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INSIGHT-Welcome back dropouts: data suggests Americans rejoining workforce

* Labor force participation rising in most states

* Trend could signal inflation threat not building

WASHINGTON, June 5 (Reuters) - For the first time in six years, the share of people who either have a job or are looking for one is on the rise in a majority of U.S. states, a sign one of the deepest scars of the economic crisis could be healing.

Most states have experienced sharp declines in labor force participation since the 2007-2009 recession, but a Reuters analysis of government data found a reversal could be underway.

The data bolsters Federal Reserve Chair Janet Yellen's view that America has ample room to create jobs without causing uncomfortably high inflation and it buttresses arguments for keeping interest rates low. If Yellen is wrong, the Fed's easy money policies could lead employers to bid up wages for scarce talent, stoking price increases.

Anecdotal reports suggest that in many parts of the country, demand for labor appears to be growing enough to get people who had dropped out of the workforce to restart their job hunts.

"We are getting more job creation and we are seeing more people come in," said Paul Turek, a labor economist with Washington state's Employment Security Department.

Washington is one of 32 states where the participation rate rose in the six months through April, according to the Reuters analysis. Together, these states account for a majority of the nation's working-age population.

It was the second straight month where most states chalked up gains over a six-month period.

The data covering the 50 states and the District of Columbia is volatile, so it does not provide conclusive evidence of a bounce back in the labor force.

But since the start of the recession in December 2007, the direction of participation rates has been clear: they have been falling. It has been rare in recent years for more than a handful of states to show improved labor participation over any six-month period.

Now there's evidence the pendulum may be swinging back.

The gains are spread across the country - from states with rebounding construction industries like Florida and Utah to those with job growth in health care and education like West Virginia.

The Fed's Beige Book of anecdotal economic reports for May, which was released on Wednesday, said the U.S. labor market "generally improved," with the central bank's Kansas City district reporting that businesses were now having to compete for workers, the Cleveland and Chicago districts noting an upturn in demand for temporary employees, and Atlanta pointing to a jump in the number of workers moving from temporary to permanent jobs. It said wage pressures remained "subdued."

Texas is another state making gains. Blessed with robust economic growth, the speed with which unemployed Texans find jobs is nearly twice as high as in the rest of the country, a dynamic that is coaxing discouraged workers from the sidelines, Dallas Fed economist Anil Kumar told Reuters. He expects a similar pattern will emerge nationwide.

"As the economy continues to improve, at least some of the people (will) be drawn back into the labor force," Kumar said.

Whether or not they return could be vital for the strength of the U.S. economy, for the behavior of inflation, and for the path of monetary policy.

'THE JOBS ARE THERE'

The U.S. jobless rate has declined steadily over the last four years, but much of the drop was due to people giving up the hunt for work, which means they were no longer counted as unemployed.

In April, the national participation rate fell to 62.8 percent, revisiting a 36-year low reached late last year, although a report on Friday is expected to show it ticked up in May. During 2007, before the financial crisis and the recession, it was as high as 66.4 percent.

Some of the decline has been due to an aging workforce and the retirement of baby boomers, a fact that may well keep participation from ever bouncing back to its pre-crisis level.

But some dropouts went to college and are bound to eventually restart job hunts. Others grew frustrated at the lack of available jobs, but may decide to try their luck again if the economy continues to improve.

Some prominent economists, including former White House adviser Alan Krueger, argue that many of the folks on the margins of the labor force are not coming back. If that is true, higher inflation, fueled by rising wages, could come sooner than the Fed expects.

But Yellen, who took the helm at the Fed in February, has refused to write off Americans who have suffered long bouts of unemployment or given up the search for work entirely. She argues there is more slack in the economy than suggested by the nation's 6.3 percent unemployment rate, a key reason the Fed is expected to bide its time before hiking rates.

Along with the drop outs and record number of long-term unemployed, millions are working in part-time jobs even though they want full-time work - another fact Yellen has cited.

The state data, which can diverge from the national statistics because of adjustments the government makes to account for seasonal swings and other local economic factors, suggests she may be right to wait.

In places like Portland, local officials and entrepreneurs say a recovery in the job market is starting to gather pace.

Tech companies like business software manager Puppet Labs have been growing quickly in the city. Puppet Labs expects to double its work force to around 400 by the end of the year as it takes advantage of what CEO Luke Kanies said are wage levels as much as 20 percent lower than in hotter markets like San Francisco or Seattle.

While Oregon's labor participation rate has not gone up, officials say they feel the groundwork is in place.

Patrick Quinton, head of the Portland Development Commission, said the vacancy rate for commercial office space is now in the single digits because of the rapid local expansion in Portland of companies like accommodation booking service Airbnb and game maker Kixeye. That, he said, is expected to trigger a wave of office building and the creation of construction-related jobs in Portland, which accounts for around 15 percent of the state's population.

Job creation on its own is no guarantee that the country's labor pool will stabilize or expand. But recent research has held out some hope by focusing on the fate of the long-term unemployed - a group that, by historical standards, currently accounts for a disproportionate share of the unemployed.

If they were to grow frustrated and stop looking for work, they would drive the participation rate even lower. But research by both Goldman Sachs and the Fed indicates they are beginning to find jobs, gravitating, for example, to part-time work as a "stepping stone" to full-time employment.

Marlena Sessions, head of the Workforce Development Council of Seattle-King County, said there has been a noticeable turn in recent months.

In the depths of the recession, her agency was able to place around 73 percent of the people who sought help into jobs, and that figure was only 60 percent for the long-term unemployed.

Now, it is back up to the long-term average of 85 percent for all job seekers, regardless of how long they have been out of work.

"The numbers are falling and that is great, and the jobs are there and that is great," Sessions said.

(Reporting by Howard Schneider and Jason Lange in Washington; Additional reporting by Ann Saphir in San Francisco; Editing by Tim Ahmann and Martin Howell)