“The economy has returned to full employment. With full employment, good things should soon happen for many of the heretofore financially disenfranchised.” economist Mark Zandi of Moody’s Analytics
Last week Mark Zandi of Moody’s Analytics published a widely circulated report claiming that the country’s labor market had more or less fully recovered from the financial crisis and was back to a state of Full Employment. Since the report hit the wire less than a week ago the concept of “full employment” has been the subject of a lot of discourse within the financial world. So what is full employment exactly, and how do we know if we’ve reached this important milestone?
To answer these questions let’s first take a brief look at where the labor statistics currently sit. The April jobs report brought with it another decline in the headline unemployment rate to 4.4%, a level not seen since before the financial crisis ten years ago. The broader “U6” rate of unemployment, which includes marginally attached workers and workers that are part time for economic reasons, also fell to a level roughly in line with pre-financial crisis.
A more detailed analysis, particularly of the labor force participation rate, would show that there may be more widespread “underemployment” than meets the eye when glancing at these headline numbers. But the point here is that the trend has been heading in the right direction steadily since late 2009 and the labor market is now in the same ballpark it was in before the last recession.
It would be nonsensical to assume the unemployment rate could continue dropping all the way to 0%. There will always be some normal level of unemployment caused by workers shifting careers, moving to new locations or being fired or laid off for normal business reasons. This might be called the “natural” level of unemployment, or “frictional” unemployment. Full employment is the point at which the only unemployment in an economy is coming from these natural sources. No one knows exactly where the magic line is, but it’s widely assumed to be in the low single digits – perhaps somewhere between 3-5%. Thus, it’s not unreasonable to claim that the economy is now at, or at least close to, full employment.
But is there a way to know for sure? The short answer is no, not exactly. But a key indicator to watch from this point will be inflation, particularly in wages. Economic theory would suggest that a true state of full employment is indicative of an environment in which businesses have an increasingly harder time finding the skilled labor they need to fill their job openings. This supply/demand imbalance inevitably leads to upward pressure on wages. Higher wages, in turn, feed into the prices of end goods and services leading to an increase in headline inflation which has been stuck in low gear since the financial crisis.
Regardless of how you want to slice and dice the numbers, America’s labor market continues to experience a decisive recovery from the lows set in the wake of the financial crisis. It will be important to continue seeing things trend in the right direction, and in particular to see further healing internally as more part-time workers convert to full-time and more sidelined individuals reenter the workforce. We would love to see some organic wage growth take hold, which would be inflationary and would give the Fed further room to reset interest rates to a more normalized level ahead of the next recession. So while we’re not sure exactly where the magic line of Full Employment is, we think it’s safe to say we’re at least on the final stretch and moving in the right direction.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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