The workforce participation rate has fallen to 63.3%. It hasn't been this low since the late 1970's. Let's look at some numbers. Below is a chart of the labor participation rate from 2003 to the present. (All data from BLS.)
These are the associated numbers, by month, for the same time period.
Here's the really scary part, which comprises the labor participation rate since 1948, when the BLS started keeping statistics.
The rise over time is understandable. The 60's, 70's and 80's saw a lot of women entering the workforce who would not have worked in prior times. In the 60's and 70's, this was primarily women who wanted to work, especially at vocations that weren't traditionally "pink collar". By the 80's, as wages stagnated and manufacturing moved overseas, there became a need for two incomes to support a family. And then came the drop.
It's not just the 2007-09 crash, it's something more insidious. The labor participation rate peaked for the first four months of 2000 at 67.3%, and has been falling ever since. There are several explanations for some of the decrease, but not enough to explain all of it.
Part of it is in how ALL employment numbers are calculated. There are all sorts of numbers generated from different sets of statistics and there is "noise" associated with the numbers. Therefore, all sorts of things can be off. For example, if someone is making $30,000 doing ebay and Etsy, while sales taxes are paid, there are no payroll taxes, and that person wouldn't count as a member of the labour force. Alternately if there's a construction worker who can't find regular work, but is doing odd jobs for cash, he's not part of the labour force. Small start-ups, like cookie delivery with the proprietor being the sole employee, are not part of the count. And it's likely that this is part of it.
Further, there are a large number of people who are on disability, or working towards getting on disability, who are not counted as part of the BLS data. If one is in the process of applying (which can take YEARS) that person cannot take a job, or it affects processing of the claim.
There are also veterans who in prior times would have collected a military pension after 20+ years in the service and would have undertaken a second career, but now is just living off the pension, and likely income from a spouse.
It's likely that if the unemployment rate fell to 4%, which is considered full employment, some, although not all, of these folks would go back to work. Just for comparison, here's a BLS chart of unemployment from 1948 to the present.
Yes, I know your question. The reason that that unemployment spikes didn't cause great decreases in the labor participation rate is that those recessions were relatively short lived AND government benefits such as unemployment was more robust AND people used to save more money, and thus had a cushion. Further. families were stronger: there are many more single person household today than ever before. In addition, the home ownership rate was lower: people can move for a job more easily if they don't need to sell a house.
The decrease of people in the labour force greatly affects the overall economy, in the same way as higher unemployment does. That is, we're a consumer-driven economy: fewer people with disposable income decreases that amounts of goods and services bought and consumed, thus lowering the overall GDP/GNP.
So what are potential solutions? There are a few that relate to creating more jobs, but so long as there are Republicans in control of the House, I wouldn't count on any of them, despite the viability of such programs. One solution, as incongruous as it sounds, is to change the way mortgage interest interacts with taxes. This link is to a long and fascinating article on the mortgage income deduction. It shows how people making less than $100,000/year derive little benefit, if any, from mortgage interest deductions, while those making above $100,000 take almost 50% of the benefit. (Remember, MANY fewer people make over $100,000 than below that threshold, so the impact is huge.) One of the side points is that having mortgage interest deductions set the way they are affects business investment, leading to decreased wages and fewer people employed. Further, it encourages debt, thus leaving people less able to handle unemployment and more likely to leave the labour force.
Ideally, the solutions are more government spending directly on jobs programs (think FDR's alphabet soup programs) but as I said, not happening so long as there are Republicans.
My final thought is if close to 40% of the American population between 16 and 65 is not in the labour force, and that number keeps rising, how does such a large population LIVE? The number of homeless people doesn't reflect that huge an increase, so these people must be living somewhere. 30% of America isn't on SNAP, so these people must be getting food somehow. It's a puzzlement. And a real problem when that number passes the 40% threshold, which isn't that far in the future if one extrapolates the data.