Below is a complimentary Demography Unplugged research note written by Hedgeye Demography analyst Neil Howe. Click here to learn more and subscribe.

Be sure to check out his highly anticipated new book, The Fourth Turning is Here, which is now available for purchase.

ICYMI: 'Signal & Noise' is a new feature from Demography Unplugged. This column from Neil will be published biweekly.

Neil Howe: Labor Supply. Signal & Noise - 03.10.2017 rate hike

I hope you had a happy Labor Day. In deference to the vacation spirit, I will (try to) keep this note short. Besides, I am using this holiday to move my family to a new location: from the DC exurbs in Virginia to the mountains of West Virginia. I will be busy. Wish me luck.

Meanwhile, now that we’ve had a day off, let’s spend some time really thinking about labor.

Labor—and the seemingly inexhaustible supply of it—appears to be the common theme in all macro commentary over these last several months. In Q1 and Q2 of 2022, the U.S. economy underwent two massive shocks. The monetary shock was Fed chairman Jerome Powell’s boosting of the Fed Funds interest rate, its steepest vertical ascent since the chairmanship of Paul Volcker 43 years ago. The fiscal shock was the lapsing of the U.S. Treasury’s various pandemic stimulus programs, causing the federal deficit to shrink by 12 percentage points of GDP in a mere three quarters. You’d have to go back even earlier, to 1946 (the demobilization following World War II), to find a precedent for this hit.

Either shock alone, economists thought, should be more than enough to push the economy into recession. The two together? It was a dead cinch.

As if to oblige the economists, most of the long-term recession indicators began blinking red later in 2022: the yield curve inverted badly; M2 and credit plunged YoY; consumer expectations and small business optimism sunk. Early this year, many of the medium-term indicators have also gone critical, especially in the manufacturing, housing, and construction sectors.

Nevertheless, as we’ve all seen, the economy keeps chugging ahead—economists be damned. And the explanation seems to be an endless supply of employment. Every month, it seems, more workers get hired, those workers spend, firms make money, and the next month those firms hire yet more workers. Who knows where it may end? For Q3, the Atlanta Fed is forecasting a blistering annualized GDP growth rate of nearly 6%. Absent some productivity miracle, that means (you guessed it) yet more workers are coming on stream.

While I don’t think we can say that the recession indicators have been proven wrong, it is fair to say that they haven’t worked as rapidly as most economists last year thought they would. And that’s because we’ve been able to hire so many people. In 2021, U.S. employment grew by an astonishing +6.21M. Then in 2022, it grew by another +3.16M. And then in 2023, by another +2.24M.

Neil Howe: Labor Supply. Signal & Noise - USemploymentgains

Which should prompt us to ask a rather simple question: Where are all these new workers coming from?

Our first answer to this question might be that we have still been recovering from the pandemic. And sure, that may have been true for most of 2021 when we were still recovering from the pandemic-induced joblessness. But by the end of 2021, the pandemic was pretty much in the rearview mirror. By December 2021, the employment/population ratio had already reached 59.7%. Today, twenty months later, it isn’t much higher. As of August 2023, it is 60.4%. That’s an increase of a mere +0.7%, which translates into an employment increase of only +1.87M. I say “only” because over the course of 2022 and thus far in 2023, the economy has added +5.40M jobs. (See again the numbers in the previous paragraph.)

Since the end of 2021, in other words, pandemic “recovery” only explains about one-third (35%) of all job growth.

This being America, we might think the most obvious place to find all the other new jobs would be that old standby: population growth. To be sure, population growth is still happening. Yet as many of us are coming to recognize, the quantitative impact of such growth in the United States is shrinking fast—and may, in time, turn negative, just as it already has in much of Europe and East Asia. Today, the very large Boomer cohorts (born in the late 1950s) are now retiring and exiting the workforce. And only the relatively small late-wave Millennial cohorts (born in the early ‘00s) are entering the workplace to replace them. Are more youngsters entering than oldsters leaving? Yes, but only barely.

Let’s try to quantify this replacement. Today, about 4.1M Americans are reaching age 65 each year. This number has been slowly growing in recent years; it will peak at 4.2M in 2026 (the 65th birthday of the massive 1961 birth cohort) and then slowly decline. Clearly, retirement is a complex process, different for every person. But given that the average age of Social Security “retirement” is currently 65 (the median is 64), let’s assume as a stylized fact that this represents the number of Americans leaving employment each year. We can ignore gradual changes in the average retirement age. While Americans over the last couple of decades have been retiring a bit later each year, there is some evidence that, since the pandemic, they have been retiring a bit earlier. In any case, such changes happen too slowly to matter over a couple of years.

Meanwhile, entering employment at an average age of 20 (again, it doesn’t really matter exactly which age we choose) are Americans born in 2003. With about 4.4M now turning age 20 each year, these cohorts are only slightly larger than the Boomer cohorts they are replacing. This number will rise a bit until peaking at 4.6M in 2027 (the 20th birthday of the 2007 cohort, the largest yet born in U.S. history) and then gradually decline in future years in line with the falling U.S. total fertility rate. Let’s be generous and assume that each year there are 400K more younger workers coming on stream than the retirees they are replacing.

Bottom line: This margin of demographic growth no longer amounts to much. It represents only 33K more working-age Americans per month. Optimistically assuming that three-quarters of them are actually employed, that aggregates to only about 500K net new workers over the 20 months that have transpired since the beginning of 2022. So it explains less than 10% of the 5.4M new jobs we’re trying to account for.

To be sure, I’m simplifying for the sake of clarity. There are further dynamics that could be added for the sake of accuracy. For example, the retirement of Boomers, and their replacement (in midlife: age 45-64) by smaller Gen-X cohorts, has recently pushed down the average age of workers. In so doing, it has pushed up the employment rate of the working-age population—since early retirement due to disability rises steeply after age 45. This explains the oft-heard remark that “prime-age workers” have now hit their highest labor force participation (LFP) rate since before the Great Recession. (It’s due to the unusually low average age of these prime-age workers.) And it does no doubt slightly increase employment, given the same population-wide employment rate, through a composition effect. But again, the effect is gradual. It’s nowhere near large enough to generate the tsunami of new jobs that America has recently been experiencing.

OK, so about half of all the new jobs can’t be explained by rising participation rates, nor by what demographers call “natural increase”—that is, by births minus deaths (or by youth hires minus retirements). What’s left? Clearly, something exogenous to our population. What’s left, in other words, is immigration.

Surprisingly, other than a recent story by Emily Peck in Axios and a research report last winter by the San Francisco Fed, the dominant role that immigration is playing in the current U.S. recovery has been neglected. Here’s most of what you need to know, thanks to our monthly CPS employment survey (administered by Census on behalf of BLS) which includes a question on whether the worker “is” or “is not” born in the United States.

Neil Howe: Labor Supply. Signal & Noise - emplmntLevel

One reason this story has been so long neglected is that it runs contrary to the main storyline that prevailed during the last two years of the Trump presidency and during much of the first (pandemic) year of the Biden administration.

That story was all about falling immigration, thanks first to Trump’s blustery anti-immigration rhetoric and executive orders, and later to the pandemic crackdown on cross-border traffic of all kinds. After peaking at 27.8M in late 2018 and early 2019, the number of foreign-born workers gradually declined until April 2020, when the pandemic struck and the number plunged by nearly a third in the next couple of months (more than among native-born workers) to only 22.0M. Typically, immigrants were the first to be laid off. Some waited out the famine. Others, realizing they were ineligible for benefits, fled back home.

Since the early fall of 2020, however, the trend in foreign-born workers has been almost nonstop positive. By early 2021, they had regained most of their numerical loss. By November 2021, they had exceeded their pre-pandemic highpoint—both in absolute numbers (27.9M) and as a share of U.S. employment (17.7%). Thereafter, the surge continued. Today, as of August 2023, there are 30.8M foreign-born workers comprising 18.8% of U.S. employment.

Keep in mind that the rapid rise in the foreign-born share of U.S. employment is driven not only by the strong incoming tide in net migration numbers. It’s also driven by the strong desire of these newcomers to work (an estimated 77% are between ages 18 and 64, versus 59% of native-born Americans). And it’s driven by the declining demographic growth rate in native-born workers.

How important is this newcomer inflow in sustaining current economic growth? The following chart should help answer this question.

Neil Howe: Labor Supply. Signal & Noise - gains2.0

The upper line tracks gains in total employment, as before. The lower line tracks gains in total employment excluding foreign-born workers. In 2021, just to simplify the arithmetic for you, 36% of the total gain was due to foreign-born workers. In 2022, it was 46%. Thus far in 2023, it has been 57%. So, if you’re seeking an explanation for where the missing 50% (more or less) of all employment gains have been coming from, look no further. This is it.

It makes sense that these percentages would rise over time. Early in the recovery, a lot of new jobs went to native-born Americans going back to work. But as the LFP rate began to approach its pre-pandemic level, the native-born momentum slowed. Since March of this year, indeed, America’s LFP—properly adjusted for its changing composition by age bracket—is high enough to make us wonder whether it has much upside left. It is now equal to its last cycle highpoint of February 2020, and it’s nearly one percent higher than it was during CY2007, its prior cycle highpoint. But a lofty LFP doesn’t do anything to slow down job growth by immigrants, for whom the prospect of getting hired in America (rather than where they came from) remains as attractive as ever.

The sizeable recent inflow of immigrant labor may shed light on the initial puzzle we set out to solve: namely, why the conventional economic indicators “overpredicted” the next recession. Notice in the above chart what job growth would have looked like (the red line) had new foreign-born jobs not been added. Most of 2022 would have shown steady job losses. Ditto for most of 2023. There were actually more native-born workers gainfully employed in January (7.0M) than last month in August (6.6M). Translation: The indicators did correctly predict that the economy would hit a brick wall—absent immigration. What it didn’t predict was the immigration.

So what does all this mean moving forward?

The good news is that this steady worker inflow continues to be America’s best hope for continued GDP growth in defiance of the indicators—and Fed Chairman Powell’s best hope for a “soft landing” in defiance of all the economists who told him it was unlikely.

The bad news is that immigration is no panacea against recession. Such is the clear lesson of U.S. economic history, which spans many decades in which net immigration rates were considerably higher than they are today. Even with lots of new workers, a buoyant economy can cycle down: Labor markets heat up, job growth decelerates, consumers get jittery, credit tightens, wages outgrow prices, earnings get squeezed, and investors begin to unload equities. With or without immigrants, it’s an old story.

In one respect, moreover, large cross-border migration flows may act like an unbalanced flywheel to accentuate the boom-and-bust lurching of the economic cycle. Just as a hot economy can, by pulling in more labor from outside, keep the good times rolling for longer, so too can a cooling economy, by reversing the direction of the migrant flow, make the bad times harder to shake off. Not only can new immigrants stop arriving, but many recent immigrants can and do reverse direction and head back home.

We don’t have precise data on this phenomenon, but we can get a sense of how it works by looking back at our second chart, where we can see that the number of foreign-born workers sank during the GFC and did not regain its 2007 level until 2013, five years later. The same negative swing happened during and after the 2001-02 recession, when net immigration rates were actually higher than they are today. And of course don’t forget the Great Depression of the 1930s, which started after a decade (the 1920s) in which net immigration rates were lower than they are today. Still, it is worth noting that—to this day—the 1930s remains the only full decade in American history in which the net immigration rates were actually negative (that is, emigrants outnumbered immigrants). Sure, it is possible to fire up a recovery in an economy that is steadily losing workers. But no one, I think, would argue that this makes it any easier.

Finally, let’s not neglect what impact this unbalanced flywheel may have on politics—since politics has a way of boomeranging back on the economy. Even with the economy running at full employment, the Biden administration knows that its failure to provide “border security” is a big liability with voters and that public support for “decreased” immigration has risen to a nine-year high. This fall or winter, with the 2024 election season approaching, Team Biden will feel increasing pressure to stem the inflow. The pressure will be doubly strong if the economy appears to be tipping into a recession, since everyone knows that public outrage over immigration surges during and just after economic downturns.

Earlier this summer, Biden hoped he might improve the public’s perception of his performance on immigration by introducing new penalties for individual border-crossers along with new “legal pathways” for a very sizeable stream of asylum-seekers (now 45K per month from Mexico plus another 30K per month from Cuba, Venezuela, Nicaragua, and Haiti). Initially, the new policies seemed to be working. Though they did not slow the total flow of undocumented immigrants, they did succeed in keeping them away from the nation’s borders. From May to June, the number of illegal border crossings dropped by -70%, plummeting to its lowest level since February 2021 at the height of the pandemic.  (See our close coverage of these policy changes: “Post-Title 42, Biden Tries a Carrot-and-Stick Approach,” “New Asylum Rules Slow Border Arrivals—For Now,” and “The War Over Immigration is Being Waged in Court.”)

More recently, however, Biden’s complicated reforms seem to be backfiring. Asylum-seekers are indeed maxing out on the legal pathways, but those who can’t take advantage of them are crossing borders again. Now, it appears, they are taking advantage of a weakness in Biden’s post-Title 42 regime: Biden’s DHS still cannot or will not indict or deport two or more people who arrive claiming to be families. Instead, most are released within the U.S. and put on a years-long waiting list for an asylum hearing. Predictably, monthly border crossings by families are now skyrocketing, hitting 91K in August (according to an early report published in The Washington Post), which if true would be the highest month ever.

My bet is that Biden will tighten the labor inflow in the coming months in an effort to make himself more electable next year. (Already, DHS is hustling to complete “rapid deportation” centers for migrant families in 40 cities.) If, as seems likely, we enter a recession sometime in the next six or nine months, he will tighten even more—even though, in a recession, the inflow will no doubt diminish of its own accord. At the same time, just when the economy is weakest, Congress will no doubt see fit to start chopping outlays.

We can count on policymakers to decry the timing of such moves as dismally wrongheaded. But don’t forget: The political cycle, like the business cycle, also has its own rhythm—economists be damned.

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Neil Howe is a renowned authority on generations and social change in America. An acclaimed bestselling author and speaker, he is the nation's leading thinker on today's generations—who they are, what motivates them, and how they will shape America's future.

A historian, economist, and demographer, Howe is also a recognized authority on global aging, long-term fiscal policy, and migration. He is a senior associate to the Center for Strategic and International Studies (CSIS) in Washington, D.C., where he helps direct the CSIS Global Aging Initiative.

Howe has written over a dozen books on generations, demographic change, and fiscal policy, many of them with William Strauss. Howe and Strauss' first book, Generations, is a history of America told as a sequence of generational biographies. Vice President Al Gore called it "the most stimulating book on American history that I have ever read" and sent a copy to every member of Congress. Newt Gingrich called it "an intellectual tour de force." Of their book, The Fourth Turning, The Boston Globe wrote, "If Howe and Strauss are right, they will take their place among the great American prophets." The follow-up book, The Fourth Turning Is Here, is available now.

Howe and Strauss originally coined the term "Millennial Generation" in 1991, and wrote the pioneering book on this generation, Millennials Rising. His work has been featured frequently in the media, including USA Today, CNN, the New York Times, and CBS' 60 Minutes.

Previously, with Peter G. Peterson, Howe co-authored On Borrowed Time, a pioneering call for budgetary reform and The Graying of the Great Powers with Richard Jackson.

Howe received his B.A. at U.C. Berkeley and later earned graduate degrees in economics and history from Yale University.