Immigration changes the jobs maths

Non-farm payrolls rose by 303,000 in March and unemployment dipped to 3.8 per cent. Economists who had warned that hiring this strong must push up wage inflation are having to redo their models. What they left out was a surge in immigration.

What March showed

The report was strong across the board. Hiring was led by health care, government and construction, and gains in earlier months were revised up rather than down. Yet wage growth kept easing: average hourly earnings rose by 4.1 per cent over the year, the slowest pace since mid-2021. A labour market adding more than 300,000 jobs a month while pay growth slows is not behaving the way the textbook predicts for an economy at full employment, and that puzzle is where immigration enters the story.

More workers, same wages

The Congressional Budget Office estimates that net immigration added more than three million people to the US population in 2023 alone. The influx has enlarged the pool of available workers, letting employers fill hundreds of thousands of vacancies without bidding up hourly pay. When the labour force grows this fast, big payroll gains mostly reflect the economy's greater capacity to grow, and say little about overheating.

The CBO's January estimate was far higher than earlier projections, which had assumed net immigration near its pre-pandemic pace. The increase came through several channels: more people arriving through legal routes as visa processing recovered, large numbers crossing the southern border and being released to await immigration hearings, and new humanitarian parole programmes. Many of the new arrivals are of working age, and a growing share have obtained permission to work.

The breakeven has moved

The key number for the Fed is the breakeven rate of job growth, the monthly gain needed to keep the unemployment rate steady. It depends on how fast the working-age population grows and on participation. Before the pandemic, with an ageing population and modest immigration, economists put the breakeven well below 100,000 a month. With the population growing much faster, recent estimates are far higher. A payroll gain that would once have signalled an overheating economy may now be roughly consistent with a stable labour market, which is what the steady unemployment rate suggests.

That changes how the Fed should read the monthly numbers. Strong hiring matters for inflation only if it outpaces the growth in available workers, pushing employers to compete for scarce staff. Rising job openings, faster quits and accelerating wages would be the signs of that. On most measures they have moved the other way over the past year: openings have fallen from their peak, quits have returned to pre-pandemic levels and wage growth has slowed.

The surge also complicates the statistics. The monthly jobs report combines a survey of employers, which produces the payroll figure, with a survey of households, which produces the unemployment rate, and the household survey is scaled to Census Bureau population estimates. If those estimates have not caught up with the scale of recent immigration, the household survey will understate both the labour force and employment, even as employers' payrolls capture the new hires. That may help explain why employment in the household survey has lagged well behind payrolls over the past year. It also means the unemployment rate, the Fed's main gauge of slack, rests on population figures that may later be revised substantially.

A precedent from Britain

Britain offers a comparison. When the European Union expanded eastward in 2004, Britain was among the few existing members that opened its labour market immediately, and far more workers arrived from central and eastern Europe than officials had projected. Employment rose strongly in the years that followed, while wage growth stayed moderate and inflation low. The episode showed that a large, fast inflow of workers can let an economy grow quickly without the wage pressure that would otherwise build.

The case against

The counterargument is that immigrants also add to demand. New arrivals need housing, food and transport, and they spend what they earn, so the net effect on inflation is smaller than the boost to labour supply alone suggests. Rents in cities receiving many migrants have risen, and housing is the largest component of inflation. There is also uncertainty about the numbers themselves: estimates of recent immigration have been revised sharply, and a policy change or a slowdown in arrivals could reduce the flow quickly.

Those points are fair, and they limit how much comfort the Fed can take. But inflation has not been driven mainly by wages in the past year; services prices and shelter have been the sticking points. A labour market that is adding workers as fast as it adds jobs removes one source of pressure, even if others remain.

What to watch

The indicators that would change the call are the employment cost index for the first quarter, due at the end of April, the ratio of job openings to unemployed workers, and labour-force participation among prime-age workers. The Fed meets at the start of May, and the CBO's next revisions to its population estimates will show whether the inflow is holding up.

Immigration has changed how the US jobs market works, allowing large monthly gains without the wage-driven inflation central bankers feared. While the inflow lasts, strong payroll figures are a weak argument for keeping rates high, and the Fed would do better to watch wages and services prices when it decides on its first cut.