Labour Market Slack and Stagnation

Overview of Labour Market Trends.

Part One: Labour Market Slack and Economic Stagnation

By Travis Fast

There is a growing confidence that the Canadian economy has in fact de-linked from the US economy. The faith that somehow the Canadian economy can avoid falling into a recession despite a recession in the US is to my mind fanciful thinking. In the wake of NAFTA a monumental rationalisation of the North American economy was undertaken which served to further integrate the three economies not insulate them from one another. As they say: only time will tell all; so for the moment let me leave the argument about de-coupling to the side.

Some analysts of the Canadian scene have posted graphs like this one:


This graph from Stephen Gordon purports to provide evidence that Canada has delinked and that the Sun will keep on shining. But the de-linking story critically hinges on the capacity of the Canadian economy to keep expanding. So let us assume that the likely path of US demand is inconsequential to Canadian prospects; and instead inquire about any endogenous barriers to growth that may serve to check Canadian economic expansion over the near term.

Asking the question from this angle turns what initially looked like an optimistic empiric (Gordon’s graph above) into a picture of pessimism. Canadian labour slack is now at an all time low measured by any metric you care to name. As Gordon’s graph clearly shows, employment rates are at an all time high (his graph goes back to just to 2000 but the numbers I have plotted go back to 1976). The problem with the employment rate is that it is deceptive insofar as it is of the most extreme unlikelihood that the employment rate would ever = 1. That is, such a metric is a bad indicator of labour slack because a reading 0.64 gives the impression that there is an abundance of labour supply yet to be had.

To capture labour slack we can only use the historical record to estimate where the likely ceiling to labour supply rests, and hence the degree of labour slack. Take a look at this graph plotting three measures of labour slack.

Click for larger image


The first being the most often cited and familiar: the unemployment rate. The next two (Slack A and Slack B) are interesting because they attempt to control for labour force participation rates—among other things– which can play havoc with unemployment numbers (that is why economists prefer the employment rate metric because it is calculated without reference to the size of the labour force as determined by the Labour Force Survey, but, rather, to the absolute potential pool of workers, that is, the Canadian population 15 years of age and over).

My two additional measures attempt to capture something slightly different. First Slack A is a simple plot of the participation rate minus the employment rate. We can think of this metric as another measure of unemployment. Slack B measures the differences between the unemployment rate and Slack A. Each of these metrics is interesting because they all have an absolute floor of zero. But the last metric is interesting because it tells us something about the relationship between employment rates, participation rates, and the historical degree of slack in the labour market. And by this metric we are at an all time low of 1.9%.

The last two metrics tells us that labour supply has become a potential barrier to future growth. The conditions for the long boom both in the US and Canada were partially set by the massive labour reserves and subsequent traumatisation (Greenspan’s phrase) of workers expectations that built up from the early eighties until the early 90s. Those reserves have now been worked-off. As to the post-traumatic stress of worker’s who knows.

And all of this brings us to policy. What little room is left for an expansion of labour supply can only, at this point , be addressed by policies that would have had to have been adopted some time ago. Namely, a robust active labour market policy focussed on (re)training and geographic mobility. What unemployment that exists in Alberta, for example, is purely of the supply side kind, i.e., a skills mismatch and workers seeking better employment. And this is much the same story across the West. As for the East, it is true there is more labour slack than in the West, but there has already been a massive migration West. With labour markets this tight, and with much of the unemployment explained by a skills mismatch and geographic disequilibrium it is simply not likely that market forces will be sufficient to bring the quality of supply into existence nor deliver it where it is needed.

In Sum, operating at these low levels of labour slack requires robust active labour market programs alongside a robust skills planning and forecasting regime. None of which exist at either the federal or provincial levels. And all of this brings us back to the idiocy of general, non-targeted tax cuts. They do not serve to direct economic activity either towards depressed sectors and spaces or dampen activity in over-heated sectors and spaces. Coarse tuning, such as general tax and interest rate cuts, is likely going to make things worse and may actually induce a higher rate of inflation then needs be the case.

Now of course the kind of subtle fiscal and monetary policy this brief analysis suggests cannot be readily developed let alone deployed. And this is why I think it is wishful to think that the Canadian economy can continue to expand. Crucially because all that can be done in the short term is boost the number of hours individual workers are working and this too has limits, for not even an economist can assume there is more than 24 hours in a day.


2 thoughts on “Labour Market Slack and Stagnation

  1. With very little slack in the labour market, wouldn’t you expect to see wages, and thus, consumption, rise, if only mildly? I understand that your point is different – that the absolute limits to growth will prevent producers from meeting increased demand, but with capacity spread unevenly (between West and East) might there not be some additional room for growth? At any rate, whether there is or there isn’t is, I think, besides the point, which requires that we consider that which you didn’t want to raise earlier – the decoupling myth.

    On Gordon’s blog it seems to have been agreed that the Canadian Dollar is an oil currency, at least of late. Strange that the overall evaluation of our economy by forex traders would miss the degree to which we’ve decoupled. Or have they? This question stems from the fact that Canada is of course now the largest supplier of oil to the US. So more Canadians are earning decent wages working for US owned firms out West. Ahh, if only Canada had oil (I’m quoting you here Fast). Even with a recession in the US, it is unlikely that oil prices will fall so far south as to upset the Western apple cart. But this won’t do much to stem the bleeding in the East, where branch plants have been able to to stave off total disaster by virtue of their relative competitiveness (productivity). But with the UAW having agreed to massive concessions in the US, I’m not sure that Canadian workers in the East are going to be rescued by increasing demand out West. The point here is that Canada’s relative resilience to events in the US is not indicative of de-coupling, but rather of an intensification of links between the two economies. There’s another point too, that so-called progressive economists should well have tumbled to: there is no Canadian economy – the effects of a slowdown in the US will be experienced in grossly uneven terms across Canada.

    So the question then becomes how bad will a US recession be for Ontario, for Quebec etc. My sense is that the degree to which the manufacturing and services sectors now move in tune with the US economy is astounding, such that there is likely to be a relatively rocky road ahead, at least for some large segments of the working class. More than this, the likely unevenness of it all prompts us to ask questions about likely outcomes in terms of public policy, like health care and education and…

    I hate to shoot at so many birds with one stone, but Gordon’s recent blog, which is a redux of his other work, makes the argument that the Nordic countries have their tax mix right and are therefore able to support high levels of public spending with similarly high levels of public growth. Talk about fallacy of construction. But why are policymakers in Scandinavia so smart and ones in Canada so stupid? My point in mentioning this is that if we presume that the answer to our question lies in the question itself, we’ve not answered anything but only created a vicious circle; just as his work on the mixing of taxes doesn’t permit Gordon to consider largely contextual, dare I say political economic, issues, which might in fact indicate how taxes could be appropriately remixed in Canada, so too does his work on de-coupling not permit yGordon to consider a more complex answer than the grossly misleading one yhe gives. If you assume it, so shall it come.

  2. On wages and rising consumption. Two problems. If firms can pass on wage increases via price increases the the net real gain is minimal. Second, if wages were seen to be driving prices higher (the cause of inflation) the CB would begin jacking up interest rates. This is the old problem of managing imbalances when you are approaching the outermost position on the PPF.

    And this is my point. Coarse tuning in such an environment will not induce increased wages and consumption but more likely inflation from the acute bottlenecks it creates. The same goes for private sector investment. It will go to where things are good and there is an expectation of realizing relatively less risky returns (especially in the present credit crunch).

    Gordon is thus partially right insofar as a panicked response is not warranted . The problem with his analysis is that it short sighted and myopic. Myopic insofar as he does see the field. We need a much more subtle monetary and fiscal regime right now; both to correct for the uneven geographic pace of accumulation, employment and inflation and to hedge against the prospect of a recession. I would not take too much policy creativity to kill two birds with one coordinated strategy.

    As for the Canadian dollar being a petro-currency. Silliness. The currency speculators do not even think so. What they think is that the US has structural problems and a low interest rate. Canada has some oil, higher interest rates and no apparent structural problems. Hence the CDN dollar has appreciated greatly vis a vis the US dollar but not so much against other currencies.

    The petro dollar thesis is just as dangerous as the de-linking thesis-both breed complacency owing to fanciful thinking. A kind of thinking I might add that dovetails well with the ideological times: let the markets sort it out.

    As for oil prices. Who knows where they could end up. I will only note that APEC refused to increase output for fear of falling prices in the face of decreased demand. Also outside of Alberta there is more than oil prices leading the boom and in BC not at all.

    I have argued elsewhere that should the recession in the US be long and deep enough commodity prices will fall. Alberta and the lower-mainland may avoid a recession but it will not be enough to keep Canada treading above water. It would also have the perverse effect of inducing yet another massive migration West. This is speculative of course. What we do know is that Canada is in the midst of a intra-national de-coupling which present macroeconomic policy is only serving to exacerbate.

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