Curtailing labor supply is a terrible way to boost wages

The ultimate leaky bucket

Strong demand for labor is good both because it allows continuously employed people to bargain for higher pay and better working conditions and also because it creates opportunities for people who might otherwise lack them due to prior problems with the law, mental health, substance abuse, discrimination, or disability.

But every now and again someone comes along and claims that the same virtues exist in the event of a negative shock to the supply of labor.

(Joe Raedle/Getty Images)

For years, I heard that argument primarily from people on the right, primarily with regard to immigration policy. More recently, when conservatives started arguing (wrongly, as it turns out) that the bonus unemployment insurance provisions of the American Rescue Plan were seriously crimping labor supply, some progressives started arguing that reducing labor supply is good. It turns out that the expiration of the bonus UI program did not substantially expand labor supply, but it remains true that labor supply has been reduced relative to the pre-pandemic situation. Part of trying to put a positive spin on the current economic situation has involved progressives arguing that this is a good, pro-worker dynamic.

That in turn has led Arin Dube, one of the leading progressive labor economists, to even say that we should maybe re-evaluate our thinking on immigration, and perhaps the combination of high demand and low supply of labor is good.

I will admit that there are a lot of empirical uncertainties as to what exactly is going on with the labor market right now. But I think the best read of the situation is that the economy is actually doing kind of badly, the negative shock to labor supply that we’ve experienced is a big part of that reason, and the tried and true distinction between boosting demand and curtailing supply is important. If a ton of tourists decide they want to visit your city, that could create a shortage of hotel rooms. If an arsonist burns down your city’s hotels, that could also create a shortage of lodging. But the former is good (even if inconvenient for some) and the latter is bad (even if it benefits a few owners of non-burned hotels).

What’s up with labor supply?

There are substantially fewer people employed today than there were in February of 2020.

And unlike the sluggish labor market of 2010, this is not due to a lack of labor demand. The bipartisan stimulus that passed during the Trump/Biden lame-duck period plus the American Rescue Plan succeeded in generating a surge of attempted hiring.

And this attempted hiring has not been futile by any means. The economy has added many more jobs so far in 2021 than it did during any year of the Obama or Trump administrations.

But you’re still left with the fact that we have many fewer people working today than we did two years ago, and the proximate issue is something to do with the supply of labor rather than the demand for it. Earlier this year I agreed with conservatives that bonus UI was likely a major culprit. That now looks to have been wrong. But note that even though this was a right-wing criticism of Democrats’ ARP, it would have been very good news for Democrats had it been true. Surging employment this fall would have made Biden look like a genius, and conservatives saying “actually this proves we were right about ARP” would have looked like morons. Instead, we got a continuation of job growth that, while certainly pretty good, is not exactly booming. Technically that vindicates Democrats’ position on the dispute, but in practice, it’s bad news for them.

So what’s up with labor supply? I’m not entirely sure. Some of it is population aging. Some of it is lack of immigration. Some of it is probably industry mismatch — people who work in specific sectors that are still depressed not wanting to abandon a field they’re experienced in to go work in a warehouse.

But I think it’s also that Covid has made work worse. If you’re Covid-cautious, non-remote jobs seem unsafe. If you’re not Covid-cautious, the mask rules and vaccine mandates in many workplaces are annoying. Americans are largely not living on the edge of subsistence. If something happens that makes work much more unpleasant than it used to be, lots of people have some margin to become choosier about jobs. I’m not going to be a sociopath and say it’s bad that people aren’t at the edge of subsistence and that we should be forcing them into work. But what I do want to say is that the negative shock itself is bad. If the virus vanished tomorrow and all public health worries went away, that would be a positive development for the economy. And I think when you put it that way, it’s obviously true.

Deadweight loss is bad

Say there’s someone you usually hire to babysit your kids. She’s young, she’s vaxxed, she’s feeling okay. But she lives with her elderly grandmother, and with first Delta and now Omicron in the news, she’s worried about the consequences of a breakthrough infection for her family so she’s not doing babysitting gigs anymore.

Now it’s not like this one person was the only babysitter in the world. But since some babysitters have withdrawn from the market, the price of hiring one is now higher and the convenience is down because you’re dealing with people that you don’t know as much. This leaves you worse off (due to the higher prices and reduced convenience), though that is partially offset by the higher income earned by your replacement sitter. But the crucial thing is that your original sitter is worse off than she would have been absent the negative supply shock. There’s not just a transfer from you to the new sitter, there is deadweight loss from the blocked transaction. Now what’s true is that coercing the original sitter into working wouldn’t make her any better off. As a policy matter, her preferences are her preferences, and trying to override them doesn’t help. But if Eric Topol’s dream of a pan-coronavirus vaccine materialized and alleviated her fears, that would be good.

It would be good as a public health matter, but it would also be good as a pure labor market issue.

The size of the pie matters

I’m a dummy who never took an economics class in college, but I have read several economics textbooks and they all at some point show a chart about what happens if you get a negative supply shock — prices go up and output goes down.

Everybody knows that inflation has gone up compared to where it was before the pandemic. And if you look at a chart of inflation-adjusted gross domestic, you see we’ve had a pretty good recovery but we are below either an optimistic (blue) or pessimistic (orange) projection of the pre-pandemic trend.

This is not a question of insufficient stimulus — inflation is high, and if you look at nominal GDP, we are now above the pre-pandemic trend.

And I don’t think the question of “Why did output go down while prices went up?” is particularly mysterious. This is what the textbooks say will happen if your economy suffers a supply shock. And the global economy has, indeed, suffered a serious supply shock in the form of the Covid-19 pandemic.

These days things seem polarized between the majority of the public that wants to blame Biden for bad economic circumstances and a minority fraction of progressives who wants to say the economy is actually good. But neither of those things is right — the pandemic is a huge negative supply shock and relative to the scale of the supply shock, macroeconomic management has been quite good. The pandemic is mostly bad luck, but I also think our public health response has had a lot of problems.

Again, I think that this is super-obvious at an appropriate level of abstraction — if I tried to pitch an op-ed with the thesis “a deadly global pandemic is also bad for the economy,” editors would think that was boring. But the withdrawal of labor supply is just a specific concrete manifestation of the general problem. It’s true that at the beginning of the pandemic the most salient feature of pandemic-related economic problems was collapsing demand for things like restaurants. But at this point, it’s showing up more in labor supply. And even though there are clearly some winners here, overall we’re losing with price gains outpacing wage gains.

And how could it not be? The negative supply shock has reduced overall output so any useful redistributive stuff that happens tends to get swamped and leave most people worse off.

The leakiest bucket

A million years ago the great economist Arthur Okun wrote a book called “Equality and Efficiency: The Big Tradeoff.” In it, he argues that there is a large tradeoff between increasing the size of the economic pie and distributing the pie evenly. Redistribution, in his view, is a “leaky bucket” — some of the water that you are trying to transfer from the rich to the poor ends up spilling on the floor.

My view (and I think most contemporary progressives’ view) is that this is basically wrong. If CHIP increases kids’ reading scores, and Medicaid expansion reduces low birth weight among infants, and receiving SSI reduces the incidence of childhood health problems, and the Child Tax Credit leads to higher life-long earnings, then we are seeing lots of instances where redistribution does not leak. Indeed, in a lot of ways, I think 20th-century free-market economics rather than any faddish leftist ideas is the ultimate misguided blank-slate ideology that ignores the biological foundations of the human experience.

But, leaky bucket redistribution is a thing that can happen.

And I’d say negative labor supply shocks are a good example of an extremely leaky bucket. There is clearly a non-trivial number of workers who are better off today than they would be if everyone enthusiastically leaped back into the labor force. But on the whole, the experience has been negative. If you act as if the only adverse impact on consumers is needing to pay a bit more at Target or wait a little longer for a table, you can kind of try to waive the problems away. But having school canceled because you’re out of bus drivers or non-emergency surgeries delayed because there are no nurses is a big deal. Worse, these things operate in a great chain of being such that disruptions to schooling and medical care have a negative impact on labor supply elsewhere.

Again, I think it’s obvious that the pandemic is bad — and not just for the people who have died or gotten sick.

Immigrants are still good

For all these reasons, I continue to feel confident that immigration is a net economic benefit to receiving countries. To some extent, people may feel that it is culturally harmful and that they are willing to bear a material price for the sake of maintaining homogeneity, much as Quebec has instituted lots of policies to promote the local survival of the French language even though the province would be more prosperous if it were more English-friendly.

Immigration is particularly beneficial, though, because in the modern world most of us earn a living by selling services and the presence of immigrants increases demand for services as well as the supply of labor.

I’ll concede two partially offsetting caveats to restrictionists’ views:

• The economic impact of immigrants varies based on their skill profile, so it is probably more egalitarian to let in immigrants who are more skilled on average than natives.

• When you have very inelastic housing supply, an influx of newcomers can squeeze incumbent residents out of the housing stock, especially if they are relatively high income.

This is why in addition to being obsessed with the benefits of immigration, I am obsessed with the benefits of expanded housing supply — per “One Billion Americans” it’s a seamless web.

To get back to where we began, both positive shocks to labor demand and negative shocks to labor supply generate “tight labor markets” and whiny employers. But it’s bad to get so invested in negative partisanship against whiny employers that you start thinking the negative shock to labor supply is actually good. It’s quite bad. And especially once you get out of the weird deflationary mindset of the Great Recession period and see that it’s always possible to generate more demand by cutting people checks, then there’s no reason to adopt a sunny view of curtailing labor supply.