Focus
August 04, 2023 | 13:09
Love of Labour is Lost
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Love of Labour is Lost |
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Canada’s previously drum-tight job market is loosening, as highlighted by the weak July employment report. In the latest six months, average employment growth has slowed to a 22k per-month pace, the unemployment rate has ticked up, job vacancies are falling, and wage growth has shown signs of softening. While the hiring pace is still historically solid, it is down from much stronger gains through early this year. At the same time, the supply of labour is rising rapidly, taking some stress and inflationary pressure off the job market, a development that the Bank of Canada will certainly welcome. |
Labour demand has been running in excess of supply through much of the past two years. Relative to pre-COVID levels, the demand for labour (measured by total employment and job vacancies) really surged ahead of supply as the economy moved into 2022 (Chart 1)—precisely when the Bank of Canada decided to begin raising rates. The demand side growth was at least partly enabled by loose monetary and fiscal policy that stoked excess demand conditions across the broad economy. Indeed, by late 2021, hiring intentions in the Bank of Canada’s Business Outlook Survey surged to the highest level on record, so much of the reported ‘labour shortages’ could be attributed to high demand. |
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Meantime, supply has been rising at a strong clip. The labour force rebounded quickly after the initial stages of the pandemic, and while there were lasting disruptions in some industries (e.g., restaurant workers that left for other sectors), aggregate supply has been quick to return to baseline levels. Indeed, the prime-age participation rate now sits more than a full percentage point above pre-COVID levels, and has pushed through that mark for both men and women. At the same time, surging immigration flows have piled on to lift the overall labour force by almost 600k in the past year (2.8%), the strongest non-pandemic growth rate in more than two decades. Of course, not all of the immigration flows are directly entering the job market. Based on combined data from StatCan and IRCC, we estimate that of the approximately 1 million net immigrants to Canada in 2022, almost half were international students, sponsored families or refugees, where integration into the job market might be slower. Even still, the remaining half (or more than 500k) largely fall under worker programs, provincial nominee programs or are temporary foreign workers/International Mobility Program participants. There’s much debate, even within the Bank of Canada, about the net impact of surging immigration flows on the economy. Our general view is that the immediate stress on housing, service demand and infrastructure is inflationary, and leads to higher interest rates than otherwise would be the case, before the longer-term disinflationary impact of more robust labour supply takes over. Indeed, we’ve seen clear evidence of both, first in rental prices and services inflation, but now with more ample labour force growth apparently chipping away at job vacancies and applying some upward pressure on the jobless rate. |
Perhaps the most vivid sign that previously extreme demand for labour is coming off the boil is the declining job vacancy rate (Chart 2). After peaking last spring at 5.7%, or just over 1 million openings, vacancies have been cut by a quarter to a much more manageable 4.3% level. The vacancy-unemployment ratio, which the Bank of Canada now highlights in its labour market dashboard, has dipped to just under 0.7 after nearly hitting 1.0 at the high in 2022 (i.e., a job opening for every person officially counted as unemployed, which pretty much defines full employment). While cooler, the ratio is still above the pre-pandemic trend of 0.45, and when the vacancy rate was a bit above 3%. There are some early indications that a slightly slacker job market is beginning to take some steam out of labour costs, although they continue to run well above recent norms by almost any measure. The headline unemployment rate is also flashing at least a mild warning that the job market is losing steam. After reaching 4.9% last summer, its lowest readings since the early 1970s (on a slightly different measurement in those years), the headline rate has perked up by 0.6 ppts to 5.5% in July (Chart 3). At the same time, the jobless rate for youth (15-24) pushed up to 11.5% in June (before falling to 10.2% in July), after hitting a record low of 9.0% in July 2022, in a clear sign of a softer summer job market in general. Most economists have been largely downplaying the back-up in the headline measure since a) it’s a volatile metric that can swing heavily at times, and b) it’s been accompanied by a population-fuelled sprint in the labour force. But, we would counter that the jobless rate is one of the most reliable measures of the economy’s health, with a long track record, which has worked well through previous episodes of robust population growth. One indicator for the economic outlook that can be drawn directly from the unemployment rate is the so-called Sahm Rule, which is now garnering plenty of attention stateside. The measure, developed by Claudia Sahm when she worked at the Federal Reserve, posits that it’s a foolproof recession signal for the U.S. economy when the 3-month moving average of the unemployment rate rises by 0.5 percentage points from its low of the past 12 months. Applying this rule to Canada (Chart 4), the three-month average unemployment rate is 5.37% versus the 4.9% low of the prior year, so not quite there yet—but, we will be if the jobless rate ticks up again to 5.6% in August. Still, as Chart 4 shows, there have been at least four false positives in Canada over the past 50 years when applying the Sahm Rule—in each of 1977, 1996, 2002 and 2015, Canada’s jobless rate rose by at least 0.5 ppts from the low but the overall economy was not considered to be in an official recession (it was a close call in all of the last three cases). It appears that, for Canada, it takes roughly a 0.7 ppt rise in the jobless rate from the low to signal a full-on recession. Circling back to the impact of cooler labour demand on wages, the latest job figures show that average hourly wages were up 5.0% in July, well below the 5.8% high late last year. However, the Bank of Canada continues to sound concerned that the underlying trend of 4%-to-5% is not consistent with hitting its 2% inflation target. And, looking through the noisy wage stats, a smoother metric is the two-year annualized change in pay for permanent workers, and it is indeed stuck right in the middle of the BoC’s estimate (Chart 5). Almost all of the wage measures were heavily distorted by the pandemic, and the massive shifts in the labour market at the time. But, the dust has now settled, and it’s notable that the level of inflation-adjusted average hourly wages now stands almost precisely back at its pre-pandemic level. Two key points: 1) wages thus have clearly not played a big role in driving inflation to this point, and 2) despite the wild swings in the past three years, wages have basically just kept pace with prices. |
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That final point may help explain why labour unrest seems to be growing, even as inflation is moderating and the job market is losing steam. We have long warned that the historical record shows that strike activity is highly correlated to inflation, with both reaching post-war extremes in the 1970s and early 1980s (Chart 6). The record also shows that labour unrest is a lagging indicator—that is, workers try to catch up to past inflation, especially when the job market is still relatively tight. And last year’s surprise burst in inflation, combined with a 50-year low on joblessness, was almost the textbook condition for a spike in strikes—and we’ve seen that from the federal civil service, to B.C. port workers, to grocery workers, and in the U.S. from Hollywood to perhaps the Detroit 3 automakers. The good news is that if headline inflation continues to ease and the job market loosens, this labour unrest too shall pass… eventually. Bottom Line: There is mounting evidence that the extreme tightness of the Canadian job market is easing and, if inflation cooperates, suggests that the case for the Bank of Canada moving to the sidelines is now very strong. That said, firm and persistent wage growth, which is working with a lag, suggests the Bank will still lean on the economy with these high rates for a prolonged period. |