Maybe the labor market isn’t so tight after all

Every month, economists struggle to reconcile a strong jobs report with a tepid increase in wages. How is it that hiring is solid — an average 198,000 new jobs added each month for the past year — the unemployment rate is near multi-decade lows, employers are complaining about a lack of qualified workers, yet wage growth is still flat-lining at a 2.7% annual rate?

Is it possible the labor market isn’t as tight as these metrics would seem to suggest? That’s the proposition put forth by NGDP Advisers, a macroeconomic consulting firm, in a recent research report.

“A strong labor market is characterized by a high employment-to-population ratio and a high labor-force participation rate,” the economists at NGDP Advisers write.

Neither of these pre-conditions presents itself today. In fact, the last time the civilian unemployment rate was hovering near 4% — in the latter half of 2000 — the labor-force participation rate exceeded 67% compared with 62.9% last month. The employment-to-population ratio peaked at 64.7% in 2000 compared with 60.4% now.

The percentage of people from 25-54 who are in the labor force has fallen a lot since the Great Recession began, a sign that the labor market still may have lots of slack even though the unemployment rate is just 4%.

Yes, demographics can explain part of the story as the baby boomers retire from the workforce. But fewer prime-age workers, defined as those between the ages of 25 and 54, are employed or looking for work now (82%) than at the 1999 peak (84.6%). And the number of prime-age workers as a percent of the population stands at 79.3% compared to 81.9% in 2000.

For NGDP Advisers, the explanation for the not-so-tight labor market lies in the failure of nominal spending, or nominal gross domestic product, to make up for the steep losses incurred during the Great Recession and return to trend growth. As a policy tool, NGDP targeting entails keeping nominal income growing at a stable rate while allowing real GDP and inflation to adjust within that target. NGDP level targeting allows for adjustments to the annual growth rate to offset prior deviations from trend.

In other words, the level of NGDP today implies that there is still ample slack in the economy, be it in labor or industrial capacity, to explain subdued trends in both wages and prices. Even if you don’t buy NGDP Advisers’ diagnosis, it’s clear that strong labor demand, reflected in both quantitative and qualitative data, is not driving wages higher.

On Tuesday, two economic reports conveyed the degree of labor-market strength. The Labor Department’s JOLTS report (jobs opening and labor turnover survey) for May showed an elevated level of job openings relative to both the number of hires and the number of unemployed. The gap between job openings and unemployed manifested itself for the first time in March and has continued to widen.

What’s more, workers are increasingly willing to leave their job, presumably because they are confident of finding a better one.

Confidence among small businesses remains near historic highs, according to the National Federation of Independent Business’s June survey. The single most important problem cited by small business owners? Difficulty in finding qualified workers.

Businesses aren’t going to offer a higher salary to someone who lacks the skill set for a particular position. But that doesn’t explain the apparent reluctance to use the lure of a higher wage to attract qualified workers from competitors.

Another explanation for static wage gains is that companies are using add-ons — one-time signing bonuses, for example — to attract workers without committing themselves to paying a higher wage or salary. That theory doesn’t hold up under examination. These so-called nonproduction bonuses constituted 2.8% of private-sector compensation in the first quarter, a slight increase from the 2.6% to 2.7% share in the previous two years, but nothing to support the idea that companies are using big bonuses overall as a recruiting tool.

The signals emanating from the job market are strong enough to attract discouraged workers back into the labor force. The civilian labor force increased by a hefty 601,000 in June, according to the Bureau of Labor Statistics’ survey of households. Only 102,000 of those new entrants found jobs, which caused a bump up in the unemployment rate to 4% from 3.8% the prior month.

Nothing in the preceding discussion offers a completely satisfying answer to the disconnect between strong labor demand and unimpressive compensation. One of these months, we could experience another shot heard ‘round the world, or at least through financial markets, such as the one in early February. That’s when the BLS reported an outsized 2.9% annual increase in average hourly earnings, subsequently revised to 2.8%.

Stocks plummeted, bond yields spiked, analysts cried, “see, I told you so,” and pretty soon it was all a distant memory. Then we went back to trying to reconcile strong labor demand with tepid wage increases.

Until things change, or a more convincing argument comes along, we are left to conclude that, while not obvious to the naked eye, there is still enough slack in the labor market to satisfy strong demand.

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