Prophets

Stop Misreading U.S. Job Scene: It's Tight and Getting Tighter

Fed Chair Jerome Powell should look beyond wrongheaded arguments and get monetary policy back to neutral.

Labor is getting scarcer.

Sarah Blesener/Bloomberg

Flawed interpretations of the American labor market have become too widespread. And, perhaps, intentional. 

Any objective reading of the data implies that labor is scarce, risking faster inflation and higher-than-anticipated interest rates. The most common misreadings are that the declines in the worker-to-population ratio and the labor force participation rates imply there are still plenty of people available to be hired. It's also asserted that the drop in the unemployment rate to 4.1 percent is only because these people have given up seeking work, so they aren't counted among the unemployed -- an intentionally misleading and highly deceptive explanation.

Sure, it's true that the employed-to-population ratio of 60.4 percent is still well below the 63.7 percent level of 2007. But you need to allow for changing demographics as well as changing behavior. The U.S. population is getting long in the tooth, with more than 10,000 baby boomers hitting retirement age weekly. On the opposite end of the spectrum, more young people are going to college or enrolling in graduate programs.

Both phenomena reduce the ratio of workers to total population. Of course, we should want our older workers to kick back and our young to get more education, so they can experience greater success. If we look only at prime-aged adults, those between 25 and 54, the ratio of workers to population is 79 percent, only slightly below the pre-recession level of 79.9 percent. 

Poor health is another thing. A surge in workers on disability benefits removed several million people from the job market, more than accounting for the rest of the decline in ratio of workers to population since 2008. These folks are unlikely to surrender those benefits to return to work. The opioid crisis also weighs on potential job seekers. Those afflicted are also unlikely to surge back into the labor force.

The decline in labor force participation is also commonly tied to a disappointing pace of job growth since the 2008 recession, but it actually started around 2000, many years before the slump, as shown in Chart 1. The decline is driven by the changing behavior of women. In much of the post-World War II period, female participation rose markedly, more than offsetting the gradual decline in male participation, which had begun many decades earlier. After 2000, female participation started to track the behavior of their male counterparts, albeit at a somewhat lower level. So it's absolutely clear that demography is the culprit, not the recession and a rebound is very unlikely. The Bureau of Labor Statistics also studied this and come to the same conclusion.

More fundamentally, the notion that workers have dropped out because they can't find work is unsupported by data and is readily contradicted by a host of labor market reports, which tell a coherent story of labor scarcity. Data on job openings show more than 6 million vacancies, which is an all-time high since the survey was introduced in 2001. This is corroborated by household sentiment surveys, which report jobs are plentiful.

Data on quits also supports the thesis that jobs are abundant. Workers do not quit their current jobs if they think finding another will be difficult. Symmetrically, firms are now reluctant to fire workers. They recognize that a fired worker may be difficult to replace. So, initial unemployment claims have declined to around 225,000, the lowest level in this series going back to the 1970s, even though the labor market is now more than 50 percent larger. All these reports provide a coherent data-based body of evidence that points uniformly to a scarcity of labor.

The only fly in this ointment is the claim that wages haven't behaved as if labor were scarce. If labor were really scarce, it is argued that wage inflation would be higher. That's plausible, but might not be correct.

Contrary to popular perception, wage rates have increased. Every measure of wage inflation, from the monthly average rate to the quarterly employment cost index, is now at its cyclical high and moving higher. Moreover, the labor market is far more efficient today than ever in matching workers with firms trying to hire. Internet-based recruiting enables employed and unemployed workers to apply for any job opening anywhere in the country with ease. Firms can cast a wider net than ever before when they try to hire. This should result in much better fits for job openings and a far more efficient labor market with less upward stress on wage rates, but only until labor truly becomes scarce.

Any comprehensive analysis leads to the conclusion that things are tight and wage inflation should increase over the coming months. Despite this, incoming Fed chair Jerome Powell, in his nomination testimony, said that "maximum employment" is an "imprecise thing." That's correct, but the Fed should be trying to end its highly accommodative monetary policy and bring interest rates to a neutral setting as quickly as it can.

Two Fed presidents, Charles Evans of Chicago and Neel Kashkari of Minneapolis, voted against the latest rate hike, because they want to see inflation closer to, or even above, the Fed's 2 percent objective. But with a tight labor market, the economy could get there far faster than they realize, which would make it difficult to put the inflation genie back in the bottle.

    To contact the author of this story:
    Charles Lieberman at chuck@advisorscenter.com

    To contact the editor responsible for this story:
    Daniel Moss at dmoss@bloomberg.net

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