Job market is broken, but healing

Friday's December payroll report confirmed what many regular Americans already feel: Four years after the recession ended, the economic recovery remains fragile and uneven.

The economy created just 74,000 jobs last month, well below the roughly 200,000 analysts were expecting and the 241,000 created in November. Yet the unemployment rate posted a surprisingly steep drop to 6.7 percent, from 7 percent, moving nearer to the Federal Reserve's 6.5 percent "threshold" before which policymakers will consider raising short-term interest rates to account for the strengthening economy. 

What gives? How can the job market be hot and cold at the same time?

The wildcard is the ongoing exodus of Americans out of the labor force. While household employment rose 143,000 last month, 347,000 people stopped looking for work. As a result, 92 million Americans are now out of the labor force, pushing the labor participation rate to levels not seen since 1978. 

 The nation's unemployment rate is expected to drop sharply again this month, even as millions of Americans lose extended federal jobless benefits.

This continues a dynamic we've seen since the dot-com bubble burst but that has accelerated since the financial crisis. The hollowing out of medium-skill, middle-class jobs in this country appears to be pushing many to throw up their hands in disgust, retire early, apply for disability benefits, apply for food stamps and other welfare programs, or move back in with mom and dad.

That trend is also weighing on median household income, which is down to $51,000, from a high of more than $56,000 in the late 1990s. No wonder the holiday 2013 shopping season was a relative dud: Growth in real personal consumption expenditures is trudging along at a pace that's at or below levels associated with each and every recession since the mid-1950s.

It's a Gilded Age dynamic that's unsustainable.

For one, many besieged Americans are already clamoring for redistributive policies to normalize the wealth distribution between the ultra-rich and everyone else. President Obama looks ready to make inequality the key theme of his upcoming State of the Union address and has been pushing hard to extend federal unemployment benefits and raise the national minimum wage.

Also, if the labor market to continue to tighten, which in key areas is already resulting in an emerging skills shortage in key industries, working Americans will see relief in the form of higher wages.

Federal job turnover data shows that employers are having a tougher time finding workers, hording the ones they've got, and slowly being forced to dole out raises to attract and keep talent. Productivity data shows that output per hour is stalling as unit labor costs rise, which means that new hires are not as efficient.

In fact, if the job market was working properly, based on the number of job openings out there, the unemployment rate should be closer to 5.5 percent based on government data.

Translation: Some economists think we've got a skills gap, something the CEOs at the Business Roundtable have been warning about, pointing to a recent study by the Organization of Economic Co-operation and Development that showed the U.S. falling behind global peers. Moreover, the skills gap internally is quite polarized, with a concentration of folks at the top and at the bottom. The gap is also unusually wide between the employed and unemployed.

And if we continue along the current path, wages will be forced higher as businesses compete for top-quality workers, which in turn will attract the young and ambitious to seek training in those areas. Profit margins will suffer, with the growth in the cost of labor already exceeding the rate that businesses can raise prices on their goods and services.

Given all this, it's not surprising the Business Roundtable has been pushing hard for immigration reform, specifically to increase the number of foreign, high-skill workers in science, technology, engineering and mathematics. Increasing the supply of these workers will help protect profits by keeping wages low.

But wage inflation is exactly what the economy needs to get healthy.

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