Talk is in the air of a weak economy and possible recession. It is fueled by the current lack of data and a sense that businesses and households are pulling back on spending.  Fed Chairman Jerome Powell contributed to this feeling of unease in a recent speech on weak labor markets and inflation[1]. This was the rationale he gave for the Fed’s 25 basis points rate cuts in September and October.  President Trump also sees weak labor markets and wants interest rates to be lowered by 4 times what the Fed did in October to jump start housing markets.

In spite of this gloomy picture, the unemployment rate as of August, the last month before the government shutdown , was only 4.3%. That rate has been virtually unchanged over the previous six months and is only 0.2 percentage points above June of 2024.  The reported rate for November was 4.6% with a surge in discouraged workers who are not counted as unemployed entering the labor force. What conflates the data is immigration policy reducing the size of the labor force at the same time as the demand for workers is declining. Is the labor market really weak calling for more aggressive interest rate cuts, or is it just adjusting to a smaller labor force?

To understand what Powell and Trump are seeing we need to first dive into how the employment measures they are looking at are defined. The unemployment rate comes from the Survey of Households. This is a relatively small survey generated by the Bureau of Labor Statistics through questions posed to households about the employment status and the job search status of those living in the home. Of course, undocumented individuals are not going to tell a government employee, particularly one they do not know, that they are either working or looking for a job. Therefore, they are not counted in this survey. The survey does however include independent contractors, gig works, and part-time workers. Workers who are engaged in a side-hustle because they cannot find a regular, payroll job are still counted as employed.

A companion survey, the Enterprise Survey, is specifically focused on those payroll jobs and is a survey of employers who, because they report their payroll to the government for payroll tax purposes, are not apt to misstate their payroll numbers. It is this survey that shows that even though the unemployment rate has remained relatively constant, labor market hiring has ground virtually to a halt.

From the Household Survey we find that the new additions to the labor force from February to August, people returning from leave-of-absence and recent graduates for example, has gone from 1.027 million in 2022 to 34,000 this year. This is a turnaround of 993K people. Of the decline in the labor force, 690,000 was due to discouraged workers, those who want a job but are not currently looking due to labor market conditions. As of November, the number of discouraged workers shrunk to 116K with the balance entering the labor force and pushing up the November unemployment rate. For the balance, immigration policy plays an important role. The rapidly declining immigration of working age adults is clearly in these data.

To gain some perspective on how immigration policy might affect our interpretation of labor market data let’s look back at history. There have been three episodes of restrictive immigration policy in the last 100 years: The FDR deportations or the 1930s, the Eisenhower deportations of the 1950s, and the Secure Communities Program from 2008 to 2014, each of which provide insight into the implications for employment, housing, education, and public finance today.

What happened to labor markets during these three most recent episodes of mass repatriation immigration policy? From 1930 to 1934, somewhere in excess of 400,000 Mexican and Mexican-Americans were deported. This represented around 0.35% of the U.S. population or the equivalent of 1.25 million today, the target of current immigration policy. In the 1950s approximately 1.3 million mostly Mexican nationals were deported. This was followed by the Bracero program that allowed many of the deportees to return to work, particularly in agriculture, as seasonal workers. The Bracero program ended in 1964, resulting in a loss of about 500,000 from the effective labor force. From 2008 to 2014 the U.S. instituted the Secure Communities Program resulting in the deportation of about 300,000 individuals. Each of these cases have been studied by economists to ascertain the impact on employment, wages, and housing demand. The results are almost always unambiguously negative: higher unemployment by U.S.-born Americans and immigrants with legal status, lower wage growth, and less housing demand. The three most important factors were the absence of income and hence spending by those who were no longer in the local community, the impact on complementary jobs performed by those with legal status, and the implementation of labor-saving automation. Those deported are, obviously, not going to local stores or theaters. And, for example, a reduction in agricultural production means less work in food processing including supervision and back-office work[2]. In other words, today’s immigration policy, however much the ultimate change it is intended to bring is desired, will have near-term negative consequences for communities that are intimately tied to foreign-born workers. This is already seen in the data through August for 54 counties in California. Those with a higher percentage of foreign-born residents and within which have a larger percentage of jobs in agriculture, construction and leisure and hospitality, have already begun to see elevated unemployment relative to other counties in the state.

The size of the population, where it lives and what goods and services are produced is clearly a political policy decision. The U.S. population today stands at 342 million. It could be 320 million or 360 million as there is no optimal population size. However, to move from one structure of the labor force to another has transition costs. With fewer families in an immigrant heavy community there is less demand for education and therefore for educators. With lower wages and lower production, the tax base declines and the ability of local government to fund public services is reduced. And with more capital-intensive production, income shifts from the local workforce to the owners of capital, owners who oft times do not live in the communities where the production takes place. Clearly, these forces will be leading to lower utilization of physical assets such as office and retail buildings with consequent reductions in their market values. These are the transaction costs that the current economy is facing and will face in the coming years.

While AI, technology, robotics and the onshoring of manufacturing are driving economic growth, weak labor markets due to innovation and immigration policy is shifting the benefits of that growth away from less affluent communities and towards the more highly educated affluent communities, a trend that has been with us for a while, but which is now accelerating with the Administration’s new economic policy. Although interest rate reductions will only marginally address this aspect of labor market weakness, it is the contagion to other parts of the economy that has spiked worries at the Fed and elsewhere. That is the argument for further cuts to the Fed Funds rate in spite of inflation remaining higher than the Fed’s target of 2%. Nevertheless, these forces operating on labor markets provide a recipe for less effective economic stimulation from interest rate policy.