Labor Markets Exhibiting More Slack than Expected

Total seasonally adjusted nonfarm payroll employment increased by 126,000 jobs in April and 75,000 in May 2006, failing to meet job growth expectations. From our previous discussion, we know that not only must the number of job seekers be small, as a low unemployment rate would signify, but the number of available positions must also be comparatively large. It seems reasonable then, that any useful description of labor market tightness should combine low unemployment with a surfeit of available positions.

To understand why a low unemployment rate is not by itself likely to generate substantial upward pressure on wages, consider a situation (albeit an unlikely one) in which the unemployment rate is near historical lows but there is a dearth of open positions. That is to say that the sell side of the labor market searches for jobs, but the buy side has little interest in seeking out these job searchers. In such circumstances, a searching worker can expect a long wait to find a vacant position. Data from the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey suggest the average worker does not, in fact, have a clear menu of job options. Thus, as workers must search for vacancies over time, little upward compensation pressure builds.

Current measures of vacancies and unemployment do not suggest a particularly tight labor market. However, they do not depict a particularly slack labor market either. Average hourly earnings climbed 4.2% year-on-year (y/y) in April and 3.5% in May (not seasonally adjusted), reaching $16.59. Wage income and employment started 2006 with strength, but moderated in May.

As inflation moderates, real growth in earnings rebounds, allowing workers to realize real gains in income. Despite remaining slack in labor markets, quarterly wage gains finally surpassed inflation gains in the fourth quarter of 2005 and continued to outpace inflation in the first quarter of 2006. Average hourly earnings gained 1.1% in the first quarter, compared with the top-line CPI increase of 0.6%. On average, wage growth should outpace inflation in the long run.

One of the important counter-inflationary factors is labor productivity growth. Since 1995, productivity has grown at a substantially higher pace than that seen from 1975 to 1994. While it is currently decelerating, annual growth remains strong. Productivity grew by 3.4% in 2004 and 2.7% in 2005. Its 50-year average annual growth rate is only 2.1%.

Productivity rebounded sharply in the first quarter of 2006, according to the recent Bureau of Labor Statistics release. Unit labor costs rose only 0.3% in the 12 months ending in March 2006, matching their smallest increase in more than a year. This was a relief to many concerned about mounting wage pressures. Although the underlying productivity growth rate eases, we expect it will hold or exceed its 50-year average, hovering near 2.4% throughout the forecast period. Greater technology advances and improved economic flexibility will buoy productivity in the long run. Continued, steady growth in productivity will dampen inflation, which is welcomed in the current environment of persistently high energy prices.