How labor scarcity will reshape financial markets

Thomas Mucha, Geopolitical Strategist
Juhi Dhawan, PhD, Macro Strategist
Nicolas Wylenzek, Macro Strategist
2023-08-24T12:00:00-04:00  | S2:E13  | 25:24

The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.

Episode notes

Macro strategists Juhi Dhawan and Nick Wylenzek join host Thomas Mucha to explore how automation, shifting demographics, the onshoring of manufacturing, and other macro and geopolitical dynamics are impacting labor markets across the globe.

Key topics

1:50 – Structurally tight labor markets

4:35 – How labor scarcity impacts policy

7:25 – Automation across sectors

8:55 – Worker retraining and policy solutions

11:55 – Strategic sectors

14:15 – Demographics and the Chinese economy

16:40 – European politics, immigration, and labor markets

18:55 – US immigration policy

21:25 – Long-term policy and investment implications


COLD OPEN (JUHI DHAWAN): Some people say demographics is destiny and I definitely think that when we have pronounced shifts such as what we’re observing in China’s population, they really do have an impact on the sustainable growth rate of an economy.

THOMAS MUCHA:  Today’s topic is labor markets. Now in many parts of the world including the US, Europe, and China unemployment is at historic lows. Despite recent central bank efforts to loosen things up, labor markets remain stubbornly tight. And the challenges are mounting for the long term as shifting demographics, the onshoring of manufacturing, and other macro and of course geopolitical dynamics exacerbate the situation. So here to talk about the causes and effects of structurally tight labor markets and share some recent research from our global macro team are two of my macro strategist colleagues Juhi Dhawan, who is based in Boston, and Nick Wylenzek who works in our London office. Nick welcome to WellSaid, and Juhi welcome back.

NICK WYLENZEK:Thank you.     

JUHI DHAWAN: Thank you Thomas for having me back. I’m looking forward to our conversation.

THOMAS MUCHA:  Nick, let’s set the stage here with you. I know there’s a lot to cover. Labor markets have eased recently, companies aren’t quite as strapped as they were let’s say a year ago. So why does our team see labor markets remaining so tight on a structural basis?

NICK WYLENZEK:Thank you Thomas. Look you’re absolutely right, cyclically labor market pressure has eased a little. However, as a team we believe there are four reasons that will keep labor markets structurally tight over the coming years. So first of all there’s demographic change. When you think about the aging population in Europe, China, and Japan more specifically, that means the size of the labor force is going to shrink going forward which makes labor markets structurally tighter. Secondly there’s immigration, in theory bringing in foreign workers could mitigate some of the impact of changing demographics. But we’re also seeing increasing political headwinds against immigration especially in Europe. So this would be difficult to make up for the aging population. And then thirdly there’s diversification of supply chains and onshoring. If we think about the rising geopolitical tension, if we think about the lessons we have learned, from COVID, companies and whole economies are trying to redraw and diversify their supply chains which results in significant investment in new manufacturing capacity. And the US for example is a major winner of this. After years of manufacturing capacity leaving the US this trend has reversed and the US economy is essentially going through some kind of re-industrialization. And this of course requires a lot of workers especially in the initial phase of this re-industrialization. And then lastly there’s the energy transition which is one of the biggest economic shifts since the industrial revolution. Most major economies are trying to shift away from fossil fuels towards more renewable and sustainable sources of energy. And while climate change is a big driver of that it’s also about gaining independence from major exporters or natural resources such as Russia. So this energy transition requires a lot of skilled workers. To just give you an idea in Europe solar jobs need to triple in the coming eight years to reach the EU’S 2030 targets. So the combination of this aging population, the lack of immigration, diversification of supply chains, and the energy transition leads to structurally tighter labor markets. And, of course, these trends are different for different countries, but overall they generally apply to the major global economies.

THOMAS MUCHA:  So, Juhi, Nick just laid a pretty comprehensive set of variables here that point to tightness over the long run. He also mentioned the US which is of course your area of expertise. I’m curious from your perspective, how do these factors play out for a macro strategist, for someone who is following the markets, I mean what are you paying most attention to here, and what do you think the main implications are?

JUHI DHAWAN:   When I think about relative labor scarcity becoming a more important factor in how policy is set in the future, I think immediately to central bank reaction functions and government reaction functions. From a central bank standpoint, I believe higher real rates over the course of an expansion is something that we should consider now relative to the recent past. I also believe that government policy will skew more towards areas such as immigration, that Nick mentioned, as well as dependent care, both elderly and childcare as areas and ways in which to improve labor force participation when working age populations are starting to shrink. Two other things to keep in mind from a market standpoint, one is when workers are scarce automation becomes your ally not something to really frown upon anymore. And I believe that there will be a greater push towards investment spending as a result of these changes. I also think workers will gain more bargaining power which could help reduce income inequality which is especially important in an economy like the US where income inequality has been quite pronounced. Wage growth compression might occur because when we think about the specific labor market dynamics that are in place in the United States it is the population with the lowest skills demographically that will be shrinking in the coming years, and areas such as automation might start to put some downward pressure on wage growth in a higher income segment. So these are really very different ideas to consider relative to where we’ve been in the recent past, and none of this takes away cycles, and none of this takes away the unemployment rates rise when policy tightens or so on and forth. But they do suggest a shift in terms of what do you want to own in the market and how to think about an economic expansion in its aggregate.

THOMAS MUCHA:  Okay, a lot to unpack here from both of you. And I think let’s start with automation, you know, Juhi you just mentioned that. And there are so many intersections with what we’ve been talking about, not only at the firm but on this podcast and it’s certainly a key discussion point in the markets right now. It’s also on its own a big source of job creation, someone has to build the technology and reimagine the processes needed to automate the work. So Nick, from your perspective what are some of the ways in which companies are beginning to integrate this automation that Juhi is pointing to?

NICK WYLENZEK:Yes, when most of us think about automation we think about robots making cars and washing machines. However, automation is really happening in all areas of the economy, either by making humans more productive or actually replacing them. Think about customer services where chat bots are replacing call centers to deal with most basic customer inquiries. Fast food restaurants where we put our order into a computer rather than ordering from a person. Warehouses are increasingly fully automated. AI is helping computer programmers to write code much faster. In areas like farming: automated tractors, monitoring drones, seeding and weeding robots all can significantly reduce the human labor needed for these activities. So, it’s actually really hard to find an area where automation is not being used and it’s not having an impact.

THOMAS MUCHA:  And we’re seeing this already Nick?

NICK WYLENZEK:Yes, so all these examples I just gave you they’re very real they’re happening in real time, and we can all see them in our daily life.

THOMAS MUCHA:  So Juhi related to technology and automation is this issue of course of changing skills requirements? I’ve seen the stat here on this team that 80% of companies around the world say they’re having a hard time finding workers with the right skill sets. In some countries that’s even higher. That’s a huge number. So, you know, why do you think people are so under skilled Juhi or why are these skills misaligned, and do you see an improvement in this trajectory?

JUHI DHAWAN:   One of the things that has occurred over the last 20 years or so is that worker retraining has dropped off quite noticeably and some of it was really because there was so much surplus labor available that companies didn’t have any issues trying to find workers when they needed to. As technological advances have continued to grow, and as labor has become more scarce and we have younger workforces with older workers retiring the need for worker retraining continues to go up. I believe that there will be an increased focus, and actually we already see it when we talk to companies, of trying to find ways to increase worker productivity so that the automation piece, that Nick just spoke about, is an ally to the workers at their workplace and education and worker retraining really gains a prominence for companies as a way to increase productivity. I think that this could be really the gem of the next 5-10 years if worker productivity starts to rise as increased focus comes into place to really get the training in place that is needed. But I want to emphasize that this takes time. You can’t change education systems instantaneously, you can’t have all of this happen overnight, and that’s really why we’re seeing the shift in skill requirements, why job openings in some areas are staying open for longer, and why there’s been this idea that there are sort of tighter labor markets because you’re seeing that friction of not being able to find the exact right person for the job.

THOMAS MUCHA:  Yeah, Juhi in my conversations with policy makers this idea of education obviously comes up all the time. It’s a pretty tricky policy needle to thread though. Do you see anything out there on the horizon that gives you hope at least from the policy perspective that we can get there a little bit faster than what has been the case in the past?

JUHI DHAWAN:   I think the encouragement I feel on a relative basis, Thomas, for what is as you rightly point out a thorny issue, is the fact that companies now need to make these investments and I think they might become more proactive themselves and also push for the kind of changes we need to make to ensure that the workforce of the future meets the skills of the evolving economies.

THOMAS MUCHA:  Yeah, and any of us who have children obviously are aware of the STEM push in all of our schools. And so you know this is obviously something we want to watch. Nick, you did mention obviously onshoring earlier, that’s a part of this discussion that intersects with geopolitics. I do continue to see an increasing government focus on strategic sectors that are on the frontlines of great power competition. And I’m curious Nick from your perspective, watching Europe so closely, which strategic industries are you expecting to feel the biggest impact here from this trend?

NICK WYLENZEK: I think there are two areas that are really going to be impacted from this trend. On one side you have critical technologies like semis. I think throughout COVID we all learned how important it is to have a decent supply of semiconductors and these are getting more advanced and used in increasing amounts of products. So it’s very important to have access to these products, and we are already seeing this with the US trying to build more FABS in the US. We are seeing that in Europe with the German government giving significant subsidies to TSMC and Intel to build semiconductor FABS in Eastern Germany. So there’s a clear drive for countries to become independent when it comes to sourcing these semiconductors. So that’s the first area. I think the second area that’s very important is anything around the energy transition, I think as I mentioned earlier this is going to be one of the major economic trends we’ve seen in the last century. And governments are trying to make sure that their economies have access to all the ingredients for this successful energy transition, and that includes access to rare earths, critical minerals, battery technology, certain chemicals to make solar panels. So there’s a lot of investment incentives going into individual economies to make them autarch essentially of the global supply chain to be able to produce these things locally. So these are the two areas I really think are the two areas that are most impacted.

THOMAS MUCHA:  Yeah and that certainly fits in with my research as well, this intersection of national security and climate change is certainly driving policy and I think it’s going to have major implications not only for the macro backup but also the labor situation that’s the focus of this conversation. Obviously this also puts China right in the center of this conversation. China’s labor force has been in decline since 2015, and the numbers for the next 10 years in China are about to get worse as China’s working age is set to plummet. And yet, you know, Juhi, China still accounts for about a third of global manufacturing, thanks in large part to its investments in automation. So how are labor market dynamics in your view, Juhi, affecting China’s economy domestically. And then how does that spill out for the rest of the world?

JUHI DHAWAN:   Some people say demographics is destiny and I definitely think that when we have pronounced shifts such as what we’re observing in China’s population, they really do have an impact on the sustainable growth rate of an economy. So as the Chinese population had a large number of workers earlier in the last couple of decades, we saw very fast growth rates and a pronounced step up in China’s contribution to the global economy. As that working age population, over this coming decade will start to dwindle we should expect that China will a) adapt more to technology and automation just as we’ve talked about for other countries. But also the growth rate that we should think about that’s sustainable for China starts to step down. And I know my colleague Santiago has talked a lot about this and I definitely think that there’s a lot of wisdom in thinking about what that impact will be also on the rest of the world. As a result of China being such an important part of the manufacturing chain what we’re seeing are investments by countries in other parts of the world. Also lower income economies in Southeast Asia, or closer to home here in the United States in places like Mexico as a result of some of the re-shoring initiatives. But also as the cost of labor is no longer as compelling as it was in the past in China because of that relative worker scarcity if you will. So a lot of shifts as a result of the very prominent role China has played in the manufacturing footprint for multinationals around the world that we need to consider in coming years.

THOMAS MUCHA:  Yeah, what happens in China doesn’t stay in China from a macro perspective. So you know this is central to the geopolitical question, obviously we can’t escape geopolitics on this podcast. Nick, Europe’s labor tightness has eased a little bit due to an uptick in immigration, given the refugees of the war of Ukraine, strife in the Middle East and Africa. But as you said earlier anti-mmigration political parties are on the rise in Europe. They’re becoming increasingly influential on the policy side. So what are you watching for, what are the signposts in Europe in terms of immigration policy and what this means for the labor situation?

NICK WYLENZEK:Yes, you’re right, the political right has seen a significant surge in popularity across Europe. Just to give you a few examples the AFD in Germany has massively gained popularity. National Rally in France has gained popularity, the Brothers of Italy are actually the key party in the Italian government at the moment. And we can really see this across Europe where in most countries right wing parties have gained a popularity over the last 18 months. And this was driven by two areas, one irregular immigration which has picked up since the lifting of most pandemic era travel restrictions, and there’s a growing backlash against expensive climate policies, especially as the cost-of-living crisis continues to weigh on living standards. So these two components really drove the popularity of a lot of right wing parties, and if that continues we’re likely to see more pushback against immigration in Europe. In terms of the key markers to watch I would flag the European election next year which could lead to a significant shift to the right, especially because fringe parties tend to do a bit better in European elections just because participation tends to be a bit lower. But then I would also watch the upcoming Polish elections, the Austrian elections next year, and then there’s several regional elections in Germany as well that could tilt federal politics in Germany. So these are really the key events to watch and if we see this shift towards the right manifest itself in governments or the European parliament I would expect immigration laws to tighten up in Europe rather than to ease. And as we discussed before we really need to see more immigration in Europe to deal with the demographic shift.

THOMAS MUCHA:  Yeah, so domestic politics has a large role to play here in determining what kind of macro outcomes we get. Juhi, in a bit of a contrast, to what Nick just laid out, I’ve heard you say that you believe that for the first time in a really long time US public opinion is starting to swing toward a more favorable view of immigration. So I’m curious for your thoughts on that and how this issue which is always a hot button issue, might affect the next election cycle in the US. And then beyond the election, what does this mean for the economy long term?

JUHI DHAWAN:   It’s a fascinating study to see how the pendulum shifts either in favor of or against immigration in the United States. As we know the US has had a long tradition of having immigrants be part and parcel of the economy. But I think the era of the post global financial crisis has been one where unemployment rates are very elevated. And there was really a sense that a lot of Americans suffered as a result of what was perceived as unfair competition from cheaper labor overseas. So to welcome more immigrants at a time when the unemployment rate is elevated is really hard. As the unemployment rate has dipped to cycle lows more recently I think the shift in sentiment towards having more immigrants coming in is really a function of that nuance if you will. What I would say is that on a go forward basis post elections we’re going to have to see which party wins Thomas to know what kind of policies come into place. But if the theme of enduring labor shortages persists then I think there will be more focus on either finding a path towards undocumented immigrants or finding a path to increase skilled labor, or just an overhaul in the processing time for visas. Or just a lot of different ways in which policy makers can make a difference for a number of companies who believe they could be growing faster if they only had the workers that they need.

THOMAS MUCHA:  And again Juhi relative to Europe, China, and elsewhere the US does sit in a largely favorable position here in terms of these demographic shifts correct?

JUHI DHAWAN:   That’s correct. But again policy often needs a catalyst to kind of get you there, so no promises, but I do think that given the United States’ history of favoring immigration over a period of time, if the stars do align in a way I do believe it’s possible that there could be some revamp of this policy in coming years.

THOMAS MUCHA:  All right let’s begin to wrap up this conversation by circling back again to the global context. And Juhi I’ll start with you and then I do want Nick’s views on this as well. You know broadly speaking what should we be thinking about here, what can you leave us with about the long-term policy implications, and particularly the impact on future GDP growth?

JUHI DHAWAN:   From my perspective the immediate reaction of most people when you say population growth is slowing, or we’re going to have fewer workers is to think lower growth rates, and I think that’s a fair assessment. But if the right policies are put in place and if automation or investment spending picks up to complement workers that are available, we could get a boost in productivity that we haven’t seen in a very long period of time.

THOMAS MUCHA:  We’re due.

JUHI DHAWAN:   We are due, aren’t we. So I remain in the camp of thinking that following what policy prescriptions come out in terms of the right mix whether it’s for immigration or it’s childcare or it’s research and development spending, or so on and forth, that mix could really determine who the relative winners and losers are in the global economy in the coming years. And I think that that could be really another way to add alpha for portfolios relative to where we have been in the recent past.

THOMAS MUCHA:  Nick what do you have to say about that?

NICK WYLENZEK:I absolutely agree with Juhi. Everything in the end will depend on policy response, but what seems very clear to me is that tighter labor markets will ultimately lead to more investment in automation, research and development, and software. And there will be companies that are clear beneficiaries of these trends. I would also say it will return some of the bargaining power to labor, I think that’s probably something we have missed in especially Europe and the US over the last 20 years or so as a lot of manufacturing capacity moved to the cheaper labor countries in Asia. And I think with these trends described I think we will see more bargaining power for labor in Europe and the US.

THOMAS MUCHA:  All right, well let’s end it on those relatively positive thoughts and hope for a boost in productivity and a better outlook for economic inequality and we’ll see what we get. Once again, my thanks to Juhi Dhawan and Nick Wylenzek, macro strategist here at Wellington. Thanks again for being with us on WellSaid. 


Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For  professional/institutional investors only. Your capital may be at risk. Podcast produced August 2023.

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