The long-term economic scarring of the pandemic — mostly among small businesses in leisure and hospitality, food and beverage, and retail — will dampen wage growth over the next few years.
The Beveridge curve implies a substantial shock to the labor market that will take years to unwind.
One way to see this dynamic is with the Beveridge curve, which illustrates a downward-sloping relationship between a higher level of job openings and greater unemployment. These days, the Beveridge curve implies a substantial shock to the labor market that will take years to unwind.
While employers will not reduce nominal wages for those still at work — known as downward nominal wage rigidity — the sheer number of unemployed will still create a sluggish wage environment.
Given the breadth and depth of the shock, this strongly implies that there will be a sustained mismatch between those who are unemployed for whatever reason — for example, if they cannot relocate, or lack the skills — and where the jobs are and wages are rising. We should anticipate a bifurcated wage recovery in which the median worker will experience modest to little wage growth during the recovery and the early phase of expansion.
While we do anticipate that the economy will return to full output early in 2022, we do not anticipate a return to full employment until 2025. This lag will disappoint wage growth for the median worker and will likely be a defining characteristic of the recovery and ensuing expansion.
Once the economy evolves into whatever the new normal turns out to be, we should expect the labor market to begin to tighten once again as the expansion gathers steam. Jobs should begin to go unfilled as the economy moves toward full employment and employers raise wages to compete for a dwindling supply of workers. But that is not going to be a near-term phenomenon.
Once the economy evolves into whatever the new normal turns out to be, we should expect the labor market to tighten.
This was certainly the case during the decade-long economic recovery from the Global Financial Crisis that brought the real economy to its knees in 2008-09. Wages collapsed during the Great Recession but did not hit bottom until July 2010, months after the recession had officially ended. It took that long for the concerted monetary and fiscal efforts to resuscitate the economy.
It wasn’t until 2016 that wages increased on trend until the first months of 2019. At the same time, unemployment fell from 10% of the labor force in 2010 to 3.6% by early 2019.
There are a couple of points to note. First, wage growth was stagnant from 2011 to 2015 and did not break above 2.5% year over year until after the global commodity price collapse and mini-recession in 2014 and 2015. There were many reasons for this stagnation, including the full development of the global supply chain, the deindustrialization of America and the growing dominance of service-sector employment.
And second, the figure stops in January 2020, before the outbreak of the coronavirus and the economic shutdown, which we’ll explain in the next sections.
Job vacancies and labor market tightness
As we mentioned, the tightening of the labor market can also be seen in the number of jobs that are left unfilled. As the economy grows and as businesses look to expand — and as additional service workers are needed to meet increasing consumer demand — then we would expect an increase in the number of job openings relative to the supply of labor.
This is referred to as the vacancy rate, which is the number of job openings as a percentage of the number of people in the labor force. As the labor market tightens during a recovery, there is an increase in unfilled jobs, causing the vacancy rate to increase, as shown in the figure below.
Note that during economic downturns, we would expect the supply of labor to diminish as aging employees take early retirement and as the unemployed become discouraged and quietly leave the labor force.
During recoveries, we would expect the labor force to increase as discouraged or aging workers see employment opportunities, with increasing wages luring workers back into the labor force.
We can better show the inverse relationship between job vacancies and unemployment rate with a scattergram, plotting the job vacancy rate on the Y-axis and the unemployment rate on the X-axis. In the figure above and in each of the two figures below, increases in the unemployment rate coincide with lower job vacancy rates. This relationship is known as the Beveridge curve.
We show the Beveridge curve using three measures of unemployment:
- The U3 rate, which includes those who can prove they are actively looking for employment and which catches the headlines in the press.
- The U6 rate, which is referred to as the underemployment rate and includes those workers who are only marginally attached to the work force, like those workers hanging on with part-time gigs.
- The so-called insured unemployment rate, which is the number of people who are currently collecting unemployment insurance benefits.
Insured unemployment rate
An analysis by the St. Louis Fed in 2015 suggested that there is merit in looking at the insured unemployment rate as a measure of labor market slack. But distortions in 2020 reporting caused by employees being furloughed, rehired and then furloughed again – not to mention furloughing higher-paid employees and replacing them with lower-wage new employees – is likely distorting what we think should be normal relationships.
Given that there are officially 9.8 million people unemployed, 19 million on some form of unemployment insurance and millions more who have exhausted their benefits, it is not a stretch to say that the 3.9% insured unemployment rate significantly understates the true nature of domestic labor force dynamics.
Developments in the U.S. labor market this year have been extraordinary. The obvious outliers in the three Beveridge curves all belong to the seven or eight months beginning in March and April, when the economy was shut down, widespread layoffs began and the average wage increased because low-paid employees lost their jobs. (Note that the outliers distort the fitted curves.)
The outliers are gradually moving closer to the normal relationship, month by month. This coincides with the reopening of the economy, though layoffs continue at disturbing levels each week.
What the outliers are likely not capturing, however, is the restructuring of the economy as corporations replace higher-paid older employees with younger, more technologically savvy workers, or businesses outright substitute technology for labor.
This will accentuate the competition for high-skilled labor, placing a premium on what firms pay for that labor. And that will stand in contrast with the near-term fortunes of low- and medium-skilled service workers.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
