New data released today shows the US economy added 517,000 jobs in January. This was a big surprise for a lot of people: the consensus expectation was about 190,000. That’s… slightly off. Also, conventional wisdom 2023-style holds that a strong labor market is somehow bad for the economy because it might motivate the Fed to raise rates higher or keep rates higher for longer.
What? Let’s parse through it. What the Fed is afraid of, theoretically, is a wage-price spiral. That happens when rising wages increase demand, so producers raise prices of goods and services, and then workers demand higher wages, and then prices go up again, and so on.
However, there’s no smoking gun indicating a wage-price spiral taking hold right now. And the wage-price spiral theory eliminates a lot of other factors that could cause prices to rise, pinning the blame on wages.
Let’s look at current conditions before jumping to conclusions.
There is a labor supply shortage, though.
Yes, the labor market is tight at the low end and parts of the mid-range. As just a few examples, there are teacher shortages, nurse shortages, and restaurant-worker shortages. But there are solid reasons behind these shifts, some tragic and some demographic:
More than a million people are dead from COVID in the US alone, including more than 200,000 working-age people.
Millions more people have long COVID and are out of the labor force temporarily or permanently.
The Baby Boomers have finally begun, at long last, to retire for real.
Trump-era curbs on legal immigration have not been fully lifted.
In short, there are millions fewer people in the labor force, and wages are adjusting to available supply. Also, some workers used pandemic downtime to up-skill and move into fields with better pay or better working conditions, leaving fewer workers to compete for less-skilled or less desirable jobs.
A wage adjustment in response to supply and demand is good and likely inevitable. Financial markets went on a bullish tear from 2011-ish through 2021, but the labor market generally gained productivity, not so much wages. (Yes, technology and finance were notable exceptions—and according to the linked article, so was oil shale mining and extraction!)
It appears that the regular-person labor market is now reverting to the mean. Some highly paid technology and finance workers are losing their jobs, but as the latest jobs numbers show, lots of other jobs in lots of other industries are being created, and lower-income workers may be seeing gains for the first time in many years.
This is, dare I say… awesome?
But what about inflation?
An organic wage adjustment like the one in progress may be better for inflation than an across-the-board policy with a coordinated start date like raising the federal minimum wage or implementing universal basic income. Let’s dig into that:
If the federal minimum wage, which sits at $7.25 per hour (and hasn’t budged since 2009!) were suddenly hiked to, say, $26 an hour (which is what it would have been in September 2021 if it had risen alongside productivity), it would shock the economy. Paying so many people so much more all at once would almost certainly trigger inflation, since companies would be aware of the increase date and would deliberately respond to it. On the other hand, if workers organically switch jobs for higher wages on their own initiative, there isn’t a universal trigger date and people make a range of different rates, so prices won’t react so violently or in unison.
Similar logic applies to universal basic income: if companies know every person will begin receiving $1000 a month as of a certain date, they will rationally raise prices to take that into account, mooting the effect of the program.
Let’s get back to talking about supply shortages.
We talked about labor force supply shortages. But a tight labor market is necessary but not sufficient for a wage-price spiral.
The main culprits that spurred inflation this time are manufacturing and supply-chain shortfalls, which are finally easing as China relaxes its zero-COVID strategy; a long-term shortage of housing, especially starter homes; and war-driven energy shortages. Other culprits include climate events affecting crop harvests—for example, the 2022 flooding in Pakistan—and corporate opportunism, aka “let’s raise prices because we can since everyone else is doing it.”
So, why pin blame on wages? It makes more sense to view this period of responsive wage adjustment as a much-needed catch-up. Lower-income people are the ones who most need wage increases to survive in a time of supply-driven inflation, so if their wages are going up, great. The pendulum is swinging to balance out what was a long-term broken situation. And it’s doing it without government intervention—even despite attempts at government intervention in the opposite direction.
This is great. It may be the path to a soft landing. Let that pendulum swing a bit. It’s okay to celebrate that people who need jobs can find them.
What about small business owners?
Small businesses have suffered in the past few decades. But that’s mostly because small business is over-regulated while big business is under-regulated. That’s a whole other topic for another article—and it is a big problem.
Regarding low-income workers’ wages, if over the long term the middle class gets larger, that is good for small businesses. A larger middle class means more people who have disposable income to buy products and services and houses and vacations, and the more opportunity and hope they feel, the more likely they are to stay invested in the system instead of dropping out, lying flat, or trying to undermine it.
Small businesses are suffering, undoubtedly, but I’d argue that blaming workers’ wages—which, remember, have fallen behind productivity gains for decades—is pointing the finger in the wrong direction.
Let’s talk about something good.
Sure. So far, the Fed’s rate hikes are affecting exactly the sectors that got way ahead of themselves during the boom times. Highly paid technology workers may find it takes somewhat longer to find their next job. Highly paid finance workers may be laid off and take some time to do other things or find another finance job after a while.
That’s okay. They are not starving. They will get new jobs, maybe not at a FAANG but at a company that makes more tangible products. That’s also okay. The attraction of many high-achieving students into finance and consumer internet technology hasn’t necessarily been a net positive for society (though it has made individual workers fairly well-off).
To sum up, if low-end and mid-range labor markets stay strong while finance and technology labor markets take a breather, that’s a further indication of healthy regression to the mean.
Is there any way to address the supply aspects of the labor shortage?
Sure. In the short term, the US could allow more immigrants into the country to fill lower-end positions. Since some US-based workers used their pandemic downtime to skill up and change into better careers, that is great because it will expand the middle class. In response, we need to add more workers who are willing to take the jobs vacated by those who moved up.
Another option is to get over our long-standing cultural ageism and consider hiring workers in their mid-50s and up who do still want to work and have traditionally been ignored by employers. A third and longer-term option is to develop treatments for long COVID to give people their quality of life back.
But in the meantime, consider this: if corporate profits are about the highest they’ve ever been, why is it a problem that people on the bottom rungs of the ladder are making more, too? This should not be viewed as a problem in a functional society. It is a much-needed and long-overdue correction.
If companies didn’t raise prices in an attempt to squeeze out every cent of profit as soon as possible—and it’s not a given that they have to operate like this—universal basic income might work better, but that seems idealistic given the dominant shareholder-value ethos.
I am confident inflation will continue to drop as distortions in supply chain iron out. I believe that is what is happening now and over the next six months. Therefore the Fed, if they sit on their hands for a couple of quarters will be able to claim victory without being able to explain it necessarily.