A New Outlook on Labor Markets

by Tim Nadreau, Ph.D.

The Issue:

By this point, virtually everyone has heard the narrative that the labor market is dysfunctional: millions of job openings while millions are unemployed. How can this be? What is going on? Labor market analysts jump up and down claiming “it is a skills issue", or perhaps a “population issue", or maybe it’s an “age distribution issue". Maybe the job openings require skills that the unemployed don’t have. The narrative on the right is that the government shutdowns forced unemployment, and have in effect continued the lockdowns by paying people not to work through PPP loans, stimulus checks, etc. The narrative on the left is that people are scared to go back to work or cannot find childcare for their children etc. Undoubtedly all of this has an effect on labor markets, but none of these answers—even all of these answers—are sufficient as an economic explanation.

Markets, including labor markets, tend towards equilibrium. Wages for childcare services will rise until workers would prefer the wage over their fear. Prices for such services will rise in accordance with the elasticities of the consumers and producers. Perhaps the transition dynamics, in moving towards the new equilibrium, are just taking longer than expected. That seems unlikely, however, given how quickly markets respond. What are we to do?

The Data:

Labor market data is highly nuanced—covered vs. non-covered, Census Bureau vs. Department of Labor, etc.—however, the trends are all similar. Figure 1 shows the seasonally adjusted non-farm labor in the U.S. as well as the labor force participation rate (this is the percent of eligible laborers that are actually part of the labor market). You can see how the shutdown of the economy caused a large shock in employment. But it also caused several people to drop out of the labor market all together (e.g., mothers that stopped working to take care of the kids).

Figure 2 zooms in on the employment data, including the trendline from the trough of the 2009 recession to the beginning of 2020. That trend line is extended through the fourth quarter of 2021 so we can see how far off trend we still are. The new jobs report does show continued employment growth.

One of the things we stress here at Recon Insight Group is that it is never good to look at one data set in isolation, as it will inevitably provide an inaccurate—often an extraordinarily inaccurate—understanding of the market. Actionable intelligence requires more than one piece of information. Imagine looking at a map and only knowing where your destination is. Without knowing where you are, or the orientation of the map, you are still lost. So, let’s add GDP to the picture and see what happens to the labor market story. Figure 3 shows Real GDP in billions of 2012 dollars and the associated trend line.

Everyone clambering about the labor market seems to have forgotten that the point of the labor market is productivity. Even with the “shortfall” in the labor market, productivity is already back above trend and, by all indicators, growing faster than trend! This tells quite a different story than the alarmists would have you believe. More value with fewer workers means increased labor productivity. Figure 4 shows output per worker from the trough of the 2009 recession through 2021 Q4.

So why do well-capitalized labor market firms persist in the alarmism? Consider the incentives: if the world thinks the sky is falling, chicken little can make a lot of money! Let’s not make the mistake of seeking full employment again. After all, when the pilgrims came to America there were no jobs, just work.

Our View:

This isn’t a popular position to take in a world obsessed with fear, but all we see in regards to this story is good news. The recession did exactly what it was supposed to do: unproductive laborers were released from the market, poorly managed companies failed, and the strong and well-capitalized firms survived. The economy was decluttering, making room for fresh innovation. Although painful, it is good for us as a society and as individuals to figure out what our comparative advantages are and move in that direction. This is difficult to achieve without failure. Taleb praises the failed entrepreneurs because they teach us something, something that isn’t always fun to learn.

What is the good news then? The good news is that the economy is strong and, on the main, functioning the way it is supposed to. The outward shift in firms’ marginal cost curves will likely translate into lower profits, until they can reduce their marginal costs curves through other innovation. This bodes well for the economy because entrepreneurs love profits. Innovation is coming, and in big ways: the unemployed are starting their own firms, the Wright Brothers are tinkering in their garages.