- Labor markets have been extremely tight over the last couple of years, and this is unlikely to change any time soon, given the demographic outlook.
- Total employment plus open vacancies – our measure for labor demand – are now significantly higher in Germany and the US than total labor supply (the workforce).
- Appcast and Totaljobs data show that the cost of recruiting in the US and the UK is still elevated as well as the time to fill open positions.
- The current economic slowdown might provide some relief, but the labor market of the future will be one of increasing worker shortage.
It is fair to say that workers’ bargaining power in advanced economies declined for several decades between the 1980s and the financial crisis of 2008. Post-keynesian economists have emphasized how globalization and financialization of the economy caused a general decline in the wage share of GDP. The Great Recession plunged most advanced economies into a deep downturn and unemployment rates rose substantially. The weak labor market following the Great Recession also led to low wage growth, especially at the bottom of the income distribution.
The post-Covid economic recovery is missing workers
The Covid-19 pandemic that started in early 2020 led to fundamental changes in the economy and workers gained back some bargaining power. While the initial economic downturn was extremely severe in 2020, the labor market bounced back within a year.
Economists have warned about the upcoming worker shortage in advanced economies for years. Charles Goodhart and Manoj Pradhan have written a book on the great demographic reversal and the implications for the labor market and inflation dynamics. They outline how ageing societies and worker scarcity will lead to higher wage growth in the future. They also argue that this will also lead to higher inflation down the road. Moreover, the burden on the health care system and pension system will increase as the share of the older population is rising rapidly.
The literature on “secular stagnation” suggests that these demographic trends have affected advanced economies in various ways. The increase in life expectancy is leading to excess savings, which has decreased real interest rates around the globe. This, in turn, has also led to a house price boom. With higher longevity, increasing the retirement age would be one way to overcome the challenges of missing workers and the widening gap that is opening up in national pension systems.
The Stepstone Group CEO Sebastian Dettmers has outlined that a mix of measures will be necessary to handle the looming era of people shortage in advanced economies. Measures need to focus on the productivity of work as well as on higher labor force participation.
UN population forecasts suggest that many European countries will soon face a similar population dynamic. Germany and Eastern Europe in particular, have falling fertility rates that have been below the population replacement rate for decades.
The worker shortage is increasingly hitting the labor market, especially as the demand for workers has recently increased with the post-Covid economic recovery while the supply of workers has stagnated.
The following three charts exemplify to what extent the labor market is out of balance in the US, Germany, and the UK. And the problem will only exacerbate due to the long-term demographic outlook.
Labor supply is measured by the labor force – all workers who are currently in work or actively looking for work – meaning the sum of all employed and unemployed people in the economy. The demand for labor is total employment plus all open vacancies (unfilled positions) in the economy. The two lines thus show to what extent demand is outstripping supply right now as the economy runs hot.
After almost a decade of slack following the sluggish recovery post-2008, the US labor market finally reached full employment just before the pandemic. Our chart shows how labor demand already outstripped labor supply in 2018 and 2019. This was mostly driven by monetary policy with the Powell Fed aiming for a long-lasting economic expansion. The US unemployment rate already hit a record-low back in 2019. Immigration to the US also declined at the time, thus adding to the existing labor market tightness.
While the Covid economic shock led to massive temporary layoffs during the initial lockdowns, the US labor market bounced back within a year and the economy ran hot in 2021. In fact, over the last two years labor demand has surged way above labor supply as total vacancies in the economy reached a record-high and outnumbered the unemployed.
Moreover, the very large cohort of baby boomers is about to retire in the coming years and the Covid pandemic sped up the retirement boom. Some of this was probably related to health reasons, but changes in wealth also played a role. New research suggests that surging house and stock prices can account for some of the increased retirement, too.
Even though the economy is currently cooling down somewhat as the Fed is tightening, the labor market continues unabated with more than 500,000 jobs and 300,000 jobs created in January and February, respectively. The outlook remains challenging for recruiters and may not normalize anytime soon. The current job market is very much a continuation of the tight labor market boom from before the pandemic when the unemployment rate fell below 4%.
Data from Appcast shows how the median cost per application has increased significantly, from about 20 dollars in early 2021 to over 30 dollars in early 2022. Recruitment costs surged throughout 2021 and have remained elevated ever since. This shows to what extent the labor market of today is favoring workers even as the Fed is trying to cool down the economy with interest rate hikes.
The situation in Germany very much mirrors the one in the US. Germany’s demographic headwinds are more severe than those of the UK or the US since German fertility rates have been below the replacement level for decades.
Following the financial crisis, Germany has been one of the faster-growing economies in Europe with a relatively high share of manufactured goods. The export-led growth model has coincided with a shortage of skilled workers. According to a Stepstone Group study, more than 60% of companies said back in 2019 that they lack productivity because of open positions.
The dearth of workers was thus already a constraint on growth for many years. Just before the pandemic, our estimate for total labor demand outstripped supply for the very first time in 2018. The situation briefly reversed as the Covid shock in 2020 and 2021 with various lockdowns slowed down the economy. However, as of the end of 2022, total demand exceeded total supply by almost one million workers.
In fact, total employment in Germany only declined slightly during the pandemic and is now exceeding its pre-pandemic level by more than one million workers. At the same time, job openings are also at a record high, suggesting that the lack of workers is holding the economy back.
While the energy price shock is hurting the German economy in the short-run, long-run demographics are significantly worse than in the US. We thus expect the demand for workers to outstrip supply in the future and absent a very large inflow of skilled workers from abroad, there will be little relief in sight.
As the German population is ageing rapidly, the German labor force has started to decline. The country will reach “peak employment” in this decade as the pool of workers is shrinking.
The UK economy is currently struggling more than the US and Germany as Brexit is an additional negative economic shock on top of the energy crisis and supply chains problems due to Covid. However, more recent forecasts suggest that the UK will only face a very shallow recession in 2023 and JP Morgan recently forecasted that there might be no contraction at all because consumer and business sentiment improved markedly.
Despite the more challenging short-term economic outlook, the UK economy has also seen a continuous narrowing between our two measures for labor demand and labor supply. We can see the same picture is emerging as in the US and Germany with the demand for workers increasing while the supply of workers is stagnating. In a recent report, I outlined how the Corona pandemic has created additional challenges for the UK labor market with more than half a million workers dropping out of the workforce due to long-run health issues. The UK labor market has thus also tightened dramatically over the last few years, especially as Brexit has led to a shortage of truck drivers and other manual workers.
One bright spot is that the UK is ironically adding more foreign workers now than before Brexit, mostly from non-European countries. With Britain remaining one of the most popular destination countries in the world for immigrants, domestic employers are seeking to hire more globally to solve the worker shortage.
The Totaljobs Hiring Trends index shows that the recruitment outlook remains challenging for now. The average time to hire increased by almost 3 weeks between Q4 2021 and Q2 2022, showing labor market tightness across all sectors in the UK. Employers are still struggling to fill many positions even as the average time to hire declined somewhat by the end of last year.
On the bright side, elevated demand for workers shows that the UK economy is not performing as badly as many forecasters suggested just a few months ago.
The worker shortage is a problem that has loomed for many years. And it is currently holding back the economic recovery following the Covid downturn. With societies ageing rapidly, the need for new solutions will become even greater in coming decades.
Our charts show how the demand for workers is outstripping the supply for workers by a wide margin in the US and Germany. And even for the UK, the gap between the two has never been closer.
Japan has been in many ways a precursor to what Europe should expect in the coming decades. The Japanese population peaked at a little under 130 million in the early 2000s and is expected to decline to 100 million by 2050 as a result of low fertility rates. This is already affecting the economy in various ways. Many rural communities have seen their population decline tremendously and the Japanese government is actually making an effort to re-concentrate the population in cities as to save on infrastructure spending in the depopulated areas. The dependency ratio – the number of retired workers to the active population – has been going up for many years with obvious implications for the pension system.
While technology and productivity gains can compensate – Japan is one of the most “robotized” nations on earth where even care for the elderly is being automated – technology might not be able to overcome every single problem that is resulting from missing workers.
This is precisely why the long-run prospects for countries who are betting on immigration – Australia, Canada, the US, and the UK – is better than for those who are more closed off to foreign workers.
For companies, these developments are certainly challenging, and recruiters should not waste too much time because the current labor market tightness will not be resolved any time soon. However, this environment is also an opportunity. Employers that have a clear people strategy that focuses on workers can stand out from the crowd and outperform the competition. Offering individually agreed, flexible working conditions, an attractive company culture and, also, a clear purpose can be attractive for employees. Especially women with younger children are too often discouraged to join the labor force. This is particularly an issue in the UK, which has some of the highest childcare costs in the world.
Additionally, there needs to be a focus on hiring globally. While the US and the UK have more of a history of being a migration destination and English-speaking, Germany does not need to feel left behind. More than 15% of the German population is now foreign-born. The country has some of the top universities in Europe. It is also one of the largest global economies and has high living standards. With the upcoming worker shortage, German employers would do well to recruit more globally and attract talent from abroad.