Op-ed: Labor dysfunction leads to pain in the pocket

"Yesterday, my local sandwich shop was closed due to 'staffing issues.' This is not a unique experience."
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The Federal Reserve Bank has spoken. Despite recent volatility in the markets due to concerns about financial market stability, the Fed opted to raise its benchmark Federal Funds interest rate another 0.25% to a new range of 4.75% to 5%.

The Fed is making a statement. First, it made clear that it believes the financial markets are “strong and resilient.” I agree. Second, while recognizing that inflation is trending in the right direction, inflation remains stubbornly high and “more work needs to be done.” Twenty months after Chairman Jerome Powell’s “transitory” comments, inflation, as measured by the Consumer Price Index, remains at 6.0%.

Why is inflation so persistent? After all, the massive supply chain disruptions — remember all those ships anchored at the Port of Los Angeles? — created by the pandemic have diminished.

Photo / Courtesy of NBT Bank

Kenneth J. Entenmann, NBT Bank.

Energy prices, thanks to a mild winter across the globe, have dropped nicely. The housing sector, the most interest-rate-sensitive economic sector, has stalled and prices have declined. While these trends are helping, consumer services sector inflation continues to rage. And it is the largest economic sector in the economy, representing two-thirds of economic activity.

Pent-up consumer demand continues to be strong (think leisure and hospitality, food, travel, entertainment, sports equipment, etc.). Has anyone tried to buy Taylor Swift concert tickets? Been to Disney World? Bought a plane ticket? A cheeseburger? Ouch!

The largest cost driver in the service sector is labor. The labor market is still struggling to recover from COVID, and it is the primary cause of today’s service inflation. The Federal Reserve is trying to cool the labor market through its interest rate policy.

Historically low unemployment

On first review, the typical employment benchmarks demonstrate an incredibly strong labor market. The unemployment rate is a historically low 3.5%. Continuing unemployment claims at 1.694 million are, too. However, upon further review, the labor market looks more dysfunctional than strong. The JOLTS (Job Opening and Labor Turnover) index still shows there are 10.8 million job openings in the United States — roughly twice the number of unemployed people. Yesterday, my local sandwich shop was closed due to “staffing issues.” This is not a unique experience. A historically low unemployment rate and the JOLTS/“staffing issues” are difficult to reconcile.

The main culprit for this labor dysfunction is the decline in the U.S. Labor Participation Rate. The U.S. Bureau of Labor Statistics defines the labor participation rate as an estimate of an economy’s active workforce, measured as the number of people ages 16 or older who are employed or actively seeking employment, divided by the total non-institutionalized, civilian working-age population. Starting in 2013, the labor participation rate was steady at 63%. In pre-COVID February 2020, it was 63.3. It declined to a low of 61.3 in January 2021. Today, it is 62.5%. Where did all the workers go? There are three places to look: young workers, retirees and immigrants.

First, young people continue to participate at lower levels than pre-COVID. The government responded to the pandemic by creating new support programs and enhancing others to help people manage through the crisis. Policies such as supplemental federal unemployment payments, enhanced SNAP payments, rent moratoriums, student loan payment suspensions, increased Medicaid eligibility and others make it easier for younger workers to stay out of the workforce. Clearly, the pandemic created a need for support. Officially, the federal government is scheduled to declare the “emergency” over on May 11. Now that the “emergency” is coming to an end, we as a society need to right-size our government support programs. We cannot afford to pay people not to work; we need the workers!

The second cause of the labor shortage is “retirement in excess of trend.” The baby boomers are getting old, i.e. retirement age. During COVID, the economy witnessed a run for the door by baby boomers with pension benefits and large retirement savings. Why go to work in the middle of a pandemic when you could afford to retire? Many did. It was hoped that many would return to the workforce once the pandemic passed. Unfortunately, economists have been disappointed that most have not. Apparently, retirement is a pretty good gig.

Lastly, the level of legal immigration into the U.S. is still well below pre-pandemic levels. The legal immigration process needs to be more efficient. Immigration fills the needs of two critical areas of the workforce. First, most immigrants typically join the workforce in entry-level jobs, i.e. the service sector. Think of the sandwich shop’s “staffing issues.” Second, an important segment of the immigrant population is highly educated. Highly skilled jobs in health care, technology and engineering remain open. The National Federation of Independent Business’ job survey reports that 60% of business owners reported hiring or trying to hire in January. Of those, 90% of owners reported few or no qualified applicants! Immigration can help!

The Federal Reserve Bank is hoping that its aggressive interest rate hikes will help “cool” the labor market. It hopes to decrease the demand for employment. The idea that people need to lose their jobs so the Fed can solve persistent inflation seems misplaced. The factor driving labor wage growth is not demand. It is a supply issue, a labor shortage. Higher interest rates cannot fix that. We need to get younger people back into the workforce and increase immigration efficiency. And maybe entice those boomers to get back into the job market. Unfortunately, that will require policy changes that can be politically contentious and challenging. But until we do, services inflation, driven by wages, will remain stubbornly difficult to control.

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