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Why the job market threatens to turn too hot for comfort in 2018

Mark Zandi is the chief economist at Moody’s Analytics.

It is a good time to be an American worker. There are lots of jobs. The economy has been a veritable job machine, impressively creating more than 2 million jobs each year for the past six years. Even the devastating hurricanes that hit this past summer could not disrupt the longest string of monthly job gains on record.

Nearly all industries, occupations, pay scales and regions of the country are enjoying solid job growth. Yes, lots of low-paying jobs are being created in the leisure and hospitality and restaurant industries, but there are a lot more middle-paying jobs in construction and manufacturing, and also high-paying jobs in professional and financial services.

Only the energy and agriculture-related industries are struggling to add jobs given the collapse in commodity prices a few years back, and online competition is weighing on employment at brick-and-mortar retailers and print media.

The current pace of job growth is at least twice the growth in the labor force, and unemployment and underemployment continue to steadily decline. Sub-4% unemployment is likely in coming months, something the economy rarely experiences. The last time was only for a few months at the very end of the technology bubble around Y2K.

The number of underemployed is also quickly diminishing. These include part-timers who want more hours and those that have stopped looking for work and thus are not counted as unemployed but say they would take a job if they could find a suitable one. There are an unusually large number of prime-age men who have dropped out of the workforce, but they likely have deep-seated problems like opioid addiction and disability that will be hard to overcome anytime soon.

Employment challenges

Businesses’ biggest and rapidly developing problem is finding qualified workers, since the nearly 6 million current job openings already represent a record high. Employers are also having a tough time holding on to existing workers who are quitting for better, higher-paying ones at a rate only seen in the very tightest job markets.

Wages are finally on the rise as workers come to realize they are in the driver seat. It took a while; it has been over a decade since the last time the economy was at full employment. Workers had been back on their heels, nervous about holding on to their jobs. No longer. Wage growth is closing in on a 3% pace, almost double what it was a few years back, and well over the rate of inflation.

Millennial workers – in their 20s and early 30s – are benefitting the most, as they take better jobs at higher pay. They’ve had a particularly difficult go of it as they entered the workforce in large numbers during the dark days of the Great Recession.  Many couldn’t find work, and when they did it was in nowhere jobs. They are now making up for lost time, as the average pay increase for a millennial switching from one full-time job to another is in the double-digits.

Threat of the economy overheating

This all sounds great, but there is a problem — potentially a big one. If the job market gets too tight, the economy could overheat. That is, wage pressures will intensify to the point that businesses will increase prices for their goods and services more quickly. The Federal Reserve will have no choice but to more aggressively raise interest rates in an effort to quell the accelerating inflation.

This overheating dynamic has played out prior to each of the 10 recessions since World War II. Indeed, it takes just about three years after the economy reaches full employment for the economy to overheat and recession to ensue. By most estimates, full employment is consistent with a 4.5% unemployment rate, which the economy blasted through this past summer.

The likelihood that the economy will overheat jumped when the Trump administration and Republican Congress recently passed legislation for deficit-financed tax cuts. Borrowing money from global investors to cut tax bills is pure fiscal stimulus, and will temporarily pump up growth. Even without tax cuts, unemployment was set to fall below 4%, but with them it will likely fall into the low threes. The only other time unemployment has been that low in the historical record was in the midst of the Korean War in the early 1950s when millions of Americans were fighting overseas.

The labor force could soon come to a standstill

The Trump administration’s immigration policies will only add to the overheating threat. Immigrants currently account for most of the growth in the nation’s labor force, as the large baby boom generation is retiring en masse. More millennials are starting to work, but they are being more than offset by the retiring boomers.

Even if immigrants continued to come into the country to work at the same rate as they did during the Bush and Obama administrations, the labor force would soon come to a virtual standstill. With the pullback in immigration now underway by the Trump administration, that seems likely to happen. The agriculture, construction, leisure and hospitality, retail and transportation industries will have an especially tough time finding workers. If the president wants to build a wall between the U.S. and Mexico, he will have to hire Mexican workers to build it.

It is a good time to be an American worker, but given the tax cuts and immigration policy I fear that it will only be for a brief time.

Read more:

Why this is the worst time for deficit-financed tax cuts

Zandi: This is a rip-roaring labor market

Moody’s Analytics Chief Economist: Why the Republican tax plan is set up to fail