Is This Full Employment?

The economy is doing well. Our last quarter’s annualized GDP growth was 4.2%, inflation has stayed moderately high, but below 3%, and foreign investors continue to pour capital into U.S. markets. We have even begun to see wage growth previously unseen in the post-recession recovery, to the tune of about 1% after accounting for inflation. But there’s one critical factor missing from this otherwise robust picture: employment.

Today I want to analyze the employment situation of the United States. Besides being the primary human application of an economy, the ability to work and earn a living, employment plays an integral role in the relationship between economic growth and earning power. Labor is, after all, affected by the laws of supply and demand, and where those forces meet, we arrive at Wages (the price of labor). The orthodox economic thought states that as the labor market shows less slack, meaning there is less supply, then as long as demand for labor is constant or higher, then wages should rise.

However, the employment situation in the U.S. is complicated, and like most other things in economics, there is more to it than just the headline numbers. So today, we will find out if the U.S. economy is at full employment, or if we still have room to run.

Before we get started, let’s lay some ground rules. As mentioned above, labor is affected by both supply and demand. However, as labor is the means of production stemming entirely from people, workers thus control the supply, and businesses control the demand. This is important to highlight because it is counter to traditional economic thinking on issues like pricing and inflation, which assumes businesses (good & service producers) as supply and workers (good & service consumers) as demand. Also, when tracking who is “In the Labor Force” we only use people who are currently working or who have been looking for work at least once in the last four weeks. If a person does not meet this criteria, they are considered out of the labor force. Retirees, children, and some disabled fall into this category.


Defining Unemployment

What does it take for an economy to achieve “full employment”? If you think that full employment means an unemployment rate of zero, you would be incorrect. There are three kinds of unemployment, and each are important in determining the official unemployment rate of a population. When defining these terms, we will work from best to worst.

Frictional Unemployment – This is the best kind of unemployment, because this kind does not stem from any real negative factor. Frictional unemployment measures the unemployment stemming from general worker activity. When workers quit their current jobs to search for better ones, or when workers voluntarily reenter the workforce to look for work, say, during the holidays or another seasonal time, this kind of unemployment goes up or down. Some of this kind of unemployment is healthy for an economy, because it shows that workers feel mobile and can move between jobs freely.

Structural Unemployment – This is what I would call the middle kind of unemployment, because it is affected by both workers and employers. Structural Unemployment measures unemployment that arises from different supply and demand shifts between industries in an economy. A prime example of this is the shift from fully paper-based books to online PDF’s. Fewer workers are needed to bind and print books, so demand for that kind of work decreases. Conversely, as more books are transferred to the internet, demand is increased for work in IT, and as books are now more easily available across the globe, work in translation.

Cyclical Unemployment – This is the worst kind of unemployment because, as you may have guesses, it stems from unemployment due to where an economy is in the business cycle. In times of expansion, when businesses are hiring, this kind of unemployment can be expected to decrease, and likewise in time of recession, when businesses are laying off workers, this kind of unemployment can be expected to rise.

Now that we have our terms defined, it is the combination of these kinds of unemployment that makes up the Natural Rate of Unemployment. What is the exact combination of the three kinds that makes up the natural rate? It depends on a huge amount of factors, both inherent in our three kinds and not, so there is no specific answer. However, in ‘normal’ economic times, meaning times of neither an expansion nor a recession, the natural rate is expected to be around 5%.


The Current U.S. Employment Situation

While the overall U.S. economic picture can be described on both sides of the political aisle as “Robust”, the employment situation is less agreeable to everyone. This is naturally the case, as both sides will include and exclude certain parts to fit their narrative. What do I mean by this? Well, the Right, for example, generally points to current employment conditions as very bright, citing a record number of job openings and an unemployment rate at 3.7%. The Left, meanwhile, paint a less rosy picture, citing lackluster wage increases and the quality of jobs offered.

So who is correct? As with most other things, the answer is somewhere in the middle. Here are the facts as of October 25, 2018.

I track the employment situation using a multitude of different data points. The most important one to me is the Labor Force Participation Rate, which measures the percentage of adults of working age (18+) currently in the labor force. It is important to note that as our population ages and more Baby Boomers retire, this percentage will fall, and as more students enter the workforce, this percentage will rise. The LFPR is currently as 62.7%, and has fluctuated between 62.7% and 63% since September 2013.

Other pieces of data I track include both Weekly and Continuing Jobless Claims. These measure Americans who initially file for unemployment (weekly) and who are kept on unemployment (continuing). Americans can typically collect unemployment insurance for 26 weeks (half a year), though it varies for each state. Currently, Weekly claims are at 215,000, their lowest level since 1969, and Continuing claims are at 1.636 million, the lowest in 45 years. Both claims have been steadily dropping for most of this year.

Additionally, employment information for a month is released on the first Friday of the following month (Jobs Friday). This release shows the Bureau of Labor Statistics measurements of how many jobs were added or lost that month, as well as the LFPR, Wage changes, Unemployment rate changes, and average weekly hours. If you’ve been following this blog for a few months, you will have seen my posts about Jobs Friday, and will be able to track this information for yourself.


Are We at Full Employment?

So after all this, where do we stand? Here is what I think.

The post-recession recovery has seen a steady rate of job creation, at around 192,000 jobs per month from March 2010 through September 2018. However, the job creation rate through January 2017 was closer to 210,000 jobs a month. In 2018, there have been a few months where the jobs added were more than estimates, but other months that missed estimates big time. Wage growth has been anemic at best, and stagnant to falling at worst, with 1%-2% annual increases which have been swallowed up by inflation. Only in the past year or so has wage growth started to break out over 2.5%, but inflation has followed, peaking a few months ago at 2.9% annualized.

As mentioned above, even though there has been a healthy rate of monthly job creation, the Labor Force Participation Rate has neither increased nor decreased. Couple this with the falling jobless claims, and I think a picture is starting to show under all these numbers.

Wage growth typically follows when there is no more slack in the labor market. The thinking behind this is that businesses can no longer hire workers sitting on the sidelines, and have to woo them from other businesses with higher wages or benefits. Makes sense, right? So far, we have not been seeing evidence of this in the measurement of wages. Additionally, the LFPR not moving implies that no new workers are entering the workforce, or put in other words, the oscillation between 62.7% and 63% shows that as new workers come in, a proportional amount of workers come out. Finally, the jobless claims decreasing while the number of job openings is increasing shows me that workers are slowly finding jobs, but there are far more job openings than there are workers currently looking for work.

What picture does this show? I believe that there is still a lot of slack in the labor market. There are likely many people that are just not looking for work, and no amount of tax cuts or jobs guarantees will make them want to reenter the workforce. Because of this, even though those in the workforce are finding work and making the unemployment rate seem very low, the population still shows a lot of slack in the labor market. As a result, wages are not rising because businesses do not feel enough pressure to raise wages to attract workers the old fashioned way.

On the other hand, it is likely the case that no amount of wooing by businesses will make the remaining slack in the labor force decrease by a material amount. The U.S. population is aging, and retirees likely do not want to return to work unless they absolutely have to. There are also likely people sitting out who feel disenfranchised by jobs that they feel pay them far too little for what they are worth.  With the shrinking power of collective bargaining and workers’ rights, they may feel like companies do not cater to what they want out of life, or have the beneficial corporate social footprint they desire. Compound this with the need to pay off student loans, rising mortgages, and the general cost of living, and many low-wage jobs simply will not cut it. A third reason for people not entering the labor force could be a lack of means. People may not have the desire or the capacity to move, possibly across the country, to find jobs that would suit them. People may also just want to work for a while, save their money, and retire earlier than at age 65. For these, and more, factors, people simply are not entering the workforce in the manner that businesses would like.

To summarize, even though it may look like we still have room to grow the workforce, people are not entering in the way that businesses want, and those in the workforce are finding work, but on a decreasing basis. In a nutshell, I think this is what Full Employment looks like in our current economic cycle. I do not expect employment to tighten at the same rate as in previous years, and as the cycle turns, look for employment trends to decrease in the coming years.


Do you agree with my analysis? Want me to elaborate on a data point or topic? Or maybe you just want to debate? Please feel free to comment or send me a message, and remember: opinions can tell a convincing story, but data tells a complete one.

Sources:

https://fred.stlouisfed.org/series/CIVPART

https://www.businessinsider.com/heres-how-long-unemployment-benefits-now-last-in-each-state-2014-1

https://www.cbpp.org/research/economy/chart-book-the-legacy-of-the-great-recession

https://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/unemployment.asp

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