Michael Hicks: What is happening to labor supply?

Several readers have asked what is happening in labor markets, and why it is so difficult to find workers. That’s a common concern in the post-COVID world and is worthy of a deep dive into labor market data. The Indiana experience is similar to many states, but with a few notable twists.

Indiana’s labor force has yet to recover from the COVID downturn. Both the supply of labor and our labor force participation rate are below 2018 levels. Indiana’s economy peaked after the Great Recession in 2018, as the ‘Trump Tariffs’ began to slow the demand for manufactured goods. As of the end of December, the state had 3.4 million available workers, of whom 3.2 million were employed.

That yields an unemployment rate of 3.1%, which is well below average and near a record low. However, labor markets have been worsening since spring, when the unemployment rate was just 2.2%. Still, for most employers across the Midwest, labor markets are tighter than they’ve been for all but a few months out of the past 40 years. It should be no surprise that many businesses are frustrated at the inability to find the workers they wish to employ.

However, wishing to employ someone is not the same as labor demand. A ‘help wanted’ advertisement isn’t a job in the same way that a worker asking a salary that no one will pay is not a job. It is a simple, straightforward fact that wages are the element that matches labor demand and labor supply. Both workers and businesses must acknowledge that fact, which has a beautiful symmetry. Workers who cannot find a job are asking wages that are too high. Businesses that cannot find workers are offering wages that are too low.

Of course, both businesses and workers can do other things to influence the wage rate that will satisfy their needs. Workers can obtain skills and education to improve the wages they might expect in a labor market. Businesses can improve their working conditions or fringe benefits. But, for prospective employers and employees alike, it is useful to know how many other folks remain in the available pool of workers. Fortunately, the Census has been asking a series of questions about that. We now have the best-detailed answers yet available about reasons for not working.

As of last month, there were 1.7 million adults over 18 not working in Indiana. Of these, 47.3% were retired. A full 22.4% either were ill (both COVID and non-COVID) or concerned about becoming ill from COVID. I was surprised that 23,360 were sick with COVID or caring for someone who was sick. That, along with more than 25,000 deaths, make the disease a persistent drag on the state’s economy. Death and illness from the disease continues to erase more than a year of average employment growth in Indiana.

Childcare and elder care duties accounted for a full 16.2% of unemployment in the non-retired population, amounting to more than 146,000 folks. A further 23,600, or 2.6%, reported no access to transportation for work. Traditional labor market frictions accounted for a full 10% of the unemployed. This comprised workers who’d been laid off or worked in a firm that went out of business or closed temporarily. That number is very close to the overall 3.1% unemployment rate. The survey didn’t ask if the worker was fired or quit.

A full 111,000 workers failed to answer the question in the Census survey. That is a large share of potential workers. Another 258,000 gave some other reason for being unemployed. All told, that means there are nearly 370,000 workers unemployed for reasons unknown to us. That is just about 7.5% of all adults over 18 in the state of Indiana. So, what are they doing if they aren’t working?

The best guess is that they are working, just not in the formal economy. Our statistics only provide reliable data on the number of ‘official’ employees. We undercount both sole proprietors and people who work in the informal economy—or the ‘shadow economy’ as it is often called.

The shadow economy is estimated to be as much as 12 or 13% of the U.S. economy. Most of the workers in the shadow economy engage in perfectly legal activities. Cleaning a home, babysitting or providing childcare duties, sitting with the elderly, and doing home improvements are all honest jobs. A large share of workers who do these tasks do so without reporting income.

To be clear, not reporting income from work is itself tax evasion. Together, the employer and employee fail to pay payroll taxes for Social Security and Medicare. This activity dodges income taxes, and in some cases worker’s compensation and sales tax. The reasons for engaging in the shadow economy are obvious. Payroll taxes alone account for just under 15% of a wage’s transactions. Administratively, part of this is paid by employers and part by employees, but the incidence falls on both.

The overall shadow economy is not terribly large, and much of it would not exist if it were forced to follow the formal economy rules. So, it isn’t clear that forcing the shadow economy into the formal economy would make anyone better off, but it does represent a pool of available workers. There are two paths to do so.

First, as a state government, we could ease the pathway of many workers into formal work. This would necessarily mean cutting the cost of complying with the rules we set for a formal economy. This could be done by setting minimum income thresholds on some types of taxation, or by easing occupational licensing rules. However, Indiana is already leading the nation in both of these areas, so any policy changes here would have only minimal effects.

We could also expand the state Earned Income Tax Credit. The EITC was proposed by Milton Friedman, the well-known free-market economist, as a tool for incentivizing work and reducing poverty. Thirty states have an EITC, including Indiana, though ours is among the lowest of participating states. Increasing the EITC would incentivize more workers to report their earnings, thus qualifying for higher tax credits for their work.

The other method of accessing these workers is for businesses to offer a work environment and wages that would lure them into the formal economy. That only makes sense for a business if the revenues generated by the new worker exceed their cost. If that is not the case, businesses will have to do without the new worker. With labor markets historically tight, I expect that dynamic to be common for many years.

Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball Distinguished Professor of Economics in the Miller College of Business at Ball State University. Send comments to letters@dailyjournal.net.