Photographer: Photographer: Luke Sharrett/Bloomberg

The Housing Bubble Explains Today's Odd Labor Shortage

Demand for workers outpaces supply. But employers' thinking hasn't caught up yet.

If the labor market is close to full employment, as some people argue, why isn’t wage growth higher? For one possible explanation, we can look at a similar dynamic that played out during the housing bubble.

One of the surprises of the housing bubble was how long it took investors and markets to respond even after fundamentals had turned south. During the construction boom of the early to mid-2000s, the supply of new homes for sale remained relatively steady at around four months of supply. This is because demand was growing as well, with home prices, as measured by the S&P/Case-Shiller 20-City Composite Home Price Index, increasing at over 10 percent per year.

Things began to change in 2005. Construction kept growing and home prices kept growing, but supply began to rise as well. Months’ supply grew from 4.1 at the end of 2004 to 4.9 at the end of 2005. In 2006, things really began to change. By July, months’ supply was up to 7.3, its highest level since the early 1990s, yet home prices were still up 7 percent over a year earlier. By early 2007, supply was approaching 8 months, a level which in the past had always been associated with recession, yet the Case-Shiller price index was still flat over the prior 12 months. People had become so accustomed to rising prices that even as the fundamentals had changed dramatically, they could not accept a new pricing regime.

PG Chart 1 House Supply

The parallel to the labor market today is with the listed number of job openings. At nearly 5.9 million, the number is the highest on record, and almost 170 percent above the record low of 2.2 million in July 2009.

PG Chart 2 Job Openings

Yet both hiring and wage growth have lagged somewhat behind. Many theories exist on why -- among them, that companies are becoming more picky, that there is a “skills gap” between supply and demand, and that there’s a geographical mismatch between job opportunities and potential recruits.

Perhaps a simpler explanation is how the great recession changed the psychology of employers and employees. Between the “lost decade” for employment in the 2000s and the shallow post-recession recovery, employers got used to having the bargaining power in the labor market. Now that conditions have changed, they’ve decided to forgo hiring rather than pay up for talent, in the same way that home sellers in 2006 and 2007 chose to wait and hope for a better bid, contributing to a higher housing supply, rather than accept a lower price and sell. Similarly, recession-scarred workers remain grateful simply to have jobs, and are less interested in taking risks on looking for higher-paying jobs elsewhere. In an industry like construction that’s currently hot but busted not too long ago, some former workers consider the field too risky altogether.

What breaks the impasse? In the same way that eventually elevated housing supply changed how buyers and sellers think and feel, the elevated and rising level of job openings today will continue to shift the bargaining power from employers to employees. Attrition and retirements open up key positions all the time, and if enough of them stay unfilled, output and firms will suffer. When that happens, employers will have no choice but to pay up. And every spring, a new crop of young workers with no memory of the great recession enters the labor market looking to take the best offer available.

If employers won’t adjust to market conditions, workers will put them out of business.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.