The labor market is not that bad, Mr. Chair

| February 12, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Fed Chair Powell on Thursday offered a pretty gloomy picture of the jobs situation. He made the broad point that despite considerable recovery since last April, the labor market still has a long way to go to get back to full health. That is true, but Powell overstates the weakness in the current situation and, in the process, may be overestimating the amount of time it takes to return to full employment once the pandemic is brought under control.

Chair Powell’s dire labor market narrative

On Thursday, Powell led off his description of the current state of the labor market by noting that employment is nearly 10 million below its February 2020 level. He then moved on to discuss the unemployment rate. He acknowledged that the official unemployment rate has dropped to 6.3%, but he argued that this vastly understates the weakness in the labor market. He noted that labor force participation has fallen by more over the past year than at any time in the history of the series going back to 1948. Moreover, he added that the Bureau of Labor Statistics believes some workers are being misclassified as employed when they are in fact unemployed. Adding the misclassification and the entire drop in the labor force to the ranks of the unemployed, he argued that the true unemployment rate is close to 10%.

He went on to argue that things are even worse than that. He pointed out that the household survey metrics show that more laid-off workers view themselves as having permanently lost their jobs as opposed to being temporarily laid off relative to the early months of the pandemic. Moreover, he noted that long-term unemployment—workers unemployed by more than six months—has been rising in recent months, repeating the Fed’s mantra that “extended periods of unemployment” can cause persistent scarring by eroding the ex-workers’ skills and making them harder to re-employ.

Reality check

The labor market situation is far from ideal. Powell is exactly right that aggregate employment is almost 10 million below the February 2020 level. Moreover, the official unemployment rate is 6.3%, nearly double where it was in early 2020. The situation is difficult, in large part due to the pandemic.

However, Powell’s assessment is an unfair portrayal of the situation for several reasons. To start, his calculation of the true unemployment rate is a gross exaggeration of the underlying situation. He adds two groups to the ranks of the officially designated unemployed, those that the BLS has stated may be misclassified and all of those who have dropped out of the labor force since February 2020.

The BLS discovered at the onset of the pandemic that there was a possible inaccuracy in the household survey results. Individuals that are surveyed self-report their situations. Early on, a number of firms that shut down due to pandemic restrictions told their workers that they still had their jobs and would be brought back when business permitted. Within the household survey, respondents in that situation had the option of saying that they were “employed but not at work” or “unemployed on temporary layoff.” The BLS instructed interviewers to classify anyone who said that they were employed but “absent from work due to temporary, pandemic-related business closures or cutbacks as unemployed on temporary layoff.” However, since respondents are allowed to self-identify, the BLS did not manually go back and fix the responses of those who still classified themselves as “employed but not at work.”

Since March, the BLS has closely examined the responses and quantified what the unemployment rate would have been if the cohort of people who incorrectly answered and characterized themselves as “employed but not at work” had been correctly designated as unemployed. For the first few months of the pandemic, that increment was substantial, as high as five percentage points in April. As the year progressed, the cohort shrank substantially, falling by enough to shrink the impact on the unemployment rate to around half a percentage point in late 2020.

The BLS estimated in January that the unemployment rate would have been 0.6 percentage points higher if these workers had been correctly classified. However, the BLS is careful to note that “this represents the upper bound of our estimate of misclassification and probably overstates the size of the misclassification error.” To get to the 0.6 estimate, the BLS assumes that every single person who designates themselves as “employed but not at work” is in the wrong bucket. However, that would clearly not be true, as that category does not run at zero, even in non-pandemic times. Moreover, while some workers may be misclassifying themselves because they do not entirely understand what the BLS is asking, others may be entirely correct in their assessment. If employers are paying their workers, even as the firm is closed and thus not giving their workers any hours, then, despite the BLS’s insistence, one could make a good case that those people are employed, not unemployed. While Powell adds 0.6 percentage points to the official unemployment rate to account for this misclassification, even the BLS admits that the 0.6% wedge is more of an upper bound than an accurate point estimate.

More importantly, Powell’s addition of the entire cohort that has dropped out of the labor force to the ranks of the unemployed in the current job market is entirely inappropriate. Note that to be considered unemployed, a person has to fulfill two conditions:

  • They don’t have a job, and
  • They looked for work but could not find any.

Over the years, economists have come to deem any drop in the labor force as likely reflecting workers becoming discouraged due to a lack of job opportunities. However, the pandemic presents a starkly different scenario. Businesses are desperately seeking workers, but millions of potential workers are sitting out due to health concerns, caring for sick loved ones, or staying home with school-age children forced to take classes remotely. The NFIB small business survey found that scarcity of skilled labor was the #1 problem for 21% of respondents, the most common choice. The JOLTS data show that job openings have recovered nearly all of the drop seen during the spring 2020 lockdowns, moving to a level higher than at any time since 2000 except for the two years just before the pandemic. In fact, the level of job openings is roughly 50% higher now than it was in early 2014, the last time that the unemployment rate was at 6.3%.

Moreover, another impediment to employment has re-emerged, as Congress approved a resumption of $300 weekly bonus unemployment payments. As a result, though the problem is less pervasive than last year, when the extra payments were $600 per week, there are a number of lower-wage workers who can “earn” more by staying home than by holding a job, which represents another factor preventing firms from filling their openings.

Powell’s construct is no better than half right. He is correct to suggest that for the economy to return to full employment, jobs will have to be created or restored not only for those who are officially unemployed but also for the bulk of those who have dropped out of the labor force since early last year.

However, by asserting that the true unemployment rate is 10%, Powell infers that the ranks of the unemployed are as large today as they were at the depths of the 2008-09 recession—the unemployment rate peaked in 2009 at 9.9%–and that those jobs are not available now.

In reality, there are millions of jobs available that are going unfilled because of low labor force participation. It is simply inaccurate to label those individuals as “unemployed.” As discussed last week with regard to the broader economy, economists are so accustomed to treating every sign of economic weakness as a demand-side shortfall that they have difficulty processing a situation like this, where at least part of the dislocation in the labor market is a supply-side issue. Jobs are available, but workers are balking.

Moreover, a substantial component of the demand-side portion of the shortfall relative to full employment could disappear quickly if and when the economy reopens once the pandemic is brought under control. Of the roughly 10 million drop in payrolls since February 2020, almost four million are in the leisure and hospitality category, most of which will come back quickly when restaurants are allowed to operate normally and spectator events and domestic travel (hotels and amusement parks) resume. Another 2.25 million are private- and public-sector education workers, who should be back on the job by September at the latest. Unlike in a normal business cycle, when activity would be expected to only strengthen gradually, the post-pandemic rebound should be rapid and violent. Remember the economy restored more than 7.5 million jobs in two months in May and June last year with only partial economic reopening.

Getting to Powell’s last point, the notion of scarring due to extended stints of unemployment is only partially relevant to the current situation. In a normal economic environment, every type of activity continues to occur, though perhaps at a diminished rate. In that case, when someone is laid off and fails to find a job for a prolonged period, their skills are thought to erode and the resulting gap on their resume from an extended string of unemployment makes it increasingly difficult to get rehired as time goes by. In the current environment, that will be true for some. However, millions of unemployed workers are likely to be brought back by their former employers no questions asked as soon as operations return to normal. Moreover, for many lines of work, the entire industry has been put on hiatus. No one is going to question an 18-month hole on the resume of, say, an event planner when no large events were allowed for the duration of the pandemic. That situation applies to millions of folks who are currently not working. School employees, restaurant workers, travel industry workers, and others will still be the most qualified in their line of work when the economy fully reopens, even if they were unable to work for the duration of the pandemic.

As a result, concerns about scarring or permanent damage seem misplaced. No doubt there are major issues with being thrown out of work for 18 months. One’s lifetime earnings will have taken a major hit, which will make it more difficult to save or pay down debt even though the rebate checks and extra unemployment benefits over the last year have more than filled the short-term aspect of that void in the aggregate. Another issue for some will be persistent changes to the economy sparked or accelerated by the pandemic. For example, work from home could lead to less demand for office space, fewer building managers, janitors, security guards and so on. Another possibility is that reduced business travel and entertainment could persist, impacting hotels, airlines, and business district restaurants. In any case, the time to worry about scarring will be six months or a year after the economy is largely reopened. Those who still have not found work by then will indeed be at risk of falling behind as a viable job candidate. However, that group will be vastly smaller than the current millions of “long-term unemployed.”

A snapback after pandemic

The path back to full employment looks daunting today if one is viewing the magnitude of job losses and the unemployed in the context of typical business cycles. However, if the pandemic is brought under control, the recovery in the labor market could come far more forcefully and quickly than Powell and the FOMC seem to expect.

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