By Francesco Guerrera
LONDON- No pains, all gains. That’s the surprising message sent by labor markets in the United States and Europe for the past two years. Even as interest rates rose sharply, unemployment remained low. That has given central banks on both sides of the Atlantic confidence they can deliver the economic “soft landing” of defeating inflation without causing a major recession. Their problem is that the surprising resilience of workforces is showing signs of breaking down. Once that happens, economic contractions usually ensue.
“Unemployment is like a headache or a high temperature–unpleasant and exhausting but not carrying in itself any explanation of its cause.” The famous definition of joblessness by the British economist William Henry Beveridge has been turned on its head. The labor market in most Western economies has been in rude health since the end of the pandemic, to the amazement of central bankers and Wall Street.
After all, the US Federal Reserve and the European Central Bank jacked up interest rates to combat the high inflation caused by the pandemic-related economic disruptions and Russia’s invasion of Ukraine. Higher borrowing costs normally curb demand for goods and services, reducing companies’ revenues and prompting them to cut costs by laying off workers. Newly unemployed people tighten their belts, further reducing firms’ sales and hitting economic growth. This negative loop eventually ends after rates come down again.
This time, though, it was different. The Fed began raising borrowing costs in early 2022 and lifted them to a 23-year peak. But the US unemployment rate mostly remained below 4 percent throughout this period — well under the 5.7 percent average since 1948. In the euro zone, borrowing costs touched a record high of 4 percent in September 2023, but unemployment has hovered around its all-time low of 6.4 percent for 18 months.
Meanwhile, both blocs rebounded sharply from pandemic-induced recessions. GDP in the United States expanded at a heady annual rate of 3 percent in the second quarter of 2024.
The euro zone suffered a brief contraction in 2022 but recovered to grow by 0.6 percent year-on-year in the three months to June.
The most persuasive explanation is that companies refused to fire workers even when there was not enough for them to do. The data supports this “labor hoarding” narrative. In March 2020, as the global pandemic raged, US companies laid off more than 13 million workers. A year later, that figure had dropped to around 1.4 million and it has remained around that level since. And nearly half of US CEOs expect to keep their workforce stable, according to a survey by the Business Roundtable. In Europe, the percentage of companies expecting output to decrease but employment to stay stable hit a record 31 percent during the pandemic.
Less clear is why companies are so reluctant to part with unneeded staff. One possibility is that corporate chiefs were scarred by the difficulties they faced in recruiting workers after the pandemic. The second reason is that there wasn’t that much fat to trim. Unlike economic busts caused by previous excesses, the external challenges posed by Covid-19 and war in Ukraine didn’t require the usual level of cost-cutting. The resilience of corporate profits in both the US and Europe, which also benefited from hefty fiscal stimulus, supports that view.
And yet this employment fairy tale may not have a happy ending. The loudest alarm bell is ringing in the United States, where an unerring recession indicator has been triggered. The rule — named after former Fed economist Claudia Sahm – states that when the three-month moving average unemployment rate rises at least 0.5 percentage points above its lowest point in the previous 12 months, US economic output is already contracting, or about to do so. The Sahm Rule, which has accurately predicted every US recession since 1970, was triggered in July when the jobless rate reached 4.3 percent .
In Europe, clouds are also gathering. Less than 10 percent of firms are hoarding labor while corporate profitability has fallen below its long-term average, according to Gavekal Research. And for the first time since early 2021, euro zone companies expect to reduce staff, according to a survey of 5,000 businesses by S&P Global.
These could be false alarms. The US unemployment rate edged down to 4.2 percent in August. And previous increases may have been due to a spike in immigration that boosted the labor supply. – Reuters
