- Lost productivity from the drop in labor force participation is limiting U.S. economic growth. While 2021 GDP growth will likely reach a 37-year high, we estimate it lost well over 1 percentage point because of extreme supply bottlenecks.
- Prime-age workers (ages 25-54) account for 1.4 million, or 45%, of the 3 million people who exited the labor force--and their return is key to stabilizing the job market.
- The labor force exit has added to business costs, increasing wage inflation dramatically. We expect pricing pressure to slowly ease later in 2022 but not reach the Fed's average 2.0% target until 2023. Once bond purchases reach zero in mid-2022, we expect the Fed's first interest rate hike to come in September 2022, though risks tilt to an even faster Fed response.
- U.S. labor market conditions since the pandemic began highlight a possible structural shift in the labor force, with almost two-thirds of the missing workers having left the workforce entirely. We estimate that 42% of the drop in the labor force participation rate is due to structural shifts and 58% of the drop is for reasons that stem more directly from the pandemic and may be temporary.
As the U.S. economic recovery stabilizes, supply constraints seem to be the major hurdle to achieving higher growth. Finding U.S. workers will likely remain tough in 2022, weighing on productivity and economic growth. And those workers will cost more.
Our 2021 GDP growth forecast will likely shrink by another 20 basis points to 5.5%--still a 37-year high--after a 1.0 percentage point drop to 5.7% in September. Growth in 2022 will also slip, to 3.9% (was 4.1% in September).
At least 3 million people have exited the labor force since February 2020, according to the Bureau of Labor Statistics (other estimates show an even larger drop in labor participation). That's twice the number of unemployed workers, or almost two-thirds the 4.5 million people not working since February 2020 (see chart 1). The labor participation rate is 61.6%, a 45-year low, 1.7 percentage points below the already low February 2020 rate of 63.3%, and not much better than the 48-year low of 60.2% during the pandemic.
Prime-age workers, ages 25-54, account for 45% of the 3 million people who exited the labor force. Women account for 68% of that 1.4 million. Child care concerns and virus fears for their unvaccinated children under 5 are likely the main factors keeping them out of the job market. The return of prime-wage workers is key to stabilizing the job market. We expect that many of these workers could decide to reenter the workforce, but not until pandemic-related issues are resolved. Retirees account for a smaller share of the 3 million people who exited the labor force since February 2020, though their relative participation rate has dropped a massive 8.1%, over 5x that of prime-age workers.
These enormous job market constraints are crippling business capacity, resulting in much lower economic activity than would be the case if business operations were running smoothly.
We've found that labor supply constraints are largely the result of people exiting the labor force, rather than deciding to remain unemployed and receiving unemployment benefits (see "Where Are The Workers? Three Explanations Point To An Answer," published Nov. 4, 2021). How quickly states reopened their economies, not when unemployment benefits expired, largely explained whether people remained unemployed, since most found work once businesses opened their doors. When adjusting the current 4.6% unemployment rate for all the people who left the labor force since February 2020, the adjusted rate is 6.4%, 1.8 percentage points above the headline rate.
How Long Will This Last?
The bigger question is whether the 3 million who left the workforce entirely since the pandemic will return. That depends on how much of the drop is structural and how much is temporary. We estimate that about 42% of the 3 million people who left the workforce since February 2020 are permanent, largely tied to retirement, while 58% are shorter-term, pandemic-specific decisions to leave the market.
The non-age component has a greater chance of recouping some of the shortfall. As people, particularly young parents, eventually feel that the virus has been defeated, they likely will return to work. The location mismatch--as people left crowded cities, explaining why they're now having longer commutes to work--will also narrow for similar reasons.
Among those who are sitting on the sidelines temporarily, how soon they return is still an unknown. A larger labor force means higher labor productivity, which helps determine the path of U.S. economic growth and inflation, as well as the Fed's policy decisions in 2022 and beyond.
The "Big Leave": A Structural Shift
U.S. labor market conditions since the pandemic began highlight a possible structural shift in the labor force, with 64% of the missing workers in the U.S., or 3 million of the 4.5 million total number of people, having left the workforce entirely. We expect most unemployed workers to accept jobs in the relatively near future as their benefits expire, just as some did in October. But those who have left the force entirely provide a more challenging outlook in 2022.
Structural shifts have increased because of the pandemic. These include the skills mismatch, which has been an issue for several years and only worsened with the crisis, as well as older workers retiring earlier than planned, in part over virus fears. The loss of skilled older workers from the pandemic may have, in turn, exacerbated the skills mismatch. The labor participation rate of people 65 and older fell by 10.6 percentage points in May 2020 from February and is still 8.1 percentage points below precrisis levels today, the largest percentage drop of all age groups analyzed (see chart 3). However, it makes up a small share of the 3 million.
Other reasons people left the workforce stem more directly from the pandemic, which may mean that some of the drop in the labor force will likely be temporary. For example, the pandemic-induced savings cushion from quarantine and stimulus checks, which allowed potential workers to take a wait-and-see approach, will eventually run out.
Child care constraints and virus fears likely explain the 3.9% drop in the labor participation rate for workers age 25-54, with the participation rate of women in this group falling by a much larger 4.7% (see chart 4). These rates remain down 1.4% and 1.8%, respectively, from their precrisis levels. Moreover, the smaller percentage decline hides the much larger number, 1.4 million, of prime-age workers who dropped out of the workforce. That's almost half the total number of labor force exits. Most of the 1.4 million, about 68%, were women.
While schools and child care facilities have opened, job market bottlenecks limit the number of children who can attend. And although the vaccine is now available for children 5 and older, children under 5 are still at risk, likely giving parents pause in returning to work. Virus fears will ebb as more children are eligible for the vaccine--how long that will take depends on availability, access, and participation.
We expect that many pandemic-driven constraints are temporary. Once the U.S. reaches herd immunity, the majority of people will no longer face these constraints and will return to the workforce. How soon is unclear. We suspect that as vaccines become more readily available next year, parental concerns surrounding the virus will moderate, allowing more workers to enter the job market in the second half of the year to stabilize wages. The wild card is whether those reluctant to get themselves or their children vaccinated will decide to get the shot.
The location mismatch also remains an obstacle in matching workers with jobs as commutes are still far longer from normal. According to Google trends, the distance from a worker's workplace widened dramatically during the pandemic, with people 50% further way from their workplaces in April 2020 relative to 2019 (see chart 5), as people left crowded cities for safer grounds. Today, the work commute nationwide is still 20% longer than it was in 2019. For those who use public transport, increased chances of exposure to COVID-19 are another disincentive to join the workforce.
Tackling Wage Growth Pressure And High Inflation, Plus A Need To Address Income Inequality
The labor force exit has added to business costs and increased inflation dramatically. What workers businesses find now require higher wages, with September year-over-year wage gains at a 14-year high, according to the Atlanta Fed Wage Growth Tracker. Overall supply constraints pushed total Consumer Price Index (CPI) inflation to a 31-year high on an annual basis in October, with core CPI, excluding food and fuel, at a 30-year high. That leaves real wages in negative territory. So nobody is happy about the wage dynamics!
We continue to expect pricing pressure to slowly ease in 2022, but only reach the Fed's flexible average inflation target by second-half 2023. Both the slow easing of labor supply constraints, as the pandemic fears subside and more people get vaccinated (and rejoin the workforce), and tighter monetary policy will likely slow price increases later in 2022. Moreover, negative real wages squeezing household purchasing power will also help moderate inflation. Once bond purchases reach zero, we expect the Fed's first interest rate hike to come in September 2022. But the longer people sit on the sidelines, job market pressure on wages could force the Fed to move faster than it currently expects.
The Fed could also be forced to move quickly to contain elevated inflation in 2022 if price gains prove not to be "largely transitory." The Fed's even tighter monetary policy will eventually tame price readings, but not without economic growth slowing as well. How sharp a slowdown depends on how big an inflation battle the Fed must fight.
A much tighter-than-expected monetary policy could also exacerbate income inequality in 2022. The Fed indicated in 2020 that it would broaden its job market scope beyond targeting just the national unemployment rate, which tracks closely with the white unemployment rate, to include job market conditions for other demographics. The unemployment rate for Black and Hispanic Americans is at 7.9% and 5.9%, respectively, well above the 4.6% national rate and 4.0% for white Americans.
But if high inflation persists, the Fed could be forced to respond--and tighten monetary policy--before other demographics, such as Black and Hispanic Americans, fully experience the benefits of a healthy economic recovery on job prospects.
The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
This report does not constitute a rating action.
|U.S. Chief Economist:||Beth Ann Bovino, New York + 1 (212) 438 1652;|
|Contributor:||Satyam Panday, New York + 1 (212) 438 6009;|
|Research Contributors:||Shruti Galwankar, CRISIL Global Analytical Center, an S&P affiliate, Mumbai|
|Debabrata Das, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai|
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