US labor market developments have come to center stage and play a fundamental role in the inflation debate. Why has job creation been weaker than expected, even as the US economy reopened with a bang?
Labor demand greatly outstrips labor supply: Job openings have outpaced new hires by a spectacular margin (over 3 millions in April) and many employers report difficulties in finding workers despite the still high level of unemployment. What happened to labor supply? And if this excess of labor demand persists, will it fuel stronger wage pressures and more persistent higher inflation than the Fed and market expects?
Some blame a lack of skills; some blame a lack of incentives. I think incentives are the more relevant immediate concern, but skills will play the bigger role in shaping the future trend for real wages, growth and productivity.
Skills: Some argue that the pandemic has changed the way we work and the relative size of different industries, so that the economy now requires a different mix of skills in the labor force. This makes little sense to me. We have strong labor demand in the services sectors that were most severely impacted by the pandemic: leisure and hospitality and accommodation and food top the list for job openings (together with professional and business services). These sectors by and large do not require highly skilled workers. And notice the irony: when manufacturers lamented a skills gap before the pandemic, many commentators dismissed the idea; now they invoke it to justify slow job growth in restaurants and hospitality.
Incentives: Others argue that US fiscal policy has created a Universal Basic Income (UBI) in disguise; enhanced unemployment benefits allow a significant number of people to make more money remaining unemployed than by taking a job. Staying home becomes the rational choice, especially since a strong labor market suggests your chances of finding a job will be as good tomorrow as they are today.
The Biden administration has argued that employers should offer higher wages. (This is one of the stated goals of UBI: to allow workers to refuse job offers unless employers offer high enough wages.) The slow pace of wage growth has been a source of concern for some time, so maybe this would be a desirable outcome?
It depends, as an economist would say. If employers pay higher wages but pass them through into higher prices, workers’ purchasing power and living standards will remain broadly unchanged. We’ll have higher inflation, but the country won’t get any richer.
If companies do not translate higher wages into higher prices, they will earn lower profits (assuming they cannot cut other costs; after a very tough year where companies struggled to survive, I doubt they have much fat in their budgets). Other things equal, that should reduce stock market valuations. Since higher-income households own more stocks, this would reduce economic inequality – but let’s not panic and cry at the stock market correction.
The Financial Times in a recent editorial paints a possible goldilocks scenario: higher wage pressures could push companies to invest in new technologies, raising labor productivity. This could square the circle and give us both higher wages and strong profits. Two caveats here, though: The first is that some of these innovations will be of the “labor-saving” variety – think jobs-stealing robots. That would mean that only fewer workers would enjoy the higher wages.
The second caveat is that new technologies will require better skills in the workforce. So upskilling the workforce will in any case be necessary: many workers will need to build new capabilities either to keep up with new technologies in their current industry or to move on to more qualified and better paying jobs in other sectors.
Notice here that manufacturing shows one of the largest gaps between job openings and hires, close to half a million – on a par with professional and business services, which had twice as many job openings. Repeated disruptions to global supply chains and strategic concerns are driving a process of reshoring and greater reliance on local supply chains; a stronger manufacturing sector will play a much more important role for economic growth and competitiveness going forward and the skills gap, if left unaddressed, risks becoming the Achille’s heel of the US economy.
I think enhanced unemployment benefits are playing the bigger role in holding back job growth now. We’ll find out in the coming months – they are due to expire in September, and 25 states are opting out already next week. But if we want a stronger economy, the skills gap is the greatest issue, and it predates the pandemic.
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