14 States Are Currently Below 3%

North Dakota, Wisconsin, Oklahoma, Kansas, South Dakota, Minnesota and Nebraska form a low unemployment core in the Great Plains area. Utah, Idaho and Montana represent the Rocky Mountains. Vermont and New Hampshire lead in New England. Alabama leads the South, while Indiana leads the Midwest.

https://www.bls.gov/news.release/laus.nr0.htm

22 Metro Areas with 1M+ Population (of 51) Enjoy Unemployment Rates Under 3%

Large and Small Metro Areas Have Many Low Unemployment Areas

https://www.bls.gov/web/metro/laummtrk.htm

https://data.census.gov/cedsci/table?q=labor%20force%20participation&g=0100000US%243100000&y=2020&tid=ACSST5Y2020.S2301

Low Unemployment Rates in US History

May, 1953: 2.5%

Feb, 1968 – Dec, 1969: 3.5-3.8%

Oct, 2000: 3.9%

Dec, 2006: 4.4%

Jan, 2016: 4.8% through Feb, 2020: 3.5%. 4 years “below full employment”.

Estimates of Natural (Non-accelerating Inflation) Rate of Unemployment (NAIRU) Have Been Biased Upwards and Influenced by One Period of High Inflation and Supply Chain Disruptions

In retrospect, the period before 1976 (oil, trade, inflation shocks) should have used a 4.5% NAIRU for policy decisions. The jump to 6% in the late 70’s and early 80’s is supported by history. The NAIRU was deemed to be 5% or higher as late as 2010, but could have been pegged lower. Based on the lack of inflation during the teens, the rate probably should have been set at 4% or lower.

Macroeconomic Theory

Classical economics asserted that labor markets will naturally find equilibrium wages and quantities of labor employed at the individual labor market (micro) and total economy level. The Keynesian view, embraced by 90% of professional economists, is that there are market imperfections at both the individual market level and total economy level. Most importantly, wages are “sticky downwards”. Currently employed workers resist “losing” wages by accepting pay cuts when demand is lower. Aggregate supply (production) does not automatically create an equal amount of aggregate demand in the short-run, as businesses, individuals, banks and governments often choose to save more during economic downturns or periods of greater risk. Hence, a downturn in the economy caused by any source may result in a prolonged negative spiral, rather than automatically delivering lower prices in product, money and labor markets, which could help to recover these markets.

https://www.economist.com/the-economist-explains/2017/09/22/how-low-can-unemployment-go

https://www.economist.com/the-economist-explains/2017/09/22/how-low-can-unemployment-go

Microeconomic Theory: Why is There Any Unemployment?

Economists point to frictional and structural factors. Frictional unemployment occurs because labor market information and decisions are not perfect and instantaneous. As with other markets: housing, commercial real estate, offices, bank loans, farm fields, airport gates, container ships, utilities, R&D, IPO’s, private equity, M&A, retail inventories, etc, labor markets are imperfect. It takes time for equilibrium to be found. Given the increased concentration of labor in major metropolitan markets and internet-based recruiting systems, frictional unemployment has decreased in the last 20-30 years.

Structural unemployment occurs because of mismatches between the current skills possessed and skills demanded in a given place or due to legal or regulatory limitations. Binding minimum wages have been a smaller factor in the last 40 years but may have greater impact in the future. Regulatory requirements for professional licensing have increased significantly in the last 50 years (with some “liberalization” seen in recent years), slowing the ability for individuals to move between professions.

The overall labor force participation rate increased for many years as women entered the workforce, but has declined significantly in the last 20 years for men and for women. I’ll provide a detailed analysis of these factors next week. For our purposes, focusing on short-term changes, recent history shows that the labor force participation rate can be 1-2% higher overall. Some workers have not returned from the pandemic challenges. Some early retirees may return to the labor force. Teens and college students may join the labor force at recent wage rates. Marginal groups (elderly, long-term unemployed, handicapped, drug/alcohol recovery, crime history, minorities, limited language skills, inexperienced) may be considered for more positions.

The media tends to emphasize the increased specialization and technical content required for modern jobs. This has resulted in greater structural unemployment, especially among lower-skilled individuals who held and lost manufacturing jobs between 1970-2000. It has also reduced movement between industries which require a core base of knowledge to be effective, with health care being a prime example.

On the other hand, modern corporations that worked through a dozen post-WW II business cycles eventually adapting to the “business cycle”. First, based on Japanese manufacturing, TQM or lean six sigma manufacturing principles, they reduced their operating leverage. Companies devised factories, offices, distribution centers, product lines and national businesses that could be equally profitable from 70-95% of capacity, rather than 85-95% of capacity. Second, they reduced their unavoidable “fixed costs” by importing goods, outsourcing business functions (manufacturing, IT, accounting, legal, marketing, distribution, sales, R&D) and employing temporary labor. Third, businesses systematized their processes so that core production processes could be operated by individuals with limited specialized or tribal knowledge, including managers and support staff. Fourth, businesses increasingly used matrix and project structures to effectively redeploy staff to any areas of need. So, while variable production staff is a smaller share of employment, the remaining “fixed cost” support staff can be more flexibly deployed. Fifth, after 40 years of process re-engineering, data warehouses, activity based costing and balanced scorecard reporting, companies deeply understand variable costs and incremental benefits driven by sales, production, product lines, facilities, territories and projects. “Knee-jerk” reactions to business cycle downturns are less common as firms better understand short-term incremental profits and medium-term costs of hiring and training. Sixth, firms have improved their ability to define “critical success factors” for every position. This has eliminated many irrelevant experience, degree, culture, personality and other factors from hiring screens. Seventh, firms have increasingly rotated staff through line and staff roles, allowing talented individuals to move between these roles and function effectively. Eighth, firms are more strategically oriented, growing profitable product lines and territories and dropping or “selling off” marginal channels. This means that the incremental positive value of most positions persists, even in an economic downturn.

Overall, firms have learned their “applied intermediate microeconomics” and clearly defined the marginal benefits and costs of every position. They understand exactly what incremental profit can be delivered from each position. Hence, the demand for labor services is significantly greater than it was historically, including through the downside of the business cycle. That means that the natural unemployment level is lower than in the past. Firms can profitably put more people to work than ever before.

Economists, Forecasters and Pundits are Reluctant to Predict Unemployment Below 3% Because it Was Rare Historically.

https://www.reuters.com/business/feds-bullard-says-unemployment-rate-can-go-below-3-this-year-2022-02-01/

https://www.economist.com/the-economist-explains/2017/09/22/how-low-can-unemployment-go

https://www.cnn.com/2021/11/15/economy/unemployment-rate-goldman-sachs/index.html

https://www.federalreserve.gov/faqs/economy_14424.htm

https://theweek.com/articles/696915/how-low-unemployment

Lobbyists, Journalists, Politicians and Analysts Highlight the Downsides to “Very Low” Unemployment

From a firm’s perspective, a low unemployment labor market causes increased recruiting, hiring and training costs. It results in less well-matched staff to job roles resulting in lower initial productivity. Companies might even, aghast, inadvertently hire some staff with marginally negative profit results. Hence, very low unemployment rates will increase labor costs, reduce profits, reduce demand for labor and possibly bankrupt previously functional firms.

https://www.investopedia.com/insights/downside-low-unemployment/

https://www.imf.org/external/pubs/ft/fandd/basics/32-unemployment.htm

https://www.marketplace.org/2022/04/07/is-it-possible-for-unemployment-numbers-to-be-too-low/

https://www.uschamber.com/economy/the-divide-between-job-openings-and-willing-workers-widens

https://www.umassglobal.edu/news-and-events/blog/low-unemployment-rates

Trade-off Between Unemployment and Inflation: The Phillips Curve

In the 1970’s fight between Keynesians and Monetarists/Classical Economists/Rational Expectations teams, the Keynesians emphasized the historical existence of a short-term trade-off between unemployment and inflation, especially when unemployment was very low due to a high level of aggregate demand. The conservative side noted that the historical data was inconsistent. The “rational expectations” camp emphasized that unexpected increases in inflation would lead to increased wage demands by labor. In the long-run, there is no such thing as a “free lunch”, so effective real wages would return to the level determined by the “marginal productivity of labor”. Based on recent data (pre-pandemic), it appears that the US economy can run at 3.5-4.0% unemployment without triggering significant upward wage pressures. In the post-pandemic world, the “natural” unemployment rate (NAIRU) is unclear. The labor supply has basically recovered to the pre-pandemic level. Wages are up 5% in nominal terms but are down 2% in real terms (see below).

There are Many Unemployment Measures. They Move Together.

Labor Market Slack

In a period of healthy economic growth, the economy is constrained by the limited availability of labor as an input to drive the economic engine.

https://www.richmondfed.org/research/national_economy/non_employment_index

Underemployed individuals provide the logical next best full-time employees. The current slack measure is 3.5%, (7.1% – 3.6%) on the low side, but not so low that conversions from this underemployed group to full-time employment cannot be expected.

Real Wage Rates in a Growing Economy

Jun, 2020 – Jun 2022. Nominal wages up 4.7%/year. CPI up 6.1%. 1.4% real wage decrease.

Dec, 2020 – Dec, 2021. Nominal wages up 4.9%. CPI up 7.3%. 2.4% real wage decrease.

May, 2021 – May, 2022. Nominal wages up 5.2%. CPI up 7.9%. 2.7% real wage decrease.

Nominal wage rates have increased by 5% annually in a period of 7% inflation. Employers have been able to economically justify these increases while adding 7 million people to the labor force.

Beveridge Curve: Job Openings Versus Unemployment Rate.

https://www.bls.gov/opub/ted/2014/ted_20140513.htm

Historically, there was a well-defined relationship between the national level of job openings as a percent of the labor force and the unemployment rate. Job openings were a low 2-2.5% of the labor force at the beginning of the business cycle, accompanied by higher (6-10%) unemployment, but improved to 4% openings and 4% unemployment. The current labor market has far more job openings, up to 11 million, almost twice as many job openings as unemployed workers, but the unemployment rate has only fallen to 3.6% so far. This is uncharted territory. There are more voluntary quits, so employees are switching jobs at a faster rate. The labor force participation rate has increased with these jobs and higher wages offered. But firms have not found enough acceptable hiring matches to significantly reduce the open positions level. Through time, they are likely to achieve their hiring goals, driving the unemployment rate down below 3%.

Summary

1. The demand for labor already exists. 11 million open positions is 7% of the labor force. We have enough active demand for ZERO % unemployment.
2. The supply of labor increased by 7 million people since the depths of the pandemic. The rate of monthly additions has slowed from 500-600,000 to 300,000, but that is still 3.6 million jobs added on an annual basis. We only have 6 million total people unemployed!

3. The labor force participation rate is only 62.5%. There is room for millions to return to the labor market. Before the “Great Recession” in 2008 it was at 67%. Many metro areas, large and small, enjoy labor force participation rates above 65%.

4. The underemployed population can provide up to 3% of the total labor market’s full-time jobs.

5. Frictional unemployment is minimal in the internet age. Structural unemployment may be lower than described in the media, as firms have been adapting to the “information age”, high technology and the service economy for 40-50 years.

Finally, many states and metro areas currently have unemployment rates in the “twos”. Nebraska and Utah stand at 1.9%. Minneapolis (1.5%), Birmingham (1.9%) and Indianapolis (2.0%) demonstrate that otherwise unremarkable (!!!) metro areas can function with very low unemployment rates.