Situations vacant: How can governments deal with labour shortages?

14 Apr 22

A shortage of workers across the global economy could pose some big challenges for governments.


Remember how economists warned that the Covid-19 pandemic could lead to a global unemployment crisis as businesses collapsed amid the crisis? Things have not exactly turned out that way. In the US, the unemployment rate currently stands at 3.9%, and many economists believe the country is more or less at full employment. The UK, with an unemployment rate of 4.2%, is in similar territory, while, even in the eurozone, joblessness is below its pre-pandemic level, at 7.2%.

The avoidance of mass unemployment is to be welcomed, of course. But does this unexpected outcome cause its own difficulties? As policymakers scramble to address the challenge of labour market shortages, there is growing concern about the impact on the economic recovery and already weakened public finances.

Indeed, recruitment issues are now a real preoccupation for policymakers. At the end of November, the US Bureau of Labor Statistics reported that American employers had 10.6 million job vacancies to fill – close to an all-time record. The problem is economy-wide, with employers in sectors ranging from healthcare to manufacturing and from retail to leisure and hospitality all reporting problems.

Europe is experiencing similar challenges. In the UK, vacancy rates are also at all-time highs, according to the Office for National Statistics, with four in every 100 jobs currently standing empty. The health and social care sector alone has 250,000 unfilled posts. The same problem is biting across the continent, from German manufacturers to French farmers, all of whom complain that an inability to recruit is holding them back.

In Japan, many restaurants closed over the Christmas holiday period because of staff shortages (both their own and at suppliers). The squeeze on labour availability was reflected in figures included in the Bank of Japan’s most recent Tankan quarterly survey of business conditions. Meanwhile, the Australian government’s efforts to stimulate the economy with infrastructure spending are also being undermined by recruiting difficulties in the construction industry.

The common theme running through these labour market shortages is that they reflect the disruption caused by the pandemic. However, the story differs somewhat from one economy to another, depending on how governments responded to the Covid-19 crisis. In the US, points out Neil Shearing, chief economist at research firm Capital Economics, the government opted to allow unemployment to spike sharply higher when Covid-19 hit and the economy shut down.

US phenomenon enduring

Rather than subsidising employers to keep staff on, it offered generous unemployment benefits, plus additional support through its economic stimulus programme, which included posting cheques to households across the country. “The result was that participation rates dropped dramatically. That was expected to be a temporary phenomenon, but it is proving enduring,” Shearing says. “Some older workers appear to have no intention of returning to the workforce, and even younger workers are taking much

longer than expected to come back.”

One explanation for this is that the government’s support was so generous that American households have built up savings buffers and feel little need to return to work – savings deposits have increased by $3.5trn since the end of 2019. Older workers, meanwhile, have seen stock market savings surge in value, enjoyed their time out of the workplace, and decided to retire.

It does not help that president Biden – conscious both of public health issues and the political context as mid-term elections approach – has maintained similar immigration policies to the Trump administration. Previously, a warmer embrace of immigrant labo

ur might have helped the US overcome its labour market dislocation. In the current environment, there is little prospect of that.

In Europe, meanwhile, governments took a different approach during the Covid-19 crisis, paying employers to furlough unneeded staff, rather than laying them off. That was a perfectly valid response, says Michael Wolf, a US-based global economist at Deloitte, but the hangover is a lack of flexibility in the labour market.


“During the pandemic, we saw this huge shift in consumption, with demand for goods rather than services accelerating, and that appears to have continued, even though the economy has reopened,” Wolf says. “However, Europe’s labour market is not in a position to adjust quickly, because unemployment has remained so low; staff remain attached to their former employees.” Across much of the continent, Wolf points out, large numbers of staff remain furloughed – why would they move to a new employer?

Moreover, while the service economy in much of Europe is now recovering – restaurants, cinemas and other venues, for example, are reopening their doors – there is another problem. “The heightened risk of contracting Covid-19 has made these jobs riskier than others,” Wolf points out. “Employers will find it more challenging to attract workers at pre-pandemic pay rates.”

The most inflexible labour markets will take longest to recover. Here, the UK is at an obvious disadvantage. Despite the government’s efforts to maintain employment, many foreign workers left the country during the pandemic, explains James Knightley, chief international economist at Dutch bank ING. By the end of 2020, there had been a 7.4% fall in the number of EU nationals on UK payrolls, according to the ONS.

Brexit complication

“Post-Brexit visa rules make it trickier to work in the UK in lower-paid roles, so it will be permanently harder for UK companies to source staff from overseas,” Knightley warns. So, while the UK has moved away from furloughing faster than some of its European neighbours, which should help the labour market to adjust, it now has a smaller pool of talent than prior to the pandemic.

Economists are divided on how long these issues will take to resolve, but in markets suffering an enduring fall in the size of the workforce – including the US and the UK, where immigration policy is a shared added factor – there is good reason to expect shortages to continue.

That is not to suggest increased immigration is the answer. “Work migration policy cannot be used for generalised labour shortages,” warns Alan Manning, professor of economics at the London School of Economics. “Immigration increases labour supply, but, as migrants spend their earnings, it also raises the demand for labour; any gap between the supply and demand for labour is the same.” Localised schemes to address short-term issues may be more useful, but only if carefully targeted.

Meanwhile, recruitment problems will have ongoing effects. For example, one factor driving higher inflation in advanced economies is rapid wage growth. “As 2021 ended, the prime-age employment-to-population ratio had recovered to levels last seen in late 2017, but with even stronger wage growth,” says Robert Maxim, senior research associate at the Brookings Institution in the US.

Higher labour costs around the globe will naturally continue to feed into inflationary pressures. Against this backdrop, further interest rate rises in advanced economies – most of which have already begun to tighten monetary policy – look inevitable over the course of 2022.

“We fully expect the US Federal Reserve to hike rates in March, and we think it increasingly likely that the second hike will come before mid-year, leaving room for two further increases in the second half of 2022,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics in the UK. “At this point, it is still too soon to know whether the labour market will be the source of such sustained inflation pressure that the Fed then has to tighten aggressively for an extended period.”

Even if not, there is potential for monetary policy to act as a brake on the global economic recovery from Covid-19 – and thus to limit the tax revenues that governments can look forward to. So, combined with the inhibiting effects of labour market disruption on growth, should policymakers be worried about a sharp deterioration in public finances?

“I am relatively relaxed about that prospect – I do not think we are talking about a problem on the scale of the situation following the global financial crisis, for example,” says Capital Economics’ Shearing. “And we are not seeing governments intervene with more spending to resolve labour market problems; if anything, they feel now is the time to pull back.”

Still, potential threats to public finances are not insignificant. Higher wage costs across the public sector will need to be paid for. In the UK, for example, the government announced in October an end to the freeze on public sector pay rises. Plus, there is the cost of servicing debt incurred during the response to Covid-19, which has played such a significant part in current problems.

“Governments always have to make trade-offs – did they have to spend so much to protect output?” asks Deloitte’s Wolf. “Getting the balance right is always tricky.”

Indeed. And the outcomes of policy decisions are unpredictable – two years ago, the world was worried that millions of workers would find themselves out of a job. Today, we are in a candidates’ market. The US has just recorded its third successive month of record highs in the ‘quit rate’, which charts the number of people leaving jobs. With better pay available elsewhere as competition for labour intensifies, retention has become as difficult as recruitment. As things stand, labour market problems are far from being over.

Image credit | shutterstock

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