I had an undergraduate professor who once tasked me with finding any scholarly linkage between the established price of labor (as the minimum wage) and inflation. From the layman’s perspective, it would make sense that increasing the price of an input (labor) would, in turn, increase the price of the output, whether it be a meal, or a consumer good, or a service. “It has to be a cited source that uses research to come to the conclusion that an increase in the minimum wage will therefore increase inflation.” These measly search parameters, however, yielded nothing. At the time I remember going over every document I could get my hands on, to find that not a single one would claim to make this linkage. While I didn’t expect to be inundated with options, I still expected…something. The labor market is too voluminous and too distinct from other inputs to have a direct impact on inflation. This was a perfect foray into how the labor market as a whole can operate.

One of the more influential thinkers in this sphere was economist George Stigler, who wrote extensively about the minimum wage and the idea of “search friction”. From the Mercatus Center — as pointed out by Stigler, the purpose of the minimum wage legislation—the elimination of poverty—is not seriously debatable; but the important question is if indeed the legislation fulfills this purpose. Stigler concludes that a minimum wage does not satisfy its original intentions, and will tend to increase unemployment and reduce family income; his conclusions have been supported by subsequent empirical research and these results leaded to a virtual professional consensus in the late 1960s that a minimum wage is a poor anti-poverty devise. However, recent studies have relied in the idea that if the labor market is not competitive but present characteristics of a ‘company town’, a minimum wage set at the competitive level would increase employment and the efficiency of the economy.

This idea of a set labor market ties in with another one of Stigler’s key findings, which was around this concept of search theory, or “search friction”. He argued that the “one wage” rate (a labor price f equilibrium for each sector of work dependent on perfect mobility and zero search cost), would only occur where there is no cost for information about wages offered or thought. Remember— a motif here is that no market can operate at 100% efficiency when there is a mismatch in information between the parties involved. In the labor market, where jobs are all different, and contain their own requirements, searching has a cost. The greater the search costs, the wider the range of wages for a similar job will be. People looking for work realize that wages vary between employers and have to determine the breadth and depth of their job search accordingly. Stigler’s research showed that to conduct an optimal job search, workers should reject any wage lower than their bottom line (i.e., “reservation wage”), but accept any offer above it.

Which brings us to today, where as of May of 2021 the Biden Administration has begun to push for a return of work requirements for unemployment recipients. This acknowledgement by the Administration plays into the recurring headline of the hour, which are reflecting the difficult time employers are having finding workers (particularly small businesses and service industry positions).

In the context of the Biden Admin’s push, what does it mean if we push people to search for and take jobs they are often not suited for, or over-qualified for, or do not want, only to end up with a lower net worth than before? What inefficiencies does this expose?

Let’s think of a basic economic model that assesses labor supplied (i.e., the workforce) and the cost of labor (i.e., wages). We established earlier that the labor market is more nebulous and multi-faceted than other inputs (such as the cost of raw materials), but we can still examine the nuances of the market holding all else constant. What we’re examining is an increased demand for labor (particularly what is called unskilled labor). As the demand for labor increases, the cost of labor also increases.

What is illustrated here is the dissonance between the value generated by labor (in the form of productivity), versus the value of labor itself (in the form of wages). This continuing effect has long disenfranchised many workers, with the knowledge that both their output has increased and their compensation has lower purchasing power than it did some 30-40 years ago. This newfound increased demand for labor has put this issue on the forefront, with people simply not lining up for the same low-paying positions they were prior to the pandemic. On top of the fact that for many it can be too expensive to work, the labor market has begun to demand a “new equilibrium”, so to speak, between labor supply, demand, and labor value. To apply this to the current scenario: there is an increase in demand as employers begin opening back up, only to find an influx in labor demanded and, for some, an increased cost.

An NBC headline from April of 2021 summarizes the current situation very well — “There are now more jobs available than before the pandemic. So why aren't people signing up?”. The article continues on to state that job postings plunged from 10 million before the start of the pandemic last year to just below 6 million this past May, as lockdowns forced businesses to close and reduce their workforce. Now, as vaccinations increase and companies are again able to make projections, they’re staffing up to capture booming demand, with the number of open positions across all online listings soaring 5 million above the pandemic’s start.

This coincides with a jump in the Employment Cost Index, which hiked 0.9% for Q1 2021 after gaining 0.7% in Q4 2020. That lifted the year-on-year rate of increase to 2.6% from 2.5% in the Q4. The Employment Cost Index is widely viewed by policymakers and economists as one of the better measures of labor market slack and a predictor of core inflation as it adjusts for composition and job quality changes. Economists polled by Reuters had forecast the ECI rising 0.7% in Q1 of 2021. Wages and salaries shot up 1.0% after advancing 0.8% in the fourth quarter. They were up 2.7% year-on-year. Economists expect wages will increase further in the second quarter as companies compete for scarce workers.

While the under-compensation of labor in the US is nothing new, the current labor gap shows front-and-center the effects of a sub-optimal labor market. Note that, while this is occurring across many different employment sectors (while being focused on “unskilled” and service jobs), these types of gasps in labor supply and increases in labor demand occur in striations across the entire workforce; where one sector in one area is affected, a similar sector in a similar area might not be. Heidi Shierholz from the Economic Policy Institute embellishes on this further, “One reason is that in a system as large and complex as the U.S. labor market there will always be pockets of bona fide labor shortages at any given time. But a more common reason is employers simply don’t want to raise wages high enough to attract workers. Employers post their too-low wages, can’t find workers to fill jobs at that pay level, and claim they’re facing a labor shortage.”

Notice at no point has there been a claim of a labor shortage— there is not a shortage of workers in the United States, but instead there is a perceived shortage of workers willing to work at wage X when the cost of living is Y. Looking at this issue through an economic lens, what we’re seeing is the price of labor is too low for these employers facing a lack of applicants. Shierholz pinpoints this later in her piece, “Given the ubiquity of this dynamic, I often suggest that whenever anyone says, ‘I can’t find the workers I need,’ she should really add, ‘at the wages I want to pay.’”

If a labor market is competitive (in which wages are determined by demand and supply), increasing the wage requires either increasing the demand for labor or reducing the supply. To flip this treatise on its head, if a labor market is competitive, increasing the demand for labor requires increasing the wage.