Bloomberg Línea — US professor David Card, winner of the 2021 Nobel Prize in Economics for his studies into the labor market, believes it is almost “inevitable” that the US economy will enter into recession due to the monetary tightening cycle undertaken by the Federal Reserve.
In Card’s view, the effects of the interest rate hikes will likely not be as strong as in the 1980s, when the Federal Reserve, led back then by Paul Volcker, raised interest rates to a record 20% a year to combat inflation. Even so, the hike this time around will likely cause a slowdown in economic activity, with effects even for the real estate sector, one of the most important sectors in that country’s economy.
“Basically, the only way for them [the Fed] to cool the economy is to reduce activity in the interest-rate-sensitive sectors. For example, construction and the durable goods industry. And that’s going to hurt,” Card said in an interview with Bloomberg Línea during his visit to São Paulo for an event organized by Insper.
“In the worst-case scenario, if China’s economy goes off the rails, the war in Ukraine escalates, and Russia blocks oil exports, the Fed would raise interest rates and the economy would collapse. Then we would have a very serious situation,” added Card, who is a professor at the University of California at Berkeley.
One doubt economists have is regarding the labor market.
Card notes that the number of vacancies is much higher than what would be expected for the current level of unemployment in the country (3.7% in August). The trend, he says, is for a correction as the economy slows.
“One can say with some confidence that those vacancies will not persist at this level. It seems a little unrealistic. As soon as companies stop selling at the same levels as they do now, they will stop hiring,” said the Canadian-born, naturalized American economist.
Who is David Card?
There are researchers who challenge conventional thinking and prove in their research that the academic consensus was wrong. David Card has done this not just once, but twice.
Card is recognized for a study published in the 1990s on the effect of minimum-wage increases on jobs.
Contrary to what economists believed at the time, Card and his colleague Alan Krueger, who died in 2019, demonstrated that such adjustments do not lead companies making layoffs to readjust costs, which would cause unemployment to rise.
It was not just the results that caught observers’ eyes, but the way the research was conducted.
Card and Krueger were two of the pioneers in using so-called “natural experiments” in the field of economics, that is, when the effect of a certain measure on a group of individuals under real conditions is studied.
Card and Krueger analyzed the impact of raising the minimum wage in New Jersey in 1992 relative to the neighboring state of Pennsylvania, which kept the minimum wage at the same level.
The second research that marked Card’s academic career was also a natural experiment. But in this case, the economist analyzed the effects of the sudden arrival of 125,000 Cuban immigrants to Miami in 1980, during the so-called Mariel boat lift, when the government of then-president Fidel Castro allowed people who wanted to leave the island nation to leave.
The immigrants’ arrival led to a 7% increase in Miami’s labor force. But Card found that the huge influx of people did not cause wages to fall in the region or raise the unemployment rate among low-skilled people already living in Miami.
This contradicted the common understanding that immigration causes job losses for locals.
Over the years, the economist has specialized in labor market studies and made important contributions to public policies to improve education and reduce inequality.
In one of his research projects, Card and his colleagues analyzed the wage gap between whites and non-whites in Brazil. They concluded that two-thirds of this discrepancy can be explained by educational levels, but one-third corresponds to the way companies choose professionals and end up giving preference to white workers.
In a recent study, Card and other researchers concluded that girls who were taught by more female teachers during childhood tend to be more successful during their lives, more likely to go to college, have higher incomes and live longer.
Recession: An alert for younger people
In the interview with Bloomberg Línea, Card said a US recession could have a negative effect especially for younger people entering the labor market.
The following interview has been edited for length and clarity:
Bloomberg Línea: There has been a recovery in the labor market since the most critical period of the pandemic, but the level of labor force participation remains below the pre-Covid level. What does this say about the health of the labor market?
David Card: There are a couple of factors that have led to this reduction. One is that the labor force is aging very rapidly in the United States. That may explain some of the downward trend. The other thing that seems to be happening is that there is a large group of workers who have experienced burnout during Covid. For example, healthcare workers, some teachers, drivers and train drivers. They had to work long hours. I think we are seeing something related to that. And actually, there is a very interesting analogous situation.
After World War II, the same thing happened. A large number of people were working long hours, and after the war there were a series of strikes, because people felt that they couldn’t continue working in that way. The labor force diminished. There is a combination: some people had to work much harder during Covid, and others were out of work. And those who worked too hard needed to take a break. That’s part of it.
Now we are seeing a rise in interest rates in the United States and the risk of a recession. What could be the consequences for the labor market?
I honestly think that we are heading for a recession. It is almost impossible to imagine that we are not going to have a fall [in economic activity]. I believe that the Fed is going to have to raise interest rates a lot. And that’s basically all they can do [to fight inflation]. And it’s almost inevitable. Basically, the only way they can cool the economy is to reduce activity in the interest-rate-sensitive sectors. For example, construction and the durable goods industry. And that’s going to hurt.
How much will it hurt?
I assume it won’t be as bad as in 1982, when Paul Volcker raised interest rates. But there is a problem. Europe is likely to go into a major recession. And the situation in China is very uncertain. Much of the demand for goods in the world comes indirectly from Chinese demand. This is an unknown: how China’s slowdown will influence the world economy.
In the worst-case scenario, if China’s economy goes off the rails, the war in Ukraine escalates, and Russia blocks oil exports, the Fed would raise interest rates and the economy would collapse. Then we would have a very serious situation. My specialty is not macroeconomics. But this is my vision.
And as for the labor market, what kind of consequences do you expect with the raising of interest rates?
A lot of job losses. That almost always happens. It’s very hard on people who are entering the labor market. When there is a recession, younger workers - if they get any work at all - end up being put into not very good jobs. And experience shows that it takes something between five and 10 years to recover that loss. It is very bad.
Also, one sector that ends up being very affected is the residential real estate market. Because people depend on mortgages. In the 1980s, when I bought my house, interest rates were between 9% and 10% a year. But we haven’t had rates at those levels for decades. This is going to cause a big adjustment. Presumably, one of the effects is that house prices tend to fall. And that takes a long time to happen. This could be another source of adjustment.
You mentioned in your lecture at the Insper event that good companies stop hiring during periods of recession. Is this already happening?
I don’t think so. The data we have on the supply of vacancies is updated every quarter. But people think that the demand [for workers] is still quite high.
But there is something that is way off. There is a graph that economists use that has the unemployment rate on the x-axis and the job supply rate on the y-axis. It’s called the Beveridge Curve. The point where we are now doesn’t look like it belongs on the same graph. The number of open positions is very high. Some companies are still advertising vacancies.
There is an interesting aspect to this. In a way, companies are managing to pass on their cost increases and wages have not kept up with inflation. In a way, this is good for employers. Companies say, ‘okay, let’s hire this person’.
Can salaries recover the loss from inflation?
They won’t. This is a one-off, one-time reduction in real wages, of something like 10%. It will take a decade to move back. That’s my view. There are some people who have managed to have a wage gain. But for almost everybody, there has been a loss.
Do you see a possibility that the recession will occur without the unemployment rate rising so much because of the large number of vacancies?
The number of vacancies will show different behavior. A company can publish a vacancy and decide that they are not going to hire. They can stop hiring in a matter of seconds. We see companies announcing this all the time. Some in the technology sector have said this: they have open positions, but they are not going to hire.
And we don’t have a very long history of data about open positions. Only since the 2000s. Their behavior is kind of hard to predict. I think we can say with some confidence that they will not persist at this level. It seems kind of unrealistic. As soon as companies stop making sales at the same levels as they do now, they will stop hiring.
Translated from the Portuguese by Adam Critchley