Economist Barry Bosworth says many Americans are right to feel recovery has passed them by.

The U.S. economy has “largely recovered” from the financial crisis, and the unemployment rate is down to 5%, admits economist Barry Bosworth of the Brookings Institute. Yet median household income is stuck at “well-below pre-recession levels,” he points out in a recent opinion piece, with more than half of Americans saying they continue to fall behind financially.

According to Bosworth, the sentiment of many middle-class and other Americans is supported by research he published this month. “A more detailed examination of the data suggests that the reported economic recovery has been in part an illusion, because it reflects a contraction of aggregate supply rather than a strong expansion of demand,” he explained an opinion piece.

Labor, Productivity Woes

The conundrum is tied to a continuing decline in the labor force participation rate and very modest gains in productivity, Bosworth finds, after comparing actual GDP with estimates of potential GDP. As the “sluggish recovery dragged on,” he points out, the Congressional Budget Office trimmed its estimates of potential GDP growth to the 2014 projections.

Weak GDP growth needs to be viewed critically in relationship to expected and real GDP growth since 2007, Bosworth argues. Furthermore, what’s viewed as the current reported recovery “is due to the sharply lower current estimate of potential,” the economist says.

In other words, the bar is being lowered for GDP growth, so the economy: (1) appears to be performing better than is actually the case; and (2) is not producing the strength needed to boost median household income.

“Even the revised estimate of potential GDP appears too high, and the CBO is likely to lower it further in the next budget cycle,” Bosworth said.

Though the gap between actual and potential GDP is still reported at 4%, the unemployment rate is below the rate the CBO associates with full employment. While these two figures do not have to be “in complete agreement,” the difference between these two figures “seems unduly large” today, he argues.

Participation Problem

The continuing decline in labor force participation rate has surprised economists, according to the Brookings fellow.  

Initially, the drop in the participation rate was linked to shifts like the retirement of Baby Boomers and the impact of discouraged workers leaving the labor force. Many assumed that the discouraged workers would come back to the job market after the economy picked up.

While these shifts are ongoing, Bosworth says “the surprise lies with the growing magnitude of the perceived discouraged worker component.” Who is staying out? Women in the 25-34 age group, whose participation rate has drifted back to where it was in the early-‘90s. Meanwhile, the male rate continues to drop.

At the same time, the pattern of rising participation rates among workers 55 and over has stalled. “The reasons for these changes are not fully understood, but they appear to be more than cyclical,” explained the economist.

Productivity Drop

The significance of supply-side concerns, which economists generally define as lower capital investment and lower production levels, are demonstrated in the slowing pace of productivity growth, the Brookings analyst says.

“There is growing evidence of a break in productivity performance around 2005, marking the end to the information and computing technologies boom of the late 1990s, and a return to the modest gains that dominated in the interval of 1972-95,” Bosworth explained. “Since 2005, labor productivity has improved at less than half the rate of the prior decade (1.3% vs. 2.9%).”

Just how weak has overall economic productivity growth been? It’s averaged less than 0.5% annually over the past five years, he says, in conjunction with changes in the technology, retail and other sectors that have had a negative impact on workers and hence median income.

“To the extent that productivity growth has been dominated by innovations in information and computing technologies, a slowdown seems inevitable as much of the industry has moved outside of the United States (Apple Inc., the largest IT company, has no U.S. production facilities), and in the retailing sector with the shift to large box stores, which were a source of major productivity gain, and now seems complete,” Bosworth stated.

The cycle seems poised to continue, unfortunately, he says, as these patterns become more engrained in the economy.

“With a declining proportion of Americans in the workforce and near stagnate levels of productivity, there is little room for gains in real incomes,” concluded the Brookings expert. We do not know if these trends will continue in the future, but there are no signs of a near-term turnaround.”