About the author: Julia Pollak is chief economist at ZipRecruiter.
From August through October this year, inflation appeared destined for a sustained decline, with wages growing at an annualized rate of just 3.8%. But the latest jobs report handed us not only a reversal of that trend, but also upward revisions for the prior two months of data. With the revised numbers in place, wages now appear to be growing at an annualized rate of 5.7%!
Wage growth above 5% would make it hard for the economy to return to the Federal Reserve’s 2% inflation target any time soon. That is because the major factor driving inflation now is the rising prices of services, which are still climbing because of the increase in labor costs. Labor shortages are compelling employers to pay up for talent, and data from the recent jobs report show that labor force participation, far from recovering to its pre-pandemic strength, has declined for three straight months.
The dynamic between wage growth and the Fed has understandably spooked markets, as they process the likelihood that interest rates will rise above 5% and stay there for longer, devaluing stocks and houses, reducing job creation, and triggering a recession in 2023. The Fed’s latest economic projections, released Wednesday, show its policy makers expect rates to peak at 5.1% next year. Even after the better than expected November CPI report, many observers still worry about the possibility of a wage-price spiral.
Since the Federal Reserve’s anti-inflation medicine of raising interest rates can have such unpleasant side effects, it falls on the White House and Congress to explore alternative remedies. Inflation is, after all, a solvable problem and Washington has tools at its disposal that it is not yet using.
A Marshall Plan-style blueprint that Congress should consider would be aimed at reducing the inflation-igniting gap between demand and supply, not by reducing demand for goods and services (as interest rate hikes are intended to do), but by growing their supply. Initiatives in this vein could include reducing barriers to the domestic production of everything from oil and microchips to farm goods, encouraging strategic investments that increase supplies of electricity and water, and influencing state and local governments to expand the supply of housing. But the most important component of such a plan would be a package of policies designed to increase the supply of labor.
Here are some key policy options for stimulating labor supply that enjoy bipartisan support and could conceivably make their way through the Washington, D.C. policy gauntlet:
- Permanently expand the earned-income tax credit. The EITC is the largest need-tested antipoverty program that provides cash to families, mostly to workers with dependent children. But unlike many welfare programs, it neither replaces nor discourages work. Research has found that the EITC increases labor force participation, particularly among single mothers. Permanently expanding the EITC to workers without children might similarly encourage work among these individuals.
- Expand sectoral employment programs. Sectoral employment programs are training programs that target low-wage workers and combine upfront screening, occupational and soft skills training, and wraparound services. Research has found that these programs generate consistently large, positive impacts on worker employment and earnings. They do so by reducing employment barriers for nontraditional workers, increasing credential and certificate attainment, providing pathways for workers into better jobs, and expanding the supply of qualified candidates available to employers.
- Expand access to paid family leave. A bipartisan group of Washington, D.C. scholars has proposed a compromise plan that would provide eight weeks of paid parental leave, replace 70% of wages, and offer job protection, fully funded by a combination of payroll taxes and budget savings. Research shows that paid family leave increases employment rates by making workers much less likely to quit their jobs for family reasons, ensuring greater job continuity and labor force attachment. These positive employment effects are particularly large for mothers. Research finds that the lack of paid family leave in the U.S. is a major reason why women’s labor force participation has been dropping in the U.S. despite growing in other developed countries.
- Streamline occupational licensing across state lines. An estimated one in four occupations require a license, with the states determining the number of hours of education and experience workers need, what kind of exams need to be passed, what fees applicants must pay, and what past arrests, convictions, or other behaviors are disqualifying. These requirements can prevent people from working legally or performing their jobs across state lines, but there are many solutions that can improve participation and mobility, such as interstate licensing compacts, reciprocity agreements, and so-called universal licensure laws. Many state governors have embraced such reforms in recent years, and those efforts could conceivably build momentum with a boost from the White House.
- Expand legal and skills-based immigration. The foreign-born population in the U.S. is now below the 2010-2019 trend by about 2 million. That decline is the combined effect of Trump administration immigration policies and a pandemic-induced halt in embassy and consulate operations. Although immigration is the lever that could produce the largest and swiftest increase in labor force participation, I have listed it last because each bipartisan compromise immigration reform proposal advanced in recent years has been dead on arrival in Washington. The broad contours of compromise plans have been similar: expanding the number of immigrant visas granted each year while simultaneously expanding efforts to curb illegal immigration, replacing random lotteries and family-based admissions criteria with skills- and merit-based criteria, and providing a path to citizenship for about 1.8 million immigrants brought to the U.S. illegally at a young age.
Arguably, Congress also has better tools than the Federal Reserve’s monetary policy to reduce demand for goods and services, should that be necessary to tame inflation. Congress can reduce the deficit and raise select taxes, which could be deployed in a more targeted and less economically harmful way than interest-rate increases. But the opportunity to expand American production, innovation, and economic mobility—and quell inflation in the process—could be an even cleaner win-win for politicians and for the economy.
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