The Beauty of True Capitalism - Part 1: The Current Labor Market [2022]

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As someone with a robust knowledge of economics and a passion for translating that knowledge into practical insights, I am intrigued by the recent changes in labor market dynamics. Specifically, the labor market dynamics in a world that has faced a myriad of challenges over the last few years. Since I defended my thesis in August 2021, I’ve missed writing about econ + how the world is and ought to be. I’ve always loved thinking and writing about the world, so maybe I’ll start a blog one day. For now, I’ll stick to LinkedIn.

Anyway, here’s to the rest of 2022 and all the fun challenges it may bring! It seems to me that everyone is anxious about 2022 and those challenges, so here are some thoughts on labor productivity, wages, and a sprinkle of political and behavioral economics. I hope that everyone finds these posts insightful! For those more interested in market highlights, I've bolded some key takeaways. I've also included a conclusion section. As always, these are just my opinions.

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BTD

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The labor market is changing, there's no doubt about that. What is intriguing, however, is that some firms are adapting easily to the increased demand for labor, while some are failing to retain talent. Moreover, the intricacies of labor supply/demand are multifaceted. To understand these intricacies, one must consider the decision-making processes for firms (companies) and individuals (workers), both individually and collectively. In the terms of a general economic framework, here are my thoughts on how households and firms are making decisions within the current labor market context:

(1) In short, individuals (i.e., employees) are beginning to realize that the COVID-19 pandemic has increased the bargaining power of the current labor force. Firms are demanding labor at record highs, largely due to the “Great Resignation” phenomenon that has been pervasive in recent media. However, in terms of the long-run growth of the macroeconomy, I don’t think this is a bad thing. With great humility and caution, I think the labor market is performing extremely well. We just happen to be in a period of economic change and fluidity. There’s also evidence of record high levels of employee burnout, so firms must be aware of this when they develop flexible working models. But we won't know until we're on the other side of this mess.

(2) Principal-agent problem – This problem is exhibited in many areas of economics, including political and behavioral economics, and highlights the issues that arise when there are conflicting incentives between the "principal" and the "agent." The principal hires the agent to perform tasks, and the agent represents the principal. For example, the shareholders (owners) of a company would be the principal with directors acting as their agents. The same applies to the boss-employee relationship. If incentives between the boss and the employee aren't aligned, the result (output) will be less than optimal.

Relatedly, employees sometimes have an incentive to “shirk.” It is a classic economics assumption that rational individuals always try and maximize their own utility (overall benefit/happiness/etc.). Thus, it is reasonable to assume that if given the chance, employees will do less work than they are capable of. If they are able to "shirk" for the same pay, there's less of an incentive to perform to one's full productive potential.

On an aggregated basis, this can translate into lost revenue, higher OPEX/overhead, lower labor productivity, etc. Thus, “shirking” limits the productivity of employees and thereby the productive capacity of the entire macroeconomy. Fortunately, proper incentive plans can mitigate the principal-agent problem and shirking. If done correctly, these incentive plans can help firms retain talent and maximize productivity. If incentives are properly aligned, employees will be reasonably motivated to consistently perform. It is essential that employers find a way to minimize these problems, especially with the rise of flexible working models in which there is less monitoring.

(3) Flexible working models (remote, hybrid, etc.) are a huge benefit for working parents, part-time or full-time students, people with disabilities and/or mental illness, previously retired folks, etc. Therefore, you have this huge segment of the labor force that is suddenly more open to productive, well-paying jobs. That increases competition in the labor market, thus driving wages up and forcing employees to perform at a level sufficient to sustain that wage level. The latter is a theoretical guess, while the former has been consistently proven over the last few months. People are freaking out about inflation, but the economy is simply trying to adjust to some new “equilibrium.” Calm down everyone, the economy just needs a slight breather!

(4) But here’s the thing – I’m guessing that the economic benefits of WFH are just getting started. Though I’ve dialed back on my consumption of verbose and intricate academic articles, I’m sure that there are plenty of ambitious economists already diving into the data. Why? Because it may increase the productive capacity of all employees, not just those that have been incentivized to rejoin the labor force (see Thought #3). People may get more accomplished at home. Additionally, they can spend more time with their families, work from anywhere, and efficiently juggle all of life’s curveballs. Managers can jump on a quick call in between soccer practices. Directors can grind on some Excel reports when the occasional insomnia hits. On the supply side (i.e., the firms that demand labor from employees), the “cost of doing business” starts to decline. But be warned - Employees must be properly incentivized for this type of workspace to be efficient.

(5) These thoughts play into something economists call the “labor-leisure” decision. It’s basically the idea that employees have a limited production capacity – There are only 24 hours in a day, so time and resources are limited. That’s all economics is really, the study of logical decision-making in a world with scarce resources and unlimited wants (and often endangered – please consider limiting your consumption of animals, plastic, and other nonrenewable products – the economic and environmental benefits are enormous… #vegan #veganeconomist #sustainablecapitalism #sustainableeconomics).

Moreover, this means that some employees now have an unfamiliar decision to make: With the sharp increase in work-from-home jobs, are they willing to work more, or do they opt for more leisure and enjoy the time saved on their commute? Maybe it is the same as when they were in the office. Each individual has different preferences. Either way, this decision will be based on each individual attempting to maximize their utility. Of course, in an ideal world, people would have more money AND more leisure. Each individual must choose the optimal tradeoff for themselves. Therefore, they will maximize their earnings and their leisure subject to their preferences. That’s the labor-leisure decision. For example, workaholics would tend to opt for more labor (hours) and less leisure. Simple, right? At the microeconomic level, this labor-leisure tradeoff can prove valuable to both firms and workers.

This is the beauty of capitalism and the crux of my central theory from Thought #4 – Employees may be able to simply accomplish more at home than in a traditional office setting. If they are more productive, they can opt for more leisure (i.e., stop working after completing all tasks) or work more. If they opt for more labor (hours) while being more productive, presumably they will earn higher wages. However, it should be noted that wages are often "sticky," though it is reasonable to assume that this increased worker productivity would eventually lead to higher wages. Sticky prices take a while to adjust to supply and demand conditions.

If this "productivity shock," occurs, the macroeconomic effects would likely be substantial. This leads to increases in labor productivity, which translates into greater output/GDP growth. Conversely, the firm benefits because it can quickly adapt and provide value to the consumer and the shareholder. This “adaptability” is certainly valuable, even more during a highly volatile pandemic.

(6) One must also consider the cost of obtaining information about relevant job opportunities and the abundance of information readily available to job seekers. Coupled with the recent, substantial increase in bargaining power, employees are at a distinct advantage.

I enjoy my job thoroughly, but I would be lying if I said that I don’t see 80+ financial analyst postings in Nashville per week. And I didn’t see their compensation estimates. However, I have always been intrinsically motivated and MAPCO continues to challenge me to work in ways that constantly push my boundaries and understanding of this industry and its strategic initiatives. C-Stores are really cool right now! That's the academic truth in my eyes. I thrive on that and it’s my incentive for working hard and coming up with creative solutions to challenging problems. Maybe I’m an exception to the rule, but I think the above “job posting” observation is worth noting. It ties back to Thought #3, which detailed the inner workings of the current labor market, especially increased demand (and competition) for high-quality, productive workers. People don't always need money to work harder and more efficiently. Sometimes they need a little support/trust and some PTO when they are overworked. Other intangible benefits matter, such as the flexibility of WFH. Firms are having to compete at a historically unprecedented level for top talent.

(7) As a result of these exogenous shocks to the economy, workers have more bargaining power due to labor shortages. There is also increased demand for productive employees and steep competition in the labor market (and don’t forget the dual-edged benefits of flexible WFH models!).

All three of these mechanisms, among other things, are responsible for the sharp increase in overall compensation that the U.S. macroeconomy has experienced recently. As an individual who freely gives my labor in exchange for compensation (see Thought #5 for some conclusions on how the labor-leisure maximization decision has been changing), I think it’s crucial to educate my network on the unique opportunity that the COVID-19 recovery presents. At the end of the day, the employment contract between workers and firms is fluid and highly variable. When workers can efficiently deliver results while simultaneously having more free time, everyone wins! But more importantly, this conversation helps put current macroeconomic trends into perspective. If firms can find a way to harness the power of economics, incentives, and recent fluctuations in labor productivity, they can “win” the COVID-19 recovery period and deliver results to their consumers and shareholders. The cost to hire, retain, and train excellent talent is exorbitant right now, so firms must be agile and aware of the preferences and demands of the current labor market. As stated previously, workers have much greater bargaining power now. For employees, you are at an advantage! Show them you are worth the value that you bring to the table.

(Conclusion) And lastly, I don’t precisely know what’s going on with the macroeconomy or with individual firms. These are mere thoughts from a recent graduate student that likes to write and simplify economics into something logical and digestible. Economics is simply a framework for thinking about how the world works – If you’re not taking advantage of this type of critical analysis, reach out and I can point you in the right direction. Always down to “talk econ!”

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Thoughts?