From ‘labor hoarding’ to layoffs: Get ready for a brutal U-turn in the job market

Given how upside-down the US economy is right now, it can be tempting to grab on to any inkling of good news. This desire for positivity may explain the popularity of a hot, new theory about the job market: labor hoarding. This buzzy term has caught on among some economists and pundits as a way to explain the relative resilience of the labor market despite the worsening outlook for economic growth.

Labor hoarding refers to the idea that since businesses spent the past two years struggling to fill open roles, they are now reluctant to lay off or fire the workers they fought so hard to hire. This could soften a recession, the theory goes, by keeping workers in their jobs even when employers see customer demand drop during a recession. But the catchy phrase and supporting anecdotes don’t hold up under close examination.

A bet on the future

The idea of labor hoarding is basically an assumption about the bet that companies are making on the future of the labor market and customer demand. If companies assume labor markets are going to be tight — that wages are going up and the job market is going to tilt in the favor of workers — employers may be willing to suffer smaller profits or weaker productivity to hold on to workers. If they assume labor markets are going to be loose — that workers will be easy to find and willing to take lower wages to secure employment — companies will eliminate jobs as a first line of defense for profitability in a downturn.

This was one of the explanations for the surge in hiring in the early 2010s: People attributed it to companies “hoarding” cheap workers because they expected wages to start rising. This time around, the labor market is already tight, so labor-hoarding proponents assume businesses are betting that predictions of a recession are overblown and they need to be ready for customer demand to stay strong. Since it’s already expensive to hire workers, they’d rather just ride out the economic soft patch with the workers they have — sacrificing productivity to hang on to every worker in case spending bounces back down the road.

Similarly, companies can make predictions on the future of consumer demand and adjust their costs based on those expectations. A business that assumes demand will hold up or bounce back will always be hesitant to cut costs by selling off their backlog of products at a discount, selling off assets like equipment or buildings, or firing workers since the firm would miss out on higher profits when demand recovers. It can be perfectly rational for a business to rack up costs now holding on to a stockpile of hard-to-acquire inputs (including labor) if that means those inventories are available later. In an environment where every conceivable input has gone through one shortage or another, including workers, it makes sense that businesses are focused on production headaches down the road. In this narrow sense, labor hoarding is a very real thing: Businesses may be slightly slower to lay off people than they otherwise would have been, even in the face of slowing customer demand.

That said, it’s important not to overstate this shift. In the chart below, I compare the number of hires businesses are making with the number of layoffs, firings, and other discharges. As shown, while layoffs are very low, they are starting to rise. Similarly, hiring rates have definitely started to slow down. The slowdown in hiring is an even more important signal of changing attitudes around the job market — businesses are more likely to adjust how many new employees they bring on in times of weakness before they shift to shedding workers. Today, high but falling hiring rates show businesses are proving very successful at attracting workers but putting less effort into it.

Another helpful tool to see how businesses are adapting to the labor market is the Bureau of Labor Statistics’ quarterly Business Employment Dynamics report. It strips out the volatile hires and layoffs made when businesses open and close and focuses instead on the employment changes at existing companies — which give a better indication of how firms are thinking about the job market. When we look only at existing establishments, we see that through the end of 2021 (the latest data available) job losses were low but at a relatively similar level to before the pandemic: with more than 5 million people fired each quarter. Sure, hiring was much more important — existing establishments created millions of net jobs per quarter — but in an environment where businesses were desperate to hang on to employees, as the labor-hoarding theory goes, we would expect to see much more extreme declines in firing. Instead, we’re seeing a more-balanced response consistent with a tight labor market that is losing some steam.

Additionally, for the hoarding narrative to hold up, businesses must also be holding on to workers despite weakening sales. As the economy surged out of the COVID-19 recession, real consumer spending soared by leaps and bounds, surpassing the pre-pandemic peak, and then some, by mid-2021. Theseincreased sales justified hiring more workers to fulfill that demand. So far in 2022, growth in real consumer spending has slowed but not yet declined. If businesses are going to hoard labor despite weak consumer demand, then consumer demand has to weaken first. So far, that hasn’t happened.

Just you wait …

Through this whole discussion, we haven’t focused much on the most important factor that undermines the labor-hoarding thesis: The job market is a lagging indicator. Today’s “labor hoarding” could easily turn out to be a late reaction from employers who’re not yet responding to weaker demand.

To illustrate this, the charts below show the average of two economic variables for every recession since 1953 through 2007. The Institute for Supply Management’s manufacturing purchasing managers’ index, a survey of senior executives at manufacturing firms, tends to capture real-time economic conditions quite well: It typically begins to contract the month before a recession starts and hits the bottom about half a year after the start of a recession. 

Unemployment, on the other hand, may start ticking up slightly around the start of a recession, but it doesn’t peak until 1 ½ years after the recession starts. Just because companies are holding on to workers now doesn’t mean that will be the case when things get ugly.

Because labor markets lag, caution around rosy predictions for how companies will react to a weakening economy is always needed. In November 2007, the jobs report showed that the US added 166,000 jobs, well above economists’ estimates. The strength of the labor market led to skepticism that the subprime-mortgage crisis was all that much to be worried about — a month later the most severe recession since the Great Depression started.

Even now, there are signs from specific sectors hit hardest by the recent market mess that layoffs are coming. From 2013 to 2021, the phrase “tech layoffs” appeared in Bloomberg News stories only 637 times. From May to September this year alone, that number was more than 960 as tech companies ranging from the gigantic Meta to much-smaller companies that recently debuted on public markets via special-purpose acquisition companies,laid off workers or reduced head count. Over the past few months, we’ve also started to see the segments of the labor market most sensitive to interest-rate hikes shed employees: Loan-brokerage employment is down almost 3% from its April peak, while employment at real-estate firms is down 1% amid still rapid payrolls growth across most other industries.

The theory of labor hoarding rests on hopeful assumptions. Maybe the Federal Reserve’s inflation fighting won’t push the US into a deep recession. Maybe companies will refuse to cut costs even when demand weakens. Maybe workers will be able to retain some of the gains they made earlier in the pandemic. But we’re already seeing some weakness on the edges of America’s job market at the very beginning of what could be a Fed-induced recession. So when the real pain starts, there’s a good chance the US will quickly shift from labor hoarding to layoffs.

George Pearkes is the Global Macro Strategist for Bespoke Investment Group.