A Tight Labor Market: Challenges for Business, Opportunities for Workers?

One of the strange aspects of today’s economy is that while economic anxiety is running high amid continued inflation, the labor market continues to show signs of strength. Last week’s jobs report indicated strong job growth and continued low unemployment in California. Over the past year, a tight labor market has meant more bargaining power and higher wages for workers, but businesses have struggled with labor shortages and higher operating costs. As the U.S. Federal Reserve continues to raise interest rates in an effort to cool inflation, worker productivity may be key to balancing the needs of workers and businesses amid unstable economic conditions.

It would take quite a correction to shake the labor market from its current strong position. Job openings remain well above historical trends, as California’s economy has now regained all the jobs lost during the pandemic. While simmering in recent months, job openings remain high. Throughout the past year and for the first time in decades, California has more job openings than job seekers. While this is good news for job seekers, it also limits businesses’ workforce plans and growth—and rising wages have put upward pressure on prices.

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This tight labor market gives workers greater opportunities. Most economists believe that the historically high quit rate (above 2%) over the past 20 months is tied to the historically high share of job openings: with the number of job openings, workers can quit more easily, because they know likely to find another job quickly. The share of workers who quit began to rise in April 2020, reaching a peak in February 2022. But since the spring, job openings and quit rates have declined sharply and steadily, perhaps indicating a return to more typical model. Finally, in September, the layoff rate was still historically low; however, recent mass layoffs in the tech sector may change this picture going forward.

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Because there are few Californians looking for work relative to job openings, businesses looking to hire have a tougher time of it. This, in turn, can lead to an offer of wages to attract and retain workers, as we have seen notably in the leisure and hospitality sectors. It can also reduce layoffs if an economic downturn comes soon, because employers have had a difficult period in hiring and may be reluctant to lose their workforce.

All of this sounds good for workers and difficult for businesses. However, today’s tight labor market can provide greater economic returns for workers and businesses under the right conditions. Increases in wages are sustainable when they are supported by improvements in productivity. This can result from changes in business practices, capital, and technology that unlock the skills of the workforce. While productivity is notoriously difficult to quantify, official measures suggest labor productivity in California has increased over 2020 and 2021. However, national data for this year suggests labor productivity has begun to decline.

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What can policy makers do to support improvements in worker productivity? During the pandemic, some businesses and sectors invested in technology to survive when face-to-face operations were halted—those investments were made possible by federal and state business grants and loans. While some technology (such as self-service kiosks in fast food restaurants) can reduce the number of workers a business needs, it also helps the workforce become more efficient and productive, allowing workers to command a higher wage. By supporting education and training, the government is a major player in investing to improve productivity on the individual side as well. While the pandemic has shortened educational trajectories for some young adults who have suspended or slowed their college plans, continued state investments in education and training, if used effectively, can help support long-term gains in productivity—and economic mobility.

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