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Immigration Reform May Bruise Stocks

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Over the past 30 years, business has been pushing labor for concessions on wages and workplace flexibility. While wages stagnated and benefits were reduced, profits as a share of GDP rose to an all-time high. This is no doubt the reason why, despite a sluggish economic recovery, major Wall Street indices have been setting records. However, impending immigration reform may be the first step toward reversing this trend.

Power Balance

The history of capitalism has been characterized by a constant tug-of-war between labor and employers. It has not been a zero-sum game; business thrives when labor is cheap and flexible, but demand also increases when workers can buy more. Nevertheless, at any time there have always been losers along with winners.

When modern capitalism first emerged in Europe and North America early in the 19th century, employers enjoyed a decisive advantage. They could pay subsistence wages, set arbitrarily long hours and routinely use child labor. Safety and other workplace rules barely existed, nor were there any fringe benefits, even though some paternalistic bosses, of their own free will, provided housing, healthcare, education and even pensions to their workers.

The second half of the 19th century was marked by political and economic strife as workers demanded better conditions and higher wages. By the start of the 20th century the balance of power began to shift away from employers and toward labor. While there were various theories why this was so—the threat of leftist ideologies, the spread of representative democracy and the rise of trade unions—the more likely explanation was the changing relationship between supply and demand for labor. The rapid pace of industrialization and the emergence of large, labor-intensive industrial plants operated by tens of thousands of workers created huge demand for labor. Immigration and migration from countryside to cities could no longer satisfy this demand adequately, especially since urbanization also reduced fertility rates.

The first decades after the end of World War II were the high point for labor. The workforce became heavily unionized and blue-collar wages, both union and not, afforded single-breadwinner households middle-class lifestyles, complete with private homes and luxuries, such as several private cars. Not only did a 35-40 hour workweek become the norm, but employers paid for a variety of generous, and costly, benefits.

While it is true that more opulent workers provided higher demand for goods and services produced by companies, labor markets of the 1960s and 1970s became inflexible and cut into corporate profits. Profits before taxes as a share of GDP fell in the early 1950s and stayed low until the early 1980s, bottoming at around 6%.

However, the underlying supply and demand relationship in the labor market began to shift again around 1980. Technology enabled more production to move overseas, such that American workers were forced to compete head-on with much less costly and more flexible labor in poorer countries. This, plus growing illegal immigration in the century’s final decades, shifted power to employers and put downward pressure on wages.

Battered Labor

Consensus estimates put the number of undocumented aliens in the United States at 10-12 million. A higher proportion of them are in the workforce compared to overall population, which means that there are some 7-8 million illegal workers. They make up a solid 5% of the workforce, but their impact on wages and workplace flexibility is even greater than their numbers suggest. Illegal immigrants take less prestigious jobs—such as working in a slaughterhouse, bussing tables at restaurants or cleaning houses. To attract legal employees to such vital occupations, wages would have had to go up, setting off a chain reaction of higher wages across the boards, higher prices and lower profits.

The economic crisis of 2008-09 has had a pivotal aftermath for labor. The economy has recovered relatively quickly, and by most important measures—including GDP, personal incomes, consumer spending and stock prices—pre-crisis peaks have been surpassed. But that’s not so in labor markets. Employment has lagged far behind the rest of the economy.

Moreover, the headline unemployment rate, which fell to 7.5% in April, grossly understates the problem. The ratio of employment to population, which averaged at over 63% over the past 20 years, has declined to 58.5%. The number of long-term unemployed, those out of work for 27 weeks or more, remains at around 4.5 million, or more than a third of all unemployed. Underemployment, the so-called U6 rate, comprised of workers who would like to work more hours but can’t, is at around 14%.

Underemployment may even be getting worse. In April, while the U.S. economy created 165,000 new jobs, hours worked were cut by 0.4%. It may have been a statistical glitch, but it fits a longer-term pattern, which has been exacerbated by the impending introduction of Obamacare at the start of 2014. Employers not only remain reluctant to hire new employees, but are shifting their existing workforces to a part-time basis. This allows them to avoid providing health insurance, pensions and other benefits. At the same time, the seemingly inexhaustible pool of unemployed or underemployed workers affords businesses plenty of flexibility to use their workforces more creatively.

All of a sudden, American workers are playing the same role in the labor market as undocumented aliens. They are working irregular shifts for relatively little pay and no benefits. It may not have been good for working families, but the corporate sector has prospered. Profits as a share of GDP have been around 12%, an all-time high and double what they were back in the early 1980s.

Meanwhile, illegal immigration may be on its last legs. Since 2008, the number of people crossing the U.S. border illegally has fallen sharply, as have remittances to Mexico from Mexicans working in the U.S. The crisis in the construction industry in California, Arizona, Nevada and elsewhere has undoubtedly played a role, as has a recent economic upswing in Mexico, but U.S. government policies should not be discounted as well. Border patrols have been beefed up, deportations have increased sharply and enforcement against businesses employing illegal aliens has tightened.

These measures have been implemented as an immigration reform bill makes its way through Congress. Whatever its final shape, immigration reform will disrupt the status quo in the labor market. Some—or even most—illegal aliens may be forced to return to their native countries, at last for a brief time period and maybe for much longer.

Meanwhile, the U.S. labor force is shrinking. The percentage of Americans in the workforce has fallen since the economic crisis and, while the population continues to grow, the number of people willing to work has been stagnant. The situation is much worse among younger workers, both the 25-to-34 and under-25 age groups. Their official jobless rate is more than twice the national average and, worse, their workforce participation has shrunk dramatically over the past five years. It is a classic “lost generation,” a large proportion of whom could become unemployable over the longer term.

Business Impact

These trends suggest a possible labor shortage in the U.S. in coming years, especially if the economy gathers steam. Labor shortages can develop quickly; one did, albeit briefly, during the tech boom in the second half of the 1990s. Employers will then start to compete for workers, bidding up wages and giving up much of the flexibility at the workplace they have acquired in recent years. And, unlike previous periods of full employment, there may not be the safety valve of illegal immigration to take pressure off employers.

From the point of view of the stock market, it should be kept in mind that profits as a share of GDP dropped sharply in 1997-1999, the worst years of the labor shortage, even though the U.S. economy was growing strongly at the time.


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