by Gwynn Guilford, The Wall Street Journal, August 14, 2022
As anyone who has lost luggage or waited half an hour for a restaurant check can tell you, America needs way more workers in some parts of the economy.
Economists think so too. Many of them see the imbalance in labor supply and demand as at the heart of the U.S.’s current economic challenges. They say that fixing it is critical to achieving a so-called soft economic landing, in which the highest inflation in four decades comes down without unemployment rising enough to trigger a recession.
A key part of the equation has been moving in the wrong direction: The supply of workers has been shrinking. The labor force is about 600,000 smaller than in early 2020, when Covid-19 triggered a deep but short recession. It is several million smaller if you adjust for the increase in population. After approaching prepandemic levels earlier this year, the number of workers has fallen since March by 400,000, according to Labor Department data.
The labor-force participation rate—the share of the population 16 years and older working or seeking work—was 62.1% in July, down from 62.4% in March, and much lower than the prepandemic rate of 63.4%, the Labor Department said.
In the short term, stalled labor-supply improvement is a concern because it increases the risk of a more damaging recession in the next year or two.
“The hope for many to achieve a soft landing is that you meet in the middle, with demand cooling off and labor supply picking up, and we reach a much healthier equilibrium between the two,” said Michael Pugliese, economist at Wells Fargo. “But if labor supply flatlines or keeps falling, you need to bring demand down even more in order to cool off wage growth.”
Inflation is near a four-decade high, coming in at 8.5% in July, and the imbalances in the labor market are part of the reason. Energy shortages and logistics glitches have faded some as sources of inflation, but price pressures fueled by a tight labor market are replacing them. Wages and salaries for private-sector workers rose 5.7% in the second quarter from a year earlier, the swiftest pace since records began in 2001, and wage growth accelerated in July.
That is an uncomfortable situation for the Fed. It is currently trying to bring inflation back to its 2% goal by raising interest rates. The hope is to cool the economy and create more labor-market slack, influencing the demand part of the equation. Usually this requires an increase in unemployment. But with job openings unusually high, it is theoretically possible to cool demand without triggering mass layoffs.
That so far appears to be happening. Unemployment claims have risen to their highest levels this year, suggesting it is becoming slightly harder for laid-off workers to find new jobs. Job openings are down nearly 10% from March levels, though they remain historically high and well above the number of unemployed people looking for work.
To ease wage pressures without having to reduce employment outright, though, more workers are needed to fill jobs.
Without them, said Mr. Pugliese, the Fed will have to work harder to reduce labor demand by raising interest rates more, creating a greater chance that much tighter financial conditions trigger mass layoffs and a recession.
Stagnant labor supply is also a long-term worry, because a limited supply of workers could constrain the economy’s growth potential in the long term. An undersized labor force means fewer workers to build cars or clean hotel rooms, limiting how much actual output the economy can produce. Departures from the labor force tend to be “sticky,” meaning that those who drop out for a considerable time can find it hard to return.
Some of the decline in labor supply is due to increased retirement decisions triggered by Covid-19. Among those 55 and up, 38.7% were working or looking for work in July, down from 40.3% before the pandemic.
Slowing immigration was a factor weighing on the size of the labor force early in the pandemic. It is less so now but isn’t likely to become a source of labor-force growth. After dropping sharply, visa issuance has risen nearly to prepandemic levels, according to BCA Research analysis of State Department data.
Economists have long anticipated this decline as the U.S. population ages. Far more mysterious is what is holding back the rest of the workforce. The participation rate among those ages 16 to 54 was 76.1% in July, compared with 77% in February 2020. Reasons suspected as recently as a year ago—trillions of dollars in pandemic aid,fear of Covid-19, and child-care obligations—have either not been borne out or are no longer an issue to most.
“The big mystery is not around old versus young, men versus women. It’s around skilled and unskilled workers,” said Peter Berezin, chief global strategist at BCA Research, noting that by education level, participation rates remain the most depressed among those with a high-school diploma but no college. “Unskilled workers have been much more reluctant to enter the labor force than you would have expected, given that wage gains for unskilled or less-skilled positions have been stronger than for everyone else.”
It could have something to do with how Covid-19 has changed the nature of work and affected mental health, said Brian Bethune, an economist at Boston College.
“A lot of jobs have become a lot more difficult—from teaching to working on airline crews with packed airplanes and irate passengers,” he said. “So people have just said, ‘Enough’s enough.’ ”
That dynamic could be self-reinforcing. Labor shortages—particularly in industries that require a lot of interaction—make the work itself more risky and unpleasant, which in turn makes people reluctant to return to these jobs.
“While wages have risen, maybe they haven’t risen enough to compensate for the fact that when everyone’s short-staffed, it means you have to do extra work,” said Mr. Berezin. “Employers may have to raise wages significantly in [inflation-adjusted] terms, which would make the Fed’s life more difficult.”