keep U.S. incomes rising even if domestic employment falls. Technology can boost the returns we get from each hour worked. U.S. capital could also be invested in countries where work is still expanding. But employment rates are falling across the world. China and India also face aging workforces. Sending capital to emerging markets won't save us.
The U.S. needs to address its employment crisis head on. Here are five ways to boost the job market, some of which have successfully worked in other parts of the world:
Raise the retirement age
Longer life spans imply that government should provide better incentives for workers to retire later. Among industrialized countries, people generally work later in life where the official retirement age is higher. As a first step, the U.S. should raise the earliest eligibility age for reduced Social Security retirement benefits from 62. The age threshold for full benefits should also be increased from its current level of 65 for older workers and 67 for younger workers. The U.S. last revised these limits in 1983, when employment-population ratios were still increasing. Nevertheless, the average effective retirement age for American men fell to 65 in 2012 from 68.5 in the late 1960s.
Promote employment for the working poor
Government needs to stimulate the supply of labor by reducing the implicit marginal tax rate imposed on the working poor through clawbacks in public benefits that kick in whenever their earnings rise. A single parent making $20,000 a year faces an implicit marginal tax rate of over 70% on any increase in income, according to the Congressional Budget Office. Successive U.S. and other industrialized-country governments have enacted reforms to bring these implicit tax rates down, but more remains to be done. In the past, the CBO has found that such reforms have positive effects on the hours low-income employees choose to work.
Raise the Earned Income Tax Credit
Rather than raise the minimum wage, the White House could focus on increasing the Earned Income Tax Credit (EITC). This would keep wages tied to productivity while still putting more money in the pockets of low-income workers. The United Kingdom provides much larger income-related tax credits than the U.S., and, despite a more generous social welfare system, it has a higher employment-population ratio.
Reform U.S. immigration policy
The federal government should admit more foreign workers, but it needs to do so thoughtfully. The U.S. should move to an immigration system that assesses the skills and age of its potential newcomers to ensure that they have sufficient training and youth to make sustained contributions to the U.S. workforce. For decades, Canada has operated a points-based immigration framework that has ensured its new arrivals are skewed toward the young and employable. As a result, the rate at which immigrants to Canada find jobs is the third-highest amongst industrialized countries, and immigrants drive nearly all of the growth in the country's labor force.
Get more women to work
Over the longer term, the U.S. needs to encourage higher birth rates and support women's participation in the formal labor market. The U.S. ranks 17th in the industrialized world in female labor force participation, according to the Organisation for Economic Co-operation and Development. Promoting maternity leave at nearly full pay combined with better and more affordable childcare, as the Nordic countries have done, can foster childbearing and encourage new mothers to return to the workforce.
As the recession recedes and the Fed's taper continues, it will become clear that America has a labor-supply challenge that, left unaddressed, will be a drag on growth for decades. Policymakers need to act on this challenge now.
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