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The tight US labor supply has been a defining characteristic of the current US expansion and it colors the near-term outlook for inflation and interest rates. But labor dynamics will also be a critical long-term story that affects a wide range of economic and financial market outcomes. The point at which labor demand and supply find their equilibrium and the ways in which wages interact with a tighter labor market will, for example, have a meaningful impact on which sectors and companies outperform the equity market in coming years.
The US labor situation will be an ongoing area of focus in my research, and I would like to highlight a few of my initial conclusions up front:
With the large baby boomer generation now retiring and being followed by the smaller Gen X and the elongated profile of Gen Y and Gen Z (i.e., Gen Y and Gen Z are large but births were spread out over a long period), I expect relative labor scarcity to be one of the enduring themes of the next decade. Of course, the US is not alone in facing such demographic challenges — and in fact, it is better off than some other major economies in terms of the working-age population, thanks in part to a recent boost in the prime worker population from Gen Y. But the long-term trend reflects my view that this theme will endure (Figure 1).
In addition, the US, long upheld for its flexible labor markets and high participation rates, is now at the lower end of G20 nations for both male and female labor force participation rates (Figure 2). Among men, this decline is explained by a confluence of factors, including the opioid crisis, rising incarceration rates, and declining education rates. Among women, the shift can be tied to pandemic-related effects (e.g., more women stepped away from work to care for ailing family members) and the rising cost and scarcity of childcare. Inflecting these numbers back in a positive direction will require the right mix of policy and investment.
As a starting point for US policy, there may be a lot to learn from Japan, which grew its labor force over the past decade despite a rapidly shrinking working-age population. Among the tactics that proved effective: encouraging more women to enter the workforce by offering better, more affordable childcare, introducing flexible work arrangements, and removing disincentives such as a low retirement age. Addressing the cost of childcare, in particular, would move the needle in the US, where it tends to be far more expensive than in other parts of the developed world. The demand for solutions is so strong that it would not surprise me if, in the runup to the next US election, a renewal of the recently expired child tax credit ends up being endorsed by both parties (if it comes with a work requirement).
To the list of possible policy solutions, I would add improving elder care affordability and availability, expanding workforce training, and finding ways to bring those previously incarcerated or recovering from opioid addiction back into the labor market. Whatever the focus of the proposed solutions, careful policy design will be critical to ensure that workforce participation is incentivized.
Lastly, a greater willingness to open US borders to immigration could help mitigate the labor-market impact of an aging society. We saw an example when, after the COVID-driven hiatus in immigration, an influx of some one million immigrants helped ease the US labor supply/demand imbalance a bit. The importance of this incremental supply is visible in wage gains, which have started to moderate at the lowest end. For instance, immigrants account for 31% of the labor force in the hotel and lodging industry1, which saw some of the biggest wage increases in 2022 and some moderation recently. Looking ahead, the current backlog of 389,000 visas2 suggests room for another boost in immigration, which would be welcome news.
The relative scarcity of labor is likely to be an enduring theme given the shift in demographics, skill mismatches, and reshoring of supply chains. Going forward, I expect the focus to be on higher investment spending and higher real rates, as well as the possibility of more power ending up in the hands of workers. Policy likely needs to be more active in this area to find winning solutions.
1Source: National Immigration Forum | 2Source: US Department of State, June 2023
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Toshiki Izumi, CFA, CMA