Opinion

A Strong Job Market Doesn’t Mean the Economy Is Recession-Proof

Economic growth has weakened considerably, but it’s still relatively easy for people to find jobs. That’s puzzling economists, who are used to seeing job offers disappear when growth slows. In other words, it’s a happy day for labor.

Things could get stranger. Judging from recent trends, there’s a chance that the economy slows down even more — or even shrinks — and yet the unemployment rate stays low.

“At this stage, our assessment is that we are set for ‘full-employment stagnation,’” Wei Li, the global chief investment strategist for the giant asset manager BlackRock, wrote to me in an email last week.

I asked Gad Levanon, the chief economist of the Burning Glass Institute, if he could imagine a recession with low unemployment. “It never happened before,” he said. “But theoretically it is possible, and I think now it is as close as we ever got to it.”

There’s a lesson here for the Federal Reserve. Policymakers at the Fed want to see clear evidence that wage pressures have weakened before they stop raising rates to curb inflation. But if the labor market refuses to soften as much as they want, they could end up overdoing their rate increases and breaking the rest of the economy.

Low unemployment can coexist with a sluggish economy because the labor market is growing slowly. And that’s because of slow growth in the working-age population, which in turn can be traced back to a long-term decline in birthrates. Obstacles to immigration have exacerbated the problem. (The pandemic pushed a lot of people out of the labor force, but that effect has mostly disappeared.) Today it takes only about 70,000 to 100,000 additional jobs per month to soak up new entrants to the labor force. A decade ago it took 150,000 to 200,000 jobs a month, Levanon estimates.

This chart shows an index of labor market tightness that Levanon created. It’s a composite of nine indicators, normalized so that the average value of each is zero. The data sources are the Bureau of Labor Statistics, the Conference Board and the National Federation of Independent Business.

Slow labor-supply growth has a good side and a bad side. On the good side, fewer people face unemployment. On the bad side, the speed limit of the economy — which is determined by the increase in the number of workers times the increase in output per worker — is lower.

The economy exceeded its speed limit when it sprang back from the steep, brief pandemic recession of 2020, but it has been slowing since under the weight of Fed rate increases. Last week the Bureau of Economic Analysis reported that the nation’s gross domestic income grew at an annual rate of just 0.5 percent in the second quarter. That followed annual rates of decline of 1.8 percent in the first quarter and 3.3 percent in the fourth quarter of last year. The gross domestic product, which conceptually should add up to the same amount as gross domestic income, has risen each of those quarters, but averaging out the two data series gives the picture of an economy that’s scarcely expanding.

In comparison the job market has been, as I said, relatively strong. On Friday the Bureau of Labor Statistics reported that payrolls grew by 187,000 jobs in August. The unemployment rate jumped to 3.8 percent from 3.5 percent in July, but that’s still below average and was explained by an unusually large rise in the number of people looking for work.

Pascal Michaillat, an economist at the University of California, Santa Cruz, likes to measure the tightness of the job market by comparing the number of job vacancies with the number of unemployed people. The labor market is efficient, he contends, when the numbers are equal — that is, when the ratio of vacancies to unemployed is exactly 1. The ratio fell to 1.4 in August from 1.6 in July, he wrote last week. To him, that means the labor market has loosened but remains too tight: “An excessive amount of labor is devoted to recruiting and hiring instead of producing,” he wrote.

One scenario is that the labor market remains tight for longer than it would otherwise, but eventually cracks. It’s common for the unemployment rate to be a lagging indicator. In the long recession that began in December 2007, the unemployment rate remained right around 5 percent through April 2008, and didn’t peak, at 10 percent, until four months after the recession had ended.

In fact, there are already some signs of cracking in the labor market. Sifting through the August jobs report, David Rosenberg, the bearish president of Toronto-based Rosenberg Research, noted that employment actually fell slightly in the cohort of 25- to 54-year-olds — the “breadwinners,” he called them. There was also a continued decline in full-time jobs, which has been masked by strong growth in part-time jobs.

One factor that can disguise labor-market weakness is labor hoarding, in which employers keep on people they don’t need so they will be available for the next upturn. That may be more prevalent now after the extreme difficulties employers have had finding workers in the past couple of years.

“Businesses experienced severe shortages over the last few years. So, they tell me they are holding on to workers and investing in safety stock,” Thomas Barkin, the president of the Federal Reserve Bank of Richmond, said in a speech a month ago. But if there’s an extended period of slow demand, employers may give up and shed their “safety stock” in large numbers.

To sum up, the job market still appears pretty healthy, even tight. But the Fed shouldn’t take that as a justification for ratcheting interest rates even higher. First, the labor market isn’t quite as strong as it appears. And second, in this era of slow labor-force growth, the cost to the economy of further weakening workers’ bargaining power to slow wage growth is unacceptably high.


Outlook: Kristalina Georgieva

The International Monetary Fund projects that global economic output will grow just 3 percent in 2028 from the year before, which is its lowest five-year-ahead forecast in the past three decades, Kristalina Georgieva, the I.M.F.’s managing director, wrote in the September-October issue of Foreign Affairs. Slow growth “spells trouble for poverty reduction and for creating jobs among burgeoning populations of young people in developing countries,” she wrote. She added: “Fragmentation risks making this already weak economic picture even worse. As growth falls, opportunities vanish and tension builds, the world — already divided by geopolitical rivalries — could splinter further into competing economic blocs.”


Quote of the Day

“Before 1870 the economy was changing only slowly, too slowly for people’s lives at the end of a century to be that materially different from how they had been at the beginning. So the economy was thus the painted-scene backdrop behind the stage, rather than the action on the stage.”

— J. Bradford DeLong, Substack post, Dec. 10, 2021

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