Where have all the workers gone?

David Kelly
Global Economist, JP Morgan and former RAO speaker

Last Thursday, as I headed home from a conference, the car I’d booked to take me to the airport didn’t show up.  Luckily there was a taxi nearby so I hopped in and discovered that, in addition to a comfortable ride to my destination, the fare entitled me to a free lecture on the state of the labor market.  “The reason your car didn’t show up”, opined the retired police sergeant at the wheel, “is you can’t find drivers anymore.  It’s the millennials - they just don’t want to work”.

As the father of two millennials and the supervisor of many others over the years, I regard that as an outrageous slur.  But we live in an age when a simple falsehood gains currency more easily than the complicated truth.  And while the driver is wrong about millennials, just about everyone running a business in America today knows about the shortage of workers.

This shortage was on full display in the March Jobs report, published last Friday.  Nonfarm payrolls expanded by a very healthy 431,000, with 95,000 added to the gains from the prior two months.  Equally impressive was a fall in the unemployment rate to 3.62%, lower than it has been in all but five months since 1969.

While the unemployment rate clearly indicates a tight labor market, other data show an even more dramatic excess demand for labor.  Last Tuesday, the Labor Department reported that there were 11.3 million job openings at the end of February, or 5.3 million more than the number of unemployed workers estimated two weeks later (in the survey week for the March Jobs report). 

It is tempting to say that this is because millions of Americans turned lazy and have just dropped out of the labor force.  However, this really isn’t accurate.

It is true that, even after a sharp recovery from its pandemic lows, the not-seasonally-adjusted labor force participation rate in March was 62.4%, down from 63.0% in March 2019.  If the labor force participation rate had not fallen over this period, the labor force would have been 1.6 million larger last month.

However, this decline can be explained in its entirety by a change in the age distribution of the population.  The labor force participation rate is defined as the percentage of the population aged 16 and over that is working or actively looking for a job.  Note that this isn’t 16 to 64 – it’s 16 to 120 and this overall statistic has naturally declined in recent years as more baby-boomers turned 65, became eligible for Medicare and retired. 

The labor force participation rate for Americans aged 18 to 64 has actually edged up slightly over the same period, from 76.28% in March 2019 to 76.29% in March 2022. 

But, if this is the case, where are all the workers?

The problem is one of population growth. 

The overall number of Americans aged 18 to 64 has risen by just 930,000 over the last three years, or 0.2% per year.  This very sluggish growth rate reflects the afore-mentioned aging of the baby-boom generation and a sharp decline in immigration.  According to Census estimates, net immigration to the United States, both legal and illegal, amounted to roughly 360,000 per year over the past two years compared to over one million per year in the middle of the last decade.  This decline reflects both tougher immigration policies and the pandemic which reduced legal immigration and caused some recent immigrants to return to their native countries.  This falloff in immigration has particularly strong impacts on the labor force as roughly 75% of new immigrants are between the ages of 16 and 65 compared to 63% of the overall population.

Assuming no dramatic change in immigration policies any time soon, we are likely to see only a modest increase in the number of available workers in the months and years ahead.  It is true that some people have not been able to look for work due to the pandemic.  However, according to last Friday’s report, there were only 874,000 Americans still in this category last month compared to a peak of almost 10 million in May of 2020.  Obviously, adding all of these 874,000 back to the labor force wouldn’t fill the 5.3 million gap between job openings and unemployed workers. 

Moreover, it is possible that even as these workers return to employment, some younger workers will leave it.  Enrollment in U.S. colleges has fallen by 1.2 million over the past three academic years and, even adjusting for a decline in population among young adults, this implies a shortfall of 763,000 in current college enrollment.  The decline in college enrollment during the pandemic is understandable given the restrictions that COVID put on the college experience.  However, as the impact of the pandemic begins to fade, there are signs that enrollments will pick up, further limiting labor supply.

There are, of course, chronic long-term trends in America that have limited labor force participation, including issues with dependent care, skills, and the reluctance of employers to hire those with substance abuse issues or felony convictions.  However, like immigration policies, none of these issues is likely to be tackled in a dramatic way over the next few years.

So how will the excess demand for workers be resolved?

First, further strong gains in wages are likely as those companies that can most profitably employ workers bid up their compensation.  These higher wages should slowly draw more people into the labor market, particularly as people exhaust savings and credit built up over the pandemic.  More expensive labor should also lead to further productivity gains as companies use labor-saving technology and business practices to offset the lack of workers.

Second, demand growth in the economy should moderate as employment gains slow, interest costs rise and fiscal policy turns contractionary.  After an initial post-pandemic surge, many restaurants and entertainment venues could see demand slip away.  The demand for at-home delivery could slump while downtown offices and airports could remain quieter than before the pandemic.  Eventually, of course, demand growth could slow enough for a shock to tip the economy into recession and, sadly, nothing fixes excess demand for labor faster than a recession.

However, until then, the labor market should remain very tight by historical standards adding to inflation pressures.  This will encourage the Federal Reserve to continue its recent, more hawkish stance, putting upward pressure on long-term interest rates.

The lack of workers should, at least for a while, help reduce income inequality and raise wages.  However, for investors still suggests a relatively short-duration approach to fixed income and, within equities, a need to focus on those companies with reasonable valuations that can offset a lack of cheap labor with greater productivity, strong revenue growth or both.

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