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Labor Market Strength Is Also a Sign of Dysfunction

The biggest puzzle in the US economy this year has been two straight quarters of negative real economic growth accompanied by booming job growth. As a result, on a year-over-year basis,  workforce productivity growth  has been historically bad. There’s plenty of reasons for this following two weird pandemic years, but an underexplored cause is that the strong labor market has led to too much turnover in the workplace, creating disruptions and unpredictability for businesses. A softer labor market would be better for workers, employers and consumers alike. 

In the first six months of the year, the total number of hours worked by Americans grew at a 2.5% annualized rate, with employment growing by 2.7 million workers. Ordinarily, with that kind of growth in total hours worked you’d expect real gross domestic product growth of 4% or so — 2.5% growth in hours and 1.5% productivity growth, assuming workers became more productive at roughly the same pace as in the 2010’s.

That’s not what we got. Instead, the economy contracted at a 1.6% annualized rate in the first quarter and a 0.6% rate in the second quarter. Employers were hiring at a historically-robust pace but the economy shrunk somewhat as the productivity of the workforce fell.

That’s been costly for everyone. Hiring more people to produce less stuff has meant lower profits for companies, pressuring them to raise prices, which consumers have felt in the form of inflation. And this isn’t a great dynamic for workers, either. A high churn rate means a lot of new employees trying to get up to speed at a challenging time in the economy, with longer-tenured workers having to pick up the slack for colleagues who are quitting or those who are new and not yet fully trained.

The Wall Street Journal reported a couple weeks ago about a beer distributor in Michigan struggling with this dynamic. Due to high attrition, they’re employing 8 to 12 more people than they ordinarily would. This produces a chaotic work environment where efficiency is down, profits are down, payroll is up because of the increased staffing, while they’re holding onto people that other employers need.

In general, strong labor markets are better than weak labor markets. Workers feel valued and tend to see increased living standards, and employers have incentives to become more productive and invest in labor-saving equipment and tools. But as we’ve seen over the past 18 months or so, a labor market that’s too out of balance leads to chaos, dysfunction, inefficiency and high inflation.

For that reason, some of the signs of decreased labor market churn that we’ve gotten over the past several months should be cheered by everyone. The rate at which private sector workers quit their jobs peaked in November and has been falling gradually ever since, though it remains above pre-pandemic levels. The level of job openings has fallen by 1.8 million since March, still 3 million above pre-pandemic, but a sign that the labor market is becoming more balanced.

After Friday’s jobs report we can say that hours worked grew at a 2.9% annualized rate in the third quarter — slightly faster than we saw in the first half of the year. For the time being, expectations for real economic growth in the quarter are positive, with the Federal Reserve Bank of Atlanta’s GDP tracker estimating 2.9% growth, which is at least in-line with the rise in hours worked.

Part of the recent poor productivity has been due to a labor market that’s been dysfunctional more than it’s been strong. We need productivity growth to rebound from the abysmal trend we’ve seen so far in 2022 if we’re going to avoid more draconian economic outcomes in 2023 from efforts to contain inflation.

The intense labor market churn that we’ve gotten in 2021 and 2022 may have been a necessary part of reopening the economy after pandemic-related shutdowns and finding our way to a new normal. But it’s not sustainable, and we should welcome the deceleration we’ve seen over the past several months, with more to come.

More From Other Writers at Bloomberg Opinion:

Labor Market Is Coming for Margins — or Worse: Jonathan Levin

Retailers Should Prepare for a Revenge Christmas: Andrea Felsted

Biden Is Failing Homeowners in Inflation Fight: Karl W. Smith

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments and may have a stake in the areas he writes about.

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