Inflation Is Eating the Labor Market. Gains Are a Mirage.

The U.S. economy added 147,000 jobs in June, nearly 40,000 more than expected. (Michael M. Santiago/Getty Images)

About the author: Alí R. Bustamante, Ph.D. is professor of practice at the University of New Orleans Department of Economics and Finance.

For much of the last three years, we have heard a reassuring story about the U.S. labor market: It was tight, hot, even historically strong. Policymakers pointed to low unemployment and high job openings as evidence that workers had healthy bargaining power. This story continued last week, after the Labor Department reported hiring in June outpaced predictions. Unemployment dropped to 4.1%.

Yet, beneath the rosy narrative lies an uncomfortable truth: Real wages have been falling. With long-term unemployment creeping up, labor-force participation slipping, and industries hemorrhaging jobs, the U.S. labor market is actually less robust than just a year ago.

For decades, economists relied on models built for a world of low, stable inflation. They treated indicators like the vacancy-to-unemployment ratio as a reliable gauge to labor slack in the labor market. But in recent years, these indicators haven’t worked as expected.

Inflation is distorting labor market signals.

Between April 2021 and May 2023, core consumer price inflation jumped by more than 14%—after two decades averaging just over 2%. During this surge, job vacancies soared while unemployment stayed low. Federal Reserve Chair Jerome Powell called it an “overheated labor market where demand substantially exceeds supply.”

But research shows those vacancies didn’t reflect a real strengthening of hiring. Instead, inflation eroded real wages. Workers tried to restore their purchasing power and income by switching jobs. This churn of people quitting to search for better pay drove vacancies higher, even as the job-finding rate for the unemployed didn’t improve.

This is the dark side of wage rigidity. While switching jobs helped some workers partially offset inflation, most Americans simply got poorer. By 2024, the Atlanta Fed’s Wage Tracker showed real wage growth for the median worker was about 4%—below where they would have been had pre-2020 trends continued. Even job-switchers’ nominal gains failed to keep pace with inflation.

Meanwhile, corporations benefited. Their real labor costs fell while they retained pricing power to pass higher costs to consumers, resulting in historically high profit margins.

If that was the reality behind the “hot” labor market of 2021-23, today’s conditions look even worse.

Over the past two years, the unemployment rate has risen from 3.5% to over 4.1%, with nearly one in five unemployed workers jobless for 27 weeks or more. Broader underemployment is also worsening: the U-6 rate, which captures discouraged workers and involuntary part-timers, has inched upward to 7.8%, 11.4% above the prepandemic level and its highest since 2021.

The decline in labor-force participation and in the employment-population ratio, especially for prime-age workers, suggests that overall labor force engagement is backsliding. That isn’t what a strong labor market looks like. And it signals persistent scarring and lost potential.

Industry-level data is equally troubling. Over the past year, manufacturing employment declined by 89,000 jobs and employment in professional and business services —a backbone of white-collar work—lost 36,000. Since January, employment in retail trade, transportation and warehousing, and wholesale trade has stagnated.

That isn’t just cyclical noise. It is the unwinding of the long-held understanding of how the labor market responds to inflation-driven churn. Job quits and vacancies can temporarily rise—without delivering sustainable job growth or real wage gains.

Despite these warning signs, the Trump administration and Congress’s policy choices are making things worse for workers.

The “Big, Beautiful” bill signed into law last week offers major tax cuts skewed to the wealthy while pushing the federal deficit to historic highs, without any meaningful public investment. This mix of regressive tax policy and deficit expansion fuels financial instability without offering real gains for working families.

The bill’s roughly $1 trillion in Medicaid cuts threaten to strip health coverage from millions of Americans, adding financial strain to already-stretched household budgets. At the same time, the White House and the Department of Labor have advanced executive orders and rule changes that weaken collective bargaining rights, narrow overtime protections, and limit labor standards enforcement, undermining workers’ leverage.

On the trade front, tariffs and trade tensions have added to economic uncertainty and inflationary pressures. Far from protecting workers, these policies have been proven to raise consumer prices and shrink domestic manufacturing employment.

Stripping away safety nets and labor protections will only heighten household vulnerability, deepen the cost-of-living squeeze, and make Americans more vulnerable to financial shocks. The rug is being pulled out from under workers—just as the real wages remain below prepandemic trends and the labor market is cooling further.

High vacancy rates can come from firms expanding. But they can also come from these workers desperately searching for higher pay to keep up with rising prices. This creates labor churn without net hiring gains. In this environment, real wages can still fall, even as the market appears “tight” on paper.

If policymakers had understood that better in 2021, they might have acted more aggressively to support real wage growth through strong labor standards, expanded bargaining rights, and targeted anti-inflation measures.

A new consensus must be built, one that acknowledges that a truly strong labor market is defined by rising real wages, secure employment, and genuine worker power—not just the illusion of choice in a world where everything costs more.

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.