- With just over one year since the onset of the pandemic recession, the US labor market is facing an important turning point.
- The nature of the pandemic shock pushed many workers into temporary unemployment, setting the stage for a swifter-than-expected initial recovery. However, a large and persistent group of workers exited the labor force due to pandemic-related constraints, which is now limiting how quickly labor supply, and overall employment, can recover.
- We ultimately expect labor supply constraints to ease this year. However, near-term constraints have resulted in a tighter-than-expected labor market, with implications for wage inflation. Moreover, some labor supply shortfalls, such as a surge in retirements due to COVID, may not reverse.
- Near-term labor supply constraints could complicate the outlook for Fed communication if they prove more lasting than expected, especially if wage inflation accelerates meaningfully in an environment with rapidly rising prices and inflation expectations.
Pandemic recession and initial recovery
The pandemic recession is one of the largest shocks to the US labor market in history, and it is probably the most abrupt. The impact of the pandemic was especially severe for low-skill/low-wage workers who were concentrated in industries that require a lot of social contact, such as food services, accommodation, arts, entertainment and recreation.
While the nature of the pandemic labor market shock laid the groundwork for a swifter-than-expected initial phase of the recovery, it also had a disproportionate impact on labor supply, which has recently affected how quickly the labor market can recover.
Incomplete recovery, but tighter-than-expected labor markets
While the labor market recovery has made significant progress over the last 12 months, we remain far away from the strength seen in February 2020. That said, there is increasing evidence that the labor market is tighter than what the employment-to-population ratio (EPOP) and the unemployment rate alone would suggest.
The vacancy rate and quits rate are both at or above pre-pandemic levels. Both indicators suggest a relatively favorable environment for individuals who are willing and able to work. However, we believe the discrepancy between EPOP and measures such as the vacancy rate reflect a significant number of workers facing constraints on their ability to return to their previous job or search for new employment.
Recent wage growth consistent with tighter-than-expected labor market
The strength in April average hourly earnings (AHE) despite an influx of low-wage leisure & hospitality workers provides some early evidence that employers are responding to labor shortages by increasing wages, consistent with anecdotal information.
Importantly, we believe many factors contributing to supply shortages are likely to be temporary. As a result, we do not expect a permanent new trend of higher wage inflation.
Finally, the outlook for productivity will also be important for wages. The pandemic shock may have a more lasting positive impact on productivity growth, which could limit concern over higher wage inflation.
Constraints on labor supply and the recovery
The unusual nature of the pandemic recession resulted in a significant number of workers exiting the labor market at the onset of the downturn at a much higher rate compared to the GFC.
Retirement, family responsibilities (amid widespread school closures) and concern over the virus all contributed to a decrease in labor supply. More recently, concern has emerged that $300/week enhanced unemployment benefits are keeping some workers on the sidelines and that a potential skills mismatch is preventing a more robust labor market recovery.
In 2020, temporary unemployed workers were ready to return to their previous jobs once lockdowns lifted; individuals working part time who preferred full-time work could transition back into full-time employment. By contrast, the trajectory of nonparticipants due to family responsibilities will depend on how quickly school and childcare options normalize and vaccine availability for younger children; a large portion of workers who retired since February 2020 may not return; workers concerned over COVID will need to see conditions in their local communities improve along with vaccinations.
Outlook for labor supply constraints
We believe most of the constraints on labor supply will ease this year, including:
- Family responsibilities. Schools and childcare options will continue to normalize, easing constraints on individuals with family responsibilities, aided by vaccination of the younger population and momentum from parents and administrators to return to in-person school.
- Concern over COVID. Ongoing COVID vaccinations and notable declines in the pace of new cases over recent weeks will likely help bring back workers who have thus far remained concerned about catching or transmitting the virus at work.
- Enhanced UI. To the extent that enhanced unemployment benefits are keeping some workers from returning to previous jobs or accepting new positions, those are set to expire in early September with some states acting sooner (note that, as of writing, 22 states have announced plans to end their participation in the enhanced federal programs over coming weeks, providing an important opportunity to gauge their impact). Given the sharp improvement in economic conditions and vaccinations, we do not currently expect the $300/week enhancement to be extended by Congress beyond early September.
However, some supply constraints may be more persistent:
- Retirement. Individuals who retired during the pandemic may not come back, especially considering the contrast between the impact on retirement accounts during the GFC and pandemic recession.
- Mismatch. While we do not believe mismatch is playing a significant role, our measure of industry mismatch is nevertheless elevated compared to pre-COVID levels. Some industries might face permanently lower demand for workers, such as in-person retail establishments (given the accelerated shift to online shopping) or office cleaning staff (given the likely lower level of demand for office space).
Chief US Economist