Bad News for Doomsayers (Good News for Workers!)

(Bloomberg View) -- Despite an unemployment rate that's at its lowest level in 17 years, gloomy types manage to see dark omens.

Some, especially those shaped by the inflationary period in the late 1970s, fear that when the labor market achieves a state of full employment, as it may have already, we will see not just higher wages, but also an inflationary spiral that could get out of hand without a rapid tightening of monetary policy.

Other skeptics, enamored by new technologies like robots, artificial intelligence and machine learning, fear that once we've achieved a certain level of technological progress we will see the rapid mass displacement of workers. But it's just not happening yet. Instead, 2017 has shown that a more nuanced scenario may be the future of the labor market.

The problem with the "full employment leads to an inflation spiral" theory is it doesn't take into account all the complexities in the economy. There are lots of ways the economy can respond to a shortage of workers, and broad-based higher prices may take a lot longer than thought. Take the labor market over the past 12 months. As it gets tighter and tighter, we're seeing a shift in the composition of job growth.

Consider high-paid, high-productivity jobs like those in "goods-producing industries" -- primarily construction and manufacturing -- and "professional and business services" -- high-paid knowledge jobs. These grew by 598,000 in 2016. Now consider lower-paid, lower-productivity jobs like those in the retail and hospitality sectors -- those grew by 534,000 in 2016. But in 2017, as global growth has accelerated and employers have had to deal with a tight labor market, that composition has shifted dramatically. Job growth in those high-paid, high-productivity industries in the year-to-date period ending in November has accelerated to 917,000 jobs. Meanwhile, in retail and hospitality over that same period job growth has decelerated to 238,000.

The reason for this shift might be that pricing power and price pressures differ across industries. It's well-understood by now that the retail industry is struggling for a variety of reasons ranging from overcapacity to competition from e-commerce. As labor costs go up, retailers have a choice (assuming they want to maintain profits): raise prices or cut costs by closing stores. They might choose to close, which would not contribute to an inflation spiral. In fact it would free up workers to migrate into other industries.

Similarly, restaurants have complained about a lack of pricing power, so as their labor costs go up, the outcome might be fewer restaurants rather than more $20 burritos.

The construction industry, on the other hand, doesn't have this problem, so as its costs go up, employers can raise prices and keep growing.

With 2018 looking like a period when the U.S. will spend the entire year at full employment, we should be on the lookout for labor tightness leading to a transformation of the economy away from low-productivity industries and geographies towards higher-productivity ones. We may get higher inflation, but it might not be as broad-based or rapid as some fear.

As for the concern of mass displacement of labor, if any year would have shown progress on this front, it would have been 2017. Ryan Avent may have done the best job of explaining the theory in his 2016 book, "The Wealth of Humans." He said that there was a paradox in the economy of the 2010s, whereby we were getting solid job growth but few signs of wage growth or inflation, all while reported measures of productivity growth were low. How was this consistent with rapid technological progress? His explanation was that technological progress was displacing well-paid workers the most, forcing them into lower-paid, lower-productivity professions. This process was transferring income from workers to the owners of capital, depressing overall economic growth, keeping a lid on wages and inflation, and masking true productivity growth.

But this isn't the experience we've seen in 2017. A tightening labor market is slowing the growth of low-paid employment the most. Job growth in high-paid industries has accelerated. The annualized stated level of productivity growth in the third quarter of 2017 was 3.0 percent, its highest level in three years. The Federal Reserve's late November Beige Book report noted "widespread" labor market tightness and the increased use of money and perks to attract and retain workers. This can all be explained by standard economic theory, not futuristic technological predictions.

Neither rapid increases in inflation nor rapid technology-induced job losses appears to be our future, at least in the short term. Continued above-trend job growth in 2018 should lead to increased wage pressures, increased incentives to automate jobs where it makes economic sense, higher prices for industries with pricing power, and more struggles for industries unable to raise prices to offset higher costs. But as the rest of this decade has shown us, it's not likely to lead to the dystopia that either inflationists or tech futurists fear.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg View columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.

To contact the author of this story: Conor Sen at csen9@bloomberg.net.

To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net.

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