Why HR Professionals Need to Think Like Economists?
 

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Thinking like an economist means more than just understanding inflation and economic terminology. There’s a deep connection between economics and a company’s ability to recruit and retain talent. Let’s dive in.

This article is authored by Caroline Styr, Head of Thought Leadership Research, and Will Weightman, Vice President, Global Pricing.

If you’ve taken a flight over the last few months, you may have experienced first-hand the concept of ‘finite resources,’ whether it’s the lack of ground staff impacting departure times, or the lack of hospitality staff reducing the chances of a tasty pre-flight breakfast. Post-pandemic talent scarcity means that the right people with the right skills are now a finite resource for many organisations. This key economic principle is the cornerstone of HR strategy for organisations struggling to find great talent to get the work done.

‘Thinking like an economist’ doesn’t just mean understanding the economic terminology that underpins the work of HR. HR must also look more broadly at economic factors that impact employment levels, and ultimately an organisation’s ability to recruit and retain talent. Using these factors, HR must work with stakeholders across the business to prepare for various scenarios that could impact the talent supply at their organisation.

How do economic factors impact HR?

Before we dive into specific economic factors relevant to organisations, let’s first briefly explore how economic factors relate to employment levels.

Economists will intuitively relate a country’s economic growth to its employment level. When an economy is growing, there is more demand for goods and services and subsequently more people are required to deliver. This relationship was formalised by Arthur Okun, a professor at Yale University, who established a statistical relationship between the two in 1962. According to Okun’s Law, a country’s Gross Domestic Product (GDP – the most common measure of economic growth) has a connection to employment levels, with a 1%-point increase in employment level being associated with a 2-3% increase in GDP.

That means that any economic factors impacting GDP will also impact talent supply. Policymakers, economists and central bankers frequently use Okun’s Law, including during the Great Recession (2008) and the covid-19 economic fallout.

The relationship between GDP and employment level postulated in Okun’s Law is useful as it allows us to make predictions about employment levels and therefore talent scarcity, based on GDP predictions. In our recent research with Economist Impact, we based global and regional employment level forecasts on Okun’s law and the Economist Intelligence Unit’s GDP predictions. We predicted employment levels across 75 countries until 2025.

GLOBAL LABOUR MARKET RECOVERY
When employment levels globally will return to the pre-Covid trend, in an optimistic and tempered scenario

It’s also important to take ‘employment rate sensitivity to GDP’ into account. Okun’s Law is not a one-size-fits-all approach. Different regions’ employment level will be more or less impacted by changes in GDP than others. For example, according to our research, North American employment levels are very sensitive to economic growth compared to the Asia Pacific region, where there is low sensitivity.

It’s also important to take ‘employment rate sensitivity to GDP’ into account. Okun’s Law is not a one-size-fits-all approach. Different regions’ employment level will be more or less impacted by changes in GDP than others. For example, according to our research, North American employment levels are very sensitive to economic growth compared to the Asia Pacific region, where there is low sensitivity.

Which economic factors should organisations pay attention to?

Examples of economic factors that impact GDP, and therefore employment levels, include interest rates, inflation related to the war in Ukraine and supply chain disruptions. These factors should be prioritised on a region-by-region basis. As discussed above, there is no one-size-fits-all. Based on our research, we’ll look at two regions and the related factors that are most influential: North America and Europe..

North America

The US economy rebounded strongly following the shock of the pandemic, and the labour market strengthened during the recovery period. In March 2022, the economy added 431,000 jobs and unemployment fell to 3.6%. It has remained flat since then. Our research expects employment rates to fully recover to pre-pandemic levels by the end of 2023.  North American labour markets are, however, extremely sensitive to economic growth. Therefore, the main economic factor that should be considered is Fed interest rate increases. The Fed, along with other major central banks in the global economy, will need to take decisive action to rein in inflation. The EIU expects the Fed to raise its interest rates a number of times in the next 12-24 months, reaching 2.9% in 2023. There is a risk that the Fed raises interest rates too quickly and the US economy enters into a recession. In labour market terms, pressure on wages would be significantly reduced. This scenario, and the subsequent impact on wages, talent attraction and retention, is one that organisations operating in the US should prepare for.
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Europe

The war in Ukraine is the factor that could have the biggest impact on GDP, and therefore employment level, over the next five years. As a result of the conflict, the EIU downgraded its global growth forecast for 2022 from 3.9% to 3.3% in Q1 this year. Before the war in Ukraine, employment in Europe was expected to fully recover to pre-pandemic levels in 2022. Now, European employment might not recover until 2024, There are numerous sub-factors of the Ukraine war should be considered and prepared for, depending on the organisation’s industry and location. These include energy and commodity price shocks, supply chain shocks, which will cause a slowdown in trade growth, and the delay or cancellation of investments.
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Using scenario planning to prepare for labour market uncertainty

The myriad of economic factors impacting the global labour market, and each regional labour market differently, leaves organisations operating in times of great uncertainty.

Companies navigating this economic and labour uncertainty should undertake a great deal of planning, with business and labour strategies in place for a few of the most likely outcomes. Firms that emerge successful will be those with the agility to respond quickly and creatively to changing business and labour market conditions. For multinationals, factoring in the nuances of the various markets in which they operate will be imperative.

This type of planning is often referred to as ‘scenario planning,’ which, for HR teams, should form part of a Strategic Workforce Planning programme. In its purest form, workforce planning is a framework for analysing both the current and desired future states of the workforce, which must be scoped in accordance with business context and strategy. Workforce planning can be a very complex, analytical activity involving advanced technologies and many varied data inputs. Although workforce planning is based on numbers and data, it should not be seen as dehumanising. Instead, this data helps leaders to understand and address the challenge of having the right people, with the right skills, at the right time.

The result of strategic workforce planning is a plan (or prediction) of talent requirements and sources over a given period. Scenario planning is the process of producing variations or alternative versions of the workforce plan to predict and prepare for the impact of any external factors that are likely to occur. In this sense, HR professionals can consider the impact of economic factors, such as rising interest rates and the Ukraine crisis, on their labour needs, potential sources of talent and demand over a certain period. The workforce plan is not static – instead it should be reviewed on a regular basis, considering the development of relevant factors.

It is imperative that workforce planning activities include stakeholders from across the business. It will require a collaborative effort across the strategy, human resources, operations and finance functions to map out the impact not just on team structures and operations but also on finances if higher wages for retention erode profitability. Furthermore, experts from across the organisation should be used to input into scenario analysis and validate the predictions made.

Three key takeaways:
      Economic factors, such as inflation, the Ukraine crisis, supply chain disruptions, monetary policy decisions (e.g., interest rate changes) and resulting economic growth or decline, have a significant impact on the labour market. This should be considered and planned for by HR professionals. The same events impact different regions differently, as employment level sensitivity to GDP varies across geographies and different factors impact regions specifically.

      ‘Scenario planning’ is a tried and tested strategic method of predicting the impact of various external factors on an organisation’s labour demand and supply. Planning effectively balances the labour force location and flexibility with potential scenarios. Organisations should ensure they have an effective Strategic Workforce Plan in place.

      Workforce planning and scenario planning are not HR-only activities. They should be based on strategic business priorities and influence leaders’ decision-making across the board. HR needs to collaborate with strategy, operations, business and finance functions from across the organisation.

Final word

The global labour market is yet to recover from the Covid-19 pandemic. Organisations are facing great uncertainty, but this time should be viewed as a transition period rather than a permanent state of disruption. HR professionals who think like economists are in a prime position to help navigate these challenging waters. By responding quickly and creatively to changing economic and therefore labour market conditions, organisations are capable of emerging from this period not just intact, but stronger and better positioned.