♪♪ A year ago, most economists were predicting a recession and said that the headwinds were supposed to crush the economy.

Inflation, supply chain shortages, and rising interest rates all seem to be easing right now.

What happened?

Joining us today to give us a sense of it all is Sacramento Business Review Chief Economist Sanjay Varshney.

Sanjay, what happened to the predicted recession?

Most economists were proven wrong by our economy, which has been very resilient.

And you can see, I think, one of the biggest confounding factors behind, uh, the economy proving those analysts wrong about the imminent recession is the fact that our labor market continues to stay very strong.

And as you can see, uh, in spite of all the headwinds from the interest rate hikes by the Federal Reserve- We have seen 11 so far.

We still have one more on the table possibly, uh, for next month.

Uh, we find that because many folks never came back to the labor force post-COVID, the labor market stays extremely strong.

As of last week, the job openings report shows that we still have 10 million openings and we have only half that number that are still looking for a job.

So, technically, we have two jobs per person for anybody who chooses to be in the labor force right now.

So, let... let's talk about that for a sec, because I never know whether it's good news or bad news.

On... on one hand, the fact that there are two jobs for every person means that employers have to sharpen up their pencils and that wages have risen a bit, particularly at the lower ends of the economy.

At least, that's my understanding.

On the other hand, don't those increased wages feed into inflation itself?

And that is what it is that Jerome Powell and his attempt to have a “soft landing ” has been working so hard to achieve and to kind of put the brakes on all that?

Help us understand, kind of, the reality of that.

First, we must recognize that for the last 20 years in a row, before we had COVID, we were deflationary in our economy and we were deflationary worldwide.

But because we have an aging population on the planet, we have a very strong technology force that allows people... people to have goods that are cheaper now, to produce, also to sell.

But I think what's happened in the last year is that inflation has come down pretty rapidly, contrary to what most people believe, that, you know, we might see inflation stay very sticky.

And I think that, uh, compounded with, you know, the lower wages, for example, that we are seeing right now in the labor market- because there's only that much that the employers can keep raising the wages for their employees- what we are finding now is that many employers are now changing, uh, the way they do business.

They are requiring their employees to come back into the labor force, come back into the office, for example, maybe a couple of days a week, maybe more than that.

And I think all of that stuff is having a play in the market right now.

So, I'm not concerned anymore, like I...

I was maybe a year ago, that wage inflation is going to feed into the economy, uh, and keep the inflation high, uh, persistently for... for very long.

You know, let... let's talk a little bit about the whole thing about the labor force, the employers.

Last year, when we talked, one of the sentiments that I had heard was that employers were saying, “You know, maybe a good recession restores balance between where the labor markets are and where employers are.

” A lot of push for things like remote work and that sort... and that sort of thing.

What's been the reality and- as we- As COVID falls further back in the rearview mirror, what's the reality as to what's going to be different in the future or maintain in the future that we didn't have prior to COVID?

I think it would be naive to believe that the employee is going to remain in the driver's seat forever, as we have seen, for example, in the last few years.

Um, we are clearly seeing artificial intelligence come into play.

Um, let's take the restaurant industry, for example.

They are probably the most hard-pressed to find, uh, minimum wage labor because of the shortage of labor.

And increasingly, we are finding that many of these restaurants are moving in the... in the direction of having robots do the same work.

We have a wide skills gap right now between the... the folks who are in the labor force and the kind of the- jobs that are being made available going forward in the future.

So, when... when we say, for example, that “two jobs per person, ” uh, that's actually a little bit misleading because many of the folks who are looking for jobs in the labor force do not qualify for some of the openings that we have currently in the market.

So, I think one of the future trends you're going to see is we're going to find that skills mismatch come more into play, employers will once again be in the driver's seat as... as, increasingly, you're seeing that already happen, when youre seeing many more companies lining up and wanting the employees back in the office many more days in the week.

And I think artificial intelligence- which is the biggest fear in the room right now, because artificial intelligence can easily replace humans for certain kinds of jobs- I think that is going to be the correcting factor, in my opinion, for the labor market, which clearly has defied the odds and actually has defied classical Keynesian economics.

Because, to bring inflation down, uh, most economists who believe in Keynesian economics, for example, would like to see some destruction in the labor market.

We have not seen that destruction yet.

So, you're talking about how there's a skills mismatch.

Reconcile this for me, this skills mismatch between the... the jobs that are available and the people who might pursue them is happening at the same time, where it's my understanding- and please correct me if I'm wrong- but it has been the folks who are at the most marginal ends of the economy and the either unskilled or lightly skilled who actually benefited most in terms of this recovery, with regards to increased opportunities and wage improvements.

Help... help me understand.

Either I've got it wrong or there's something I'm missing.

What has happened, post-COVID, is that we literally have changed the way we do business, uh, inside corporate America, inside small businesses and medium sized businesses.

So, yes, you're right.

Uh, you would have thought that the... the lowest skilled labor, for example, in the room would not be marginally impacted, uh, you know, by... by what's happening in the labor market with the skills gap.

I think what's happening is more and more companies are moving in the direction of using technology more effectively to make themselves more efficient.

They're using artificial intelligence to make themselves more effective.

And the new kinds of jobs that are coming up, um, I think that's where the universities in the United States have been slow to adapt.

So, when you talk about a skills gap and you talk about the majors that still are being produced in mass quantities by the colleges and universities in the United States, I think that's where the skills gap is coming in because, to a large extent, what is being taught in the academic world is still way behind where the labor market is or what the labor market needs.

Okay, let... let... let's focus on that for a sec, because you were talking about artificial intelligence and... and... and what might happen in terms of the destruction of some jobs and the creation of others, and where it is that universities are... are fall- may be falling down on the job.

The point that I...

I'm making is that during COVID, the folks who really didn't have to worry much about their jobs were the people who took care of us, the people who were delivering on... on DoorDash, providing essential and basic services, who didn't have the luxury of working at home.

A.I.

and... and its rise, it appears that the people who are most at risk are the people who typically, in most economic cycles- particularly the down parts of the economic cycles- have historically been protected.

And those are the higher level people who have letters behind their names, you know, bachelor's degrees, master's degrees, people who are engineers, computer programmers and others.

Aren't those the ones who are at the most immediate risk for A.I.

and other types of technology to replace?

Um, I think it goes both ways.

I think A.I.

can easily replace people in white collar jobs that they thought were secure.

And A.I.

can also replace the minimum wage jobs using robots, for example, to wash the dishes in restaurants where they were used to basically getting the minimum wage labor to do so.

Right?

I think one of the things that's happening with the minimum wage jobs, uh, that we were used to in the... in the previous economy is that we have seen a shift in the thinking as well.

Right now, as I speak, 5 million people did not come back into the labor force post-COVID.

Many of the folks in the Gen-Z, uh, world, for example, have a slightly different view of what the workplace should look like or what their work balance should look like.

And I think that's a challenge in the labor market right now, because many of these folks at the lower, uh, end of the wage distribution have not come back into the economy at the rate we thought were going to come back, primarily because- [Scott] So, let me interrupt you right there on that one.

So, just to make sure that we're clear, a lot of folks have not come back into the labor force.

One question that immediately comes up is how are they surviving?

But the- your second point is that they have a different reference point on work and things like work-life balance and, sort of, quality of life.

What is the implication of that- First, describe the implication of that change and what that may look like as that ripples forward into the future.

We had $10 trillion plus pumped into the economy in the name of COVID, which is still trickling through the economy, which is a reason why we still have inflation higher than where the Fed- where... where... where the Fed would like to see it.

Right?

So, now, if you look at, for example, services inflation.

That is still persistently high right now, even though goods inflation has come down.

And if you ask the question, “Why is services inflation still very high?

” the answer is that those industries that were basically dependent on exactly the minimum wage labor that you were speaking about a few minutes ago, they actually have been late in the game and finally, now they're able to hire more and more people compared to what- where they were, for example, several months ago, where they were all competing for the same labor, whether it was the construction industry, whether it was the restaurants, and they couldn't find enough people to... to put on their staff.

Right now, by offering higher wages, they are able to actually get these people into the... into the labor force.

And that's... that's what explains, for example, the very high service, uh, you know, inflation.

Uh, but I think that the challenge is that many of the same folks who are in these minimum wage jobs are really thinking about a more balanced lifestyle.

You know, they don't... they don't want to work 10 hours per day or 12 hours per day.

They want to find some time for leisure.

They want some time for their families.

So, that's a generational thinking change that I've seen, compared to the previous generations that basically said, “You know what?

I...

I know I have to go to work and I have to work very hard.

I have to bring home that paycheck.

” And part... partly responsible for this change in thinking is the fact that we had a lot of stimulus checks that went out.

So, there was a lot of free money that was put on the table for a lot of folks.

And that is still working its way through the economy right now.

But the good news is I think that money is going to dry up.

That money is going to eventually come to an end.

And I think that's when the shock to the labor market might come in, where more people would be forced to come back into the labor force.

We have seen that trend growing in the last few months, and I think- I'm just hoping, uh, that given where A.I.

is right now, for example, and the robots are, I hope that we don't hurt ourselves, uh, by having the labor force be too late to come back into the... into the game.

Because, increasingly, employers are frustrated when they're not able to find employees and they are basically turning to artificial intelligence or robots to see if they can get the work done faster.

So, I think this is an interesting juncture, uh, you know, both in the economy and in our lifetime, where we will see the labor market shake out in a certain way in the next couple of years.

When we're talking about, sort of, the views, both generationally and just on the macro level, about the economy, one of the things that is noticeable at this moment with these improving indices is that while the numbers show an improvement, if you look at the polling, there's a continued pessimism about the state of the economy.

What's behind the delta between those two?

Uh, I think one of the reasons why people are extremely pessimistic, uh, is because we just went through a really very bad bear market in 2022.

Uh, if you look at the loss in the wealth, uh, household wealth, uh- I'm not talking about across the board, I'm just talking about especially the families that were at higher risk because of the impacts from the economy, uh- I think those losses, um, you know, are still basically resonating with a lot of folks.

The stock market was down big time last year.

And it was not just the stock market that was down big time, it was also the bond market.

And keep in mind, there's a lot of folks in the United States, especially the seniors, the elderly, the retired folks who were depending on fixed income coming from their fixed income investments to put food on the table.

And the bond market was down between ten and 35% last year, depending on the kinds of bonds you were holding.

So, I think that was one shock factor, uh, that basically had a major, uh, impact on people's, uh, confidence levels.

Right?

And I think going forward, people, um, have been sort of brainwashed.

Uh, you know, of course, you know, you started the show today by asking the question, “Where is the recession?

” because everything we read about, everything we... we heard was basically pointing in the direction that a recession, a deep recession was imminent.

Fast forward, the economy is still very resilient.

The labor market is still very good.

Uh, the consumer is still strong.

I'm not saying they are- they're not weakening a little bit, but the consumer is still, you know, representing the Energizer bunny, like I call it.

You know, it keeps going and going and going.

Um, so, all those factors have allowed the economy to stay strong, uh, but people are, mentally, still expecting a recession.

So, a lot of folks I talk to on the street are still saying, “Hey, by the way, is the recession going to be here, uh, in 2023?

Is it going to be here in 2024?

” So, psychologically, we are still bracing ourselves for a major hit in the economy.

What do you think- Looking forward into the future, what do you think are the biggest risks to this “soft landing ” turning into a hard fall?

A couple of things, uh, Scott.

First, the Federal Reserve has a track record of being behind the curve, um, and they have raised the rates 11 times already and they might vote for a 12th one pretty soon.

And the lag factor that usually kicks in between the time the Federal Reserve raises the rates and when it shows up in the economy is, right now, not being considered very seriously.

So, there's still a likelihood that there might be a lot more economic damage that might show up next year because the leading economic indicators have gone negative, deeply negative, the bond market has a yield curve inverted between the two year and the ten year treasuries.

So, those two are predicting that we are going to see economic, uh, you know, sort of weakness come in, to the point where we might see a recession.

Second, we are still at risk when it comes to the geopolitical tensions in the world.

You know, we still have a war going on in Ukraine.

We still have supply chain shocks in different parts of the world.

We still have a... a lot... a lot of tension right now with China and North Korea and some of these other countries.

So, that's a second risk factor that can basically come into play, as far as the economy is concerned or any of these other weakness that we are talking about.

The third- [Scott] Oh, go ahead.

The third, I would say, is the structural shifts going on, uh, in the market, behind the scenes- for example, like artificial intelligence and robotics- which are probably going to play out in the labor market somewhere.

So, that, again, could very easily have a role to play in how the economy shapes up for the future.

And the last thing, which, you know, we seem to take- uh, you know, we... we don't, uh, sometimes, uh, you know, uh, take very seriously is that next year's election year, uh, both parties, uh, basically are equally guilty of, uh, overspending.

Uh, we have a public debt that has spun out of control.

Uh, and Fitch, uh, you know, uh, downgraded our U.S. debt this morning.

Uh, so, I think how we mismanage our economy, uh, how we mismanage our finances can easily come into play through a recession or through some other adverse impacts on the markets.

Let's talk- Let's bring it back a little bit closer to home.

As you look at California and, more specifically, the Sacramento region, what's on the horizon for us that we need to all be paying attention to, about the opportunities and challenges of our own economy?

California defies the odds, uh, you know, uh, consistently.

Uh, in spite of the challenges that we have seen in the last decade plus, uh, where people have left the state, high incomes have left the state and continue to leave, businesses have left the state, we still have a very, very sound economy here.

And by some, uh, new measures, we might now be the fourth or the fifth largest economy in the world.

So, California, uh, again, keep in mind, uh, we have a very strong Bay Area technology sector.

Uh, if I just take the five, uh, top companies in the Bay Area through the market capitalization, they are larger than every country in the world, uh, except for maybe China.

So, there's a tremendous strength, uh, behind the economic fabric in California that keeps it where it is right now, but the challenges are compounding.

And again, some of these challenges might play out in the next five, ten years, where the loss of population, the loss of businesses, the loss of the high incomes, uh, loss of talent may all basically have adverse impacts on the state of California eventually.

Uh, so, that's where the pessimism comes in that, I think, to a certain extent, our policies, uh, are being mismanaged.

Uh, you know, we have rising crime, we have rising homelessness, uh, we have challenges that the rest of the country doesn't seem to be having nearly, uh, uh, you know, in the same extent.

Uh, so, we are concerned about what's going on in California, when I look at these broader trends, which are certainly not positive.

Now, you know, you sound like an economist there, because you're “On the one hand, here's what's going right, and here's what's going wrong.

” I am curious as to, for the rest of us, if we were looking for a couple of indicators to show whether or not we are... are at least trending in the right direction or not, what... what two or three things should we be looking at over the next 12 to 24 months as we start to plan our own economic futures?

The first thing is the state budget is broken.

Uh, we went from a $95 billion surplus to almost maybe a 50 billion plus deficit this year that's being projected, and the year is far from over.

Uh, I think a broken budget is not a positive signal, going forward, for the state of California.

We have the highest percentage of our population on welfare programs.

We have the highest homelessness of any state in the country.

We have rising crime, where, even in the city of Oakland, finally, people are throwing in the towel and basically demanding that the law enforcement people do something about the rising crime that we see every day.

These are not good indicators, Scott, going forward.

This is where the average family that is basically living paycheck-to-paycheck in the state of California, barely making ends meet because our housing is the most expensive, and housing has not taken a tumble in this post-COVID world.

Uh, housing is still very expensive.

Rents are still very high.

The average family that looks at all these challenges, uh, sometimes says, “You know what?

I'm done.

And maybe I need to move out to Idaho or I need to move out to Arizona or Nevada or some other place, ” just like, for example, the extremely rich people are doing so.

So, I think the challenge I see, going forward, is the very rich people are leaving.

Uh, and then, of course, the smarter middle class families are leaving.

That's turning the state into a poor state, when it comes to the distribution of wealth and when it comes to the economic income that families have.

And that's not sustainable, because if you want to see what that looks like in the long run, I point to New York, or I point to Michigan because those are examples where, over a period of time, the policies basically were counterproductive and they became economically poor.

So, if you were sitting down, advising the policy advisors for the Sacramento region, where would you be telling them to focus their... their time and attention in growing the economy over, say, the next 2 to 3 years?

We have to get the policymakers to address some of the socioeconomic challenges, like, for example, the rising homelessness, uh, the rising crime.

At the same time, I think the policymakers need to show something distinct, thats visible, that they support business in this state.

Uh, so far, I think what we have seen from the policymakers is quite the opposite.

They seem to be very dismissive of businesses leaving the state, large companies leaving the state.

They're very dismissive of the fact that California is a state which is considered be- to be very anti-business.

Uh, I think that needs to change because we are a great state, We have a great geography here.

We have great human talent and human capital.

We want to bring more manufacturing here.

We want to bring more high tech jobs here.

But increasingly, we are seeing quite the opposite.

Manufacturing is, uh, you know, is leaving the state, has been leaving the state.

And even tech companies are getting sick and tired.

And while they have a presence here, they're moving their operation someplace else.

And finally, last word on this.

If there's a sector for the Sacramento region to watch that's going to be emerging and important to us, what is it?

Outside of the state government, the only sector, in my opinion, that's a bright spot for us is the healthcare sector.

The healthcare employers like Dignity Health, Kaiser, um, Sutter, these are the largest employers.

They are well-paid jobs.

Healthcare is a growing industry because of an aging population that we see.

We have seen a huge influx of population from the Bay Area calling Sacramento home because this is a very attractive place for residential purposes.

That's going to boost the healthcare industry even more.

And I see the healthcare industry as, like I said, growing and being the bright spot for us, for the next decade.

And I think that we'll leave it there.

And I will just mention that we also have, uh, the UC Davis Health system as well.

Go Aggies!

All right.

And that's our show.

Thanks to our guest and thanks to you for watching Studio Sacramento.

I'm Scott Syphax.

See you next time right here on KVIE.

♪♪ All episodes of Studio Sacramento, along with other KVIE programs, are available to watch online at kvie.org/video.