To The Moon

The labor market has stopped behaving.

Historically, employment has been a rather dynamic and fluid economic input. In macroeconomic models, we assume that employment can easily change in the short run. It doesn’t look like it will necessarily always be the case.

COVID-19 shocked the economy across the board. One of the most notable changes was to the labor market in the US. There was a steep rise in unemployment, which was followed by a substantial boom in jobs.

Job creation was large. Job demand was humongous. Aggregate demand swelled after the initial shock, and firms hired to meet demand projections. The labor market they were demanding in had changed, however.

Many workers were remote, or given new flexibility from their employers. This meant that people could apply to jobs pretty much anywhere while working in the comfort of their home. It also meant that employees had an abundance of remote and flexible job options.

There were lots of employers looking to hire. There were lots of new perks to be attained. Workers had the upper hand in the labor market for the first time in a while. Competition for labor bid up wages, leading to both nominal and real wage growth.

An important aspect here is that job openings held above the unemployment rate. That indicates a tight labor market. Things haven’t changed. The labor market’s tightness has decreased, but openings are still greater than unemployment. It is still relatively hard for employers to find workers.

Many employers have perhaps “learned their lesson” (or maybe overcorrected) as a result of their behavior during the pandemic. A lot of firms were quick to fire staff as uncertainty loomed in the early days of the pandemic. Soon, they discovered that they were short workers and needed more to meet demand.

This led employers into the hiring frenzy of the pandemic. Lots of job openings, less people looking for work. Employers have now begun to slow firing as a result. There is a phenomenon called “labor hoarding” — firms being hesitant to reduce their numbers and thus holding onto employees.

In situations where employers would typically reduce headcount, they seem to be holding onto them due to fears of the rehiring process. If they have to rehire in a few months, the job could be vacant for a while, they might have to pay higher wages, and they could be short-staffed in the meantime.

All those reasons have caused employers to slow down their firing process. Labor hoarding suggests that firms aren’t willing to treat labor as dynamically as they have in the past. It hasn’t been fluid.

So the question is, will labor not always be a short run variable?

Unemployment seems sticky. Even if there’s a slowdown in aggregate demand, firms might not layoff as intensely as models would suggest. Firms are hesitant to fire in a tight labor market, so unemployment will be slow to react.

It is relevant to ask whether this is a transitory phenomenon or a feature of a new macroeconomic regime. It is too early to call, but I’ll make the case for why this could be of ongoing concern.

Demographic trends are going to introduce new economic realities.

Developed countries around the world are seeing slower population growth or even the threat of declining populations. The United States is no exemption. The United States population is on track to be relatively stagnant, with very modest growth, in the upcoming decades.

Without a swelling population, we need to look at the population’s components. The Baby Boomer retirement will bring a huge percentage of Americans out of the labor force. The graying of America will result in less people of working age. These people will continue to demand goods and services, however.

If we continue to see gradual economic growth, that means there will be a struggle between a low supply of labor being outpaced by demand. Growing demand and lagging labor supply could create labor tightness into near perpetuity.

Firms would need to be cautious to fire as a permanent policy, not just as a fixture of the pandemic. Uneployment would be slow to adjust to the business cycle. This could potentially flatten the cycle, ceteris paribus. Unemployment spikes as a result of economic uncertainty would be less intense. Employees would also likely see real wage growth because they have new negotiating power in the labor market.

This would be a re-characterized labor market. Contemporary macroeconomic models assume labor adjustments in the short run. We’ll see.