Full Employment Isn’t What it Used to Be

10.21.2021: The labor market is tight. Millions of workers have yet to return to their former jobs, and others are leaving their current jobs at a record pace: 4.3 million of them quit in August alone. Meanwhile, employers are holding 10 million unfilled jobs, representing about 1.2 jobs for every sidelined worker. Sensing their strength, unions are flexing their muscles. Ten thousand John Deere workers went on strike, while unions representing 31,000 Kaiser employees authorized walkouts, according to The Washington Post. Cornell University’s School of Industrial and Labor Relations counts 178 strikes against employers so far this year. Meanwhile, the September jobs report was a big disappointment. The payroll increase of 194,000 workers was only about one-third of what Wall Street anticipated. Wages rose even though the labor participation rate declined, undermining the “transitory” inflation argument. Average hourly earnings for nonsupervisory workers rose 5.5 per cent over the 12 months through September, its biggest increase since 1982.

Graph 1, Market Update, 10.21.2021

The workforce is now down five million workers compared to the level before the pandemic, begging the question: Where are they, and what are they doing? Conventional wisdom suggests many of these sidelined workers are not reengaging into the workforce for fear of contracting COVID. The data we track, however, show a stark contrast to this notion. The number of airline travelers is rapidly approaching pre-pandemic levels, suggesting Americans are hell-bent on going out. Subway ridership is also surging. One of the only places where Americans are not showing up is at the office. According to Kastle Systems, a key card company, only an average 36 per cent of office employees nationwide are reporting to their offices.

Graph 2, Market Update, 10.21.2021

Perhaps Americans are opting for gig work or starting their own businesses. The pandemic prompted a record number of new business formations. Monthly applications for new businesses surged 50 per cent from the outset of the lockdowns. Americans are creating roughly one million new businesses annually, according to the data. Vaccine mandates are also playing a role. Following the federal government’s lead, many private businesses are requiring their employees be vaccinated. Yet, nearly 50 million Americans remain unvaccinated, and most of them are resolute. According to a recent Washington Post-ABC poll, 72 per cent of unvaccinated Americans surveyed said they would not comply with their employer’s vaccine mandate and 42 per cent they would quit if required to be vaccinated. Southwest Airlines appears to be buckling under the pressure of worker resistance, and other firms might have to follow suit.

Graph 3, Market Update, 10.21.2021

Meanwhile, prices and wages are surging. Economists argue that sustainable inflation cannot occur without a wage-price spiral, because households simply won’t pay higher prices if their paychecks don’t support it. They emphasize the fact that wages have not kept pace with the recent inflation spurt. Hourly pay rose 4.6 per cent for the 12 months ended September while the CPI surged 5.4 per cent. However, if we look at the number of workers employed, average hourly wage and average workweek, American workers’ collective paycheck grew by 8.6 per cent over that same period. This suggests there’s ample cash to pay for higher priced food, energy and even rent.

Graph 4, Market Update, 10.21.2021

Economists point to three phenomena that could dampen incipient inflation flames. First, companies unable to pass along higher costs absorb them, resulting in narrower profit margins. Recent data suggests that’s happening. Producer price growth is expanding at more than double the rate of CPI.  Producer prices (representing input costs) over the 12 months ended September surged 11.8 per cent, while consumer prices advanced 5.4 per cent over the same period, suggesting that margins are getting squeezed. On the labor front, companies are struggling to compete for workers with Amazon and Walmart, which are paying upwards to $16/hour as entry-level pay.

The second factor that could stem inflation is productivity. Productivity gains absorb real wage costs if employees produce at an hourly rate at or higher than their wage gains. The employment cost index tracks employee costs adjusted for productivity gains. An employee who makes 5 per cent more in income from year to year, but is producing 5 per cent more output per hour, doesn’t cost his employer more from year to year. Wages have spiked since the pandemic, rising as much at 5.5 per cent in 2020.  Meanwhile, year-over-year growth in the employment cost index has remained consistently below 3 per cent, suggesting productivity gains are offsetting some of the wage costs.

Graph 6, Market Update, 10.21.2021

The third factor that could dampen price gains would be sidelined workers returning to jobs. Success here is unlikely: we believe America’s workforce is smaller than what policymakers perceive. For example, baby boomers – those Americans born between 1946 and 1964 – are still working, according to a recent Pew Research Study. But that could change. The oldest baby boomers, born in the mid-1940s, are turning 75 and they’re retiring. The pandemic led many boomers to retire ahead of schedule.  Now, America’s working-age population is shrinking for the first time in its history. Immigration, a way to growth the workforce by opening our borders, has dropped significantly in recent years.

With as many would-be workers otherwise engaged, it’s possible that America’s actual labor pool is smaller than what the Fed assumes. By overestimating the size of America’s workforce, they risk a policy mistake. The Fed has signaled that full employment is their priority. They’re willing to accept higher prices in exchange for full employment, but their estimate of full employment is overestimated. If structural issues plaguing the labor market persist, like weak labor participation and high unemployment, the Fed could continue to stimulate, risking a wage-price spiral. A Federal Reserve on its heels would then be forced to tighten policy reactively and risk a sizable equity market pullback. It’s possible the bond market steps in and forces higher rates if they believe the Fed is too slow. For now, the Fed is sending a “risk on” signal to the markets, but if workers don’t return to the workforce in a meaningful way, the Fed, and the markets, will be forced to confront it later.

Graph 7, Market Update, 10.21.2021
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