Last week in one of our progress meetings I was asked by a client a very sensible question “why is record low unemployment a bad thing?”
His question arose from a news report that was attempting to explain the economic challenges currently faced and the concerns for 2023 and beyond. One of the explanations offered by the journalist was this “problem” of record low unemployment. But as my client observed, surely everyone having a job is a good thing. A totally reasonable assumption to make. So what’s going on?
At least since the industrial age economies in every corner of the globe have experienced cycles. Periods where activity and growth is strong, followed by periods of retracement as indigestion strikes. You often hear this referred to as the boom and bust cycle. Fortunately the positive boom cycles tend to run for much longer than the busts, which is why over the long term we’ve made the incredible progress that we have as a society. That we’re no longer getting from A to B on horseback, washing our clothes in the local river, or having large numbers of women dying during child birth, is evidence of the progress that we’ve made.
The role of our economic managers – government, central banks, and other regulators, is to attempt to at least preserve our standard of living, and ideally improve it over time. This typically occurs through the creation of economic growth within a nation. The busts in a boom and bust cycle are unpleasant and therefore a key role of the economic managers is to try and avoid those busts where they can, or at the very least minimise their impact.
In recent years we’ve seen several examples of economic managers taking action when economic conditions have deteriorated, most recently through the pandemic. Central banks cut interest rates, governments gave out plenty of handouts, and packages were put together to help affected industries.
But whilst there are actions that can be taken in difficult times, prevention is almost always preferable to a cure. And this is where concerns about record low unemployment come into the picture.
Currently our unemployment rate is about 3.5%. That’s the lowest it’s been in modern economic times. Since 1978 our average unemployment rate has been 6.7%, and was over 11% in the early and 90s. The unemployment rate is quite possibly the most important economic measure for policy makers. Fundamental to a democratic capitalist society is the principle that everyone has an opportunity to earn a living and support themselves. You would think then that any unemployment is a bad thing, the only good result being a zero unemployment rate. Whilst at the individual level this may be true, from the perspective of an economic manager who is trying to prevent or at least minimise the next bust cycle, very low unemployment is a worry.
Low unemployment is likely to mean wages will rise as businesses bid against one another to attract talent. These higher wages are then passed through to consumers in the form of higher prices. This leads to a vicious cycle where consumers then ask for more pay rises so they can afford the now higher prices, and if the employers give these higher wages they once again need to bump up their prices and we get an ugly vicious cycle. This is inflation and an outcome of this sort is what keeps the Reserve Bank awake at night.
Low unemployment in and of itself is not a bad thing. The worry is the knock-on impact of this low unemployment on prices and inflation. At some point businesses will not be able to pass on the necessary price rises and some will go out of business, causing the workers in those businesses to be out of work. In a low unemployment world that’s not too much of a problem, but if you get enough businesses experiencing this at the same time, you could very easily go from a boom cycle to a bust cycle. A recession. People who have lost their job can’t afford to continue mortgage repayments, pushing house prices down, potentially trapping some in situations of negative equity. Less workers means less tax income for governments which means less ability to support the economy, or racking up debt for future generations to repay.
Our interest is primarily around the impact on investment markets, but of course job security is also a consideration for us all. In the investment arena, persistent low levels of unemployment create fears about how high central banks will need to lift interest rates in an effort to cool economies down and prevent a big bust scenario. Effectively, in raising interest rates what they are hoping to achieve is a small bust scenario, perhaps unemployment rising by 1%, but not getting completely out of hand. The thinking is that this produces a more stable long term trajectory for the bulk of the population and is therefore a far better outcome than a devastating severe recession.
That unemployment is so low is a surprise outcome of the pandemic. Government intervention in most of the western world has been very successful in supporting their citizens and the businesses that operate within their nations, such that as activity returns to normal, people have savings in the bank and money to spend. It also highlighted the degree to which most of the western economies are boosted considerably by immigration. Immigration restrictions through the pandemic, be they permanent, temporary, or student visas, have meant we have fewer workers than would normally be the case. These workers often work in the lower skilled jobs, and their absence has meant higher salaries for some in these sectors, almost certainly a good thing given these tend to be our lowest paid workers, but inflationary none the less.
If you see the next reported unemployment rate go even lower, and then also see the stock market decline, hopefully you’ll now appreciate what is going on. And of course the reverse also applies. It could easily be the case that bad news on unemployment is welcomed by investment markets, signalling that central banks won’t need to raise interest rates too much further, potentially even pointing to rates going back down again in the future.
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