Economic Update: Labor Shortages and Productivity

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

Several recent economic releases point to an economy that continues to grow at a brisk rate. The one that really stands out from last week is new claims for unemployment. The latest data on unemployment claims show that national initial claims declined by almost 200,000 in one week. New claims came in at 576,000, clearly the lowest level since the shutdowns of last year. Pre-pandemic claims (early 2020) were in the low 200,000 range, and you must go way back to the late 60s to find initial claims for unemployment lower than 200,000. Keep in mind also that the labor force in the late 1960s was about half the size of the labor force of today.

We can see the labor crunch through some of these numbers. The nation’s labor force hit a trough in April of last year. As some states began to reopen, it climbed in a V-shape fashion until July of last year. Since last July, the size of the nation’s labor force has been stuck around 160 million, plus or minus. As initial unemployment claims continue to decline, and we see robust growth in monthly payroll gains, the labor crunch will only intensify if labor force numbers remain flat.

Last week, industrial production registered the first positive year over year change since August of 2019. How can we be producing more, but with a labor force that has been flat since last July? Employee productivity is the reason. In April of last year, the nation saw the largest increase in productivity since the 1940s! Remember that April was the month that we started seeing massive layoffs. Production did not completely come to a halt in April. Many manufacturers continued to produce and found a way to produce more with fewer employees. We are now about a year past the first economic shutdowns of last year, and some manufacturers are producing more today than a year ago (remember industrial production above). However, the labor force is stuck.

The combination of more production and a stagnant labor force means that employers may begin to see higher wage demands. Employers may be forced to increase wages to attract labor necessary to boost production. Or you could see continued gains to productivity. Employers will need to invest in labor-saving equipment and the nation will see an acceleration toward pre-pandemic trends of more automation. Higher productivity alone implies that wages should also increase. We see this play out in the data. Last year saw the highest jump in average weekly wages since the 1960s, as far back as available in the database!

Let’s see how this is playing out at the local level. Louisville Metro labor force reached a pre-pandemic high of around 685,000 in July 2018 and 2019. Due to seasonality, regional labor force peaks in July of each year. Since August of last year, the labor force for Louisville Metro has been stuck around the 650,000 level. Burning Glass data show that the number of job postings over the past 3 months is about 7,000 higher from August to October of 2020. We know that the unemployment rate is declining as the number of employed continues to increase. This mismatch between labor demand, as evidenced by the increase in job postings, and labor supply, as evidenced by a flat change in labor force, will make it increasingly difficult to find employees.

Moving forward, we will see ongoing challenges surrounding labor force availability. Putting my futuristic hat on for a moment, this will likely accelerate moves to more automation and labor-saving innovations. Productivity will increase even further. Productivity gains also occur with higher skilled employees, and the importance of talent will only intensify as we exit the Covid economy.

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