New Year: Old Challenges - Dealing with the Generation Gap

Companies that take DEI and ESG to heart have an easier time recruiting.

Airplane in hangar
Diane Swonk

Diane Swonk

Chief Economist, KPMG US

+1 312-665-1000

New Year: Old Challenges - Dealing with the Generation Gap
Companies that take DEI and ESG to heart have an easier time recruiting.


“Time may change me, but I can’t trace time.”

 -David Bowie, Changes, 1971

David Bowie’s hit song became an anthem for a generation of young baby boomers who were ridiculed for what was seen as an attack on societal norms, backlash to the war in Vietnam, concern for the environment and mistrust of the government. There is a lot of irony in that.

I knew intellectually that my age and late birth into a generation that defined the very term “generation gap” would someday catch up with me; I just did not know when. I found out over the holidays.

My son and I were waiting for his favorite comic to perform. He quipped, “What happened to generation X – why aren’t they angrier at baby boomers?”

We were discussing the voting patterns of millennials compared to earlier generations. They are the first generation to track more liberal instead of conservative on social and economic issues as they hit their 30s.

He is technically a “generation Z” but the reality he sees is not vastly different from that of his older, millennial sister. They are both angry at the decisions that older generations made and the economic opportunities lost due to the timing of their birth. Their privileges stemming from being born to a parent who reaped many benefits provide little solace. They see themselves as part of a whole, not unique.

He traced the arc of his short life and that of his sister, which included an extensive list of challenges:

    • 9/11 and the decades of war that followed.

    • Our affinity for carbon fuels and consequences for the environment.

    • The blow to lifetime earnings for those who graduated into the Great Recession and the years that followed.

    • An overhang of student debt.

    • A hundred-year pandemic.

    • An inability to afford a house or an apartment.

    • What remains the worst inflation in four decades.

    • Deep divisions and dysfunction in our government, which have further eroded our trust in institutions and could threaten democracy itself.

Watching Congress struggle to accomplish the most basic of tasks, elect a new leader for the House of Representatives, drove home the last point. A showdown over the debt ceiling is suddenly back in play, which is a ticking time bomb. The bond market has lost patience with foolish politicians and will punish us if we allow Congress to even flirt with defaulting on our debt payments. The pummeling of the U.K. bond market last September is evidence of that.

This edition of Economic Compass takes a closer look at the generation gap, what that means for the labor market and how it could impact the trajectory for inflation. Prime-age (25-54 years old) workers are becoming scarce, which means labor shortages are becoming more structural than cyclical.

Companies realize this and are more actively thinking about ways to invest in labor-saving technologies and how to better retain workers. Those who walk the talk on Environmental, Social and Governance (ESG) initiatives rank higher on worker engagement and profits. The challenge is that those shifts take time, something the Federal Reserve lacks.

The Fed has doubled down on its pledge to derail inflation, even though officials believe that requires a rise in unemployment. Most within the Fed expect the economy to stall and unemployment to rise by more than one percent in 2023; two participants at the last meeting forecast a full-blown recession.

The good news is that Fed-induced recessions are easier to recover from than balance sheet recessions. Our analysis suggests that the economy is more responsive to rate cuts than rate hikes. That is yet another reason that the Fed is focused on going the distance to risk overshooting on rate hikes. Otherwise, it could fall short of its goal to derail inflation.

Solid End to 2022

Real GDP is expected to rise 2.3% in the fourth quarter after jumping an upwardly revised 3.2% in the third quarter. An acceleration in consumer spending, stoked by lower prices at the gas pump, drove those gains. Inventories were also amassed but will need to be drained as we move into the start of 2023. Residential and commercial construction slipped further into the red, business investment receded and the trade deficit widened. Exports fell even faster than imports. Government spending slowed as Congress scrambled to pass a budget in the lame duck session.

Prospects for early 2023 are not as good. ISM and PMI readings for both manufacturing and service sector activity both slipped into the red in late 2022. Average hourly earnings fell faster than inflation, which further depleted the cushion on savings. The Fed continued to raise rates, the bulk of which have yet to hit credit markets. Lenders in the vehicle market have been particularly slow to pass along rate hikes to borrowers given the dampening effect that higher prices and financing costs have already had on affordability.

In response, the economy is forecast to contract by an average 1.8% in the first half of the year. The housing market, business investment and inventories are all expected to contract. Consumer spending will remain slightly more resilient, juiced by a 8.7% cost of living adjustment to Social Security payments. Those cover more than 66 million people who have a higher propensity to spend those checks.


Where Have All the Workers Gone?

Aging Demographics

Recent research by the Federal Reserve Board suggests that more than two million of the 3.5 million workers not participating in the labor market are due to a surge in retirements. Some of that represents the natural aging of the baby boom into retirement years.

Participation rates for the over 65 crowd rose steadily between 1995 and February 2020. It fell off a cliff and has not come back since the onset of the pandemic.

That was due to fear of infection and the higher risks associated with frontline jobs as the economy reopened. Long COVID may be playing a role as older workers suffered the worst of COVID infections. The isolation of the pandemic and cognitive decline among workers who retire early may have eroded their skills and ability to return.

Men have retired at a faster rate than women since 2019. Women cited family responsibilities at twice the pace of men. Many women retirees are caring for either their grandchildren or elderly parents.

A slowdown in the economy could exacerbate these trends, as employers opt to hold onto younger, cheaper workers. Attrition is an easier way to reduce staff than layoffs. However, the shifts could deal another blow to the participation rate of older workers over time.

Shortfall in Legal Immigration

Legal immigration plummeted after the 2016 election when more stringent immigration policies were put in place. The border closures due to the pandemic exacerbated that drop.

Those figures have begun to reverse but, barring a major change in policy, are likely to continue to fall short of the demand for prime-age workers. Congress punted on immigration reform during the lame duck session. Immigration shortfalls and pandemic fatalities left us with 1.5 million fewer prime-age workers than was expected prior to the pandemic.

Loss in Prime-Age Participation

One of the most pronounced trends of the post WWII era has been a loss in the participation rate of prime-age workers. The U.S. now ranks last among the Group of 20 countries, which includes the largest developed and developing economies.

That is true for both women and men. Yes, you read that right. Women’s participation in the labor force peaked in 1999 and has since lagged its peers. The participation rate among prime-age women in Canada, our neighbor to the North, reached 88.5% in November, more than 12% ahead of that for the U.S.

A lack of maternity leave and of access to affordable childcare are the primary reasons. Immigration is another; immigrants tend to participate in the labor force at a higher rate than native-born residents. They choose to immigrate to work and improve their economic opportunities. Immigrants also account for a disproportionate share of high-quality patents and innovation, but I digress.

The situation for prime-age men in the U.S. is even worse, with labor force participation on a multi-decade downtrend. The problem is not limited to the U.S.; it is just worse here than elsewhere, despite a lack of social safety nets. (See Chart 1.)

Researchers have tried to understand the gender gap in participation. There is a litany of reasons. Some of the most common include:

    • More bouts of long-term unemployment take a toll on mental and physical health and trigger a cycle of poverty for families and communities.

    • Mass incarceration and the opioid crisis, which are even more damaging to families and communities.

    • A loss of vocational education and apprenticeships.

    • Societal norms, which discourage men from accepting jobs in fields dominated by women.

    • A growing gap in educational attainment between women and men, with women far outperforming men in high school and higher education; 60% of college graduates are now women and even more account for new college entrants. The pandemic exacerbated those losses with more men dropping out of high school and college.

    • The blow in social status associated with stagnant wages and a loss in educational attainment.

The last point is particularly important for understanding the loss in participation by white men. A recent study by Pinghui Wu of the Federal Reserve Bank of Boston found that the blow to social status – a loss in education and lagging wages – explained 44% of the drop in participation among men over the last 40 years; all that decline was driven by the drop in participation by white men.

Richard Reeves of the Brookings Institution wrote in his recent book, Of Boys and Men, the unique challenges that Black men face. One example stood out. He discovered his godson, who is a tall Black man, wearing tortoise shell glasses. Reeves joked that he too needed glasses as he aged. His godson clarified. The glasses were not for his vision; the lenses were clear. They just made it easier to do well at his job.

After much research, Reeves discovered that the practice is so common that defense attorneys use glasses to soften how juries view Black male defendants. They call it the “nerd defense” to blur the threat juries see when a Black man sits in a court room. The same does not hold for white male defendants.

“Knowing they are perceived as a threat, Black men resort to unneeded eyewear, not to see us, but so that we see them,” Reeves concluded.

That is before we deal with the talent that is discarded due to disabilities, including neurological differences. This is a topic close to home. I am a severe dyslexic who watched her father carry his dyslexia to his grave rather than admit it to his friends. I used it in his eulogy to commend the obstacles he overcame and the tenacity of this character. One of his “closest” friends countered me, saying that he was too smart to be dyslexic. The two do not go hand in hand.

People of color and those lower on the socioeconomic ladder have an even harder time being seen and getting the resources they need to unleash the talent they possess. I find that mind-boggling, given the need for all-hands-on-deck and war for talent at all levels of the economy. Just imagine how much more productive we could be without those hurdles.

Chart 1: Multi-Decade Downtrend

Prime-Age Men Participation Rate, SA, %

Chart 2: High Quality Business Formation Surged

US: High-Propensity Business Applications (SA, Number)

A Demand Surge

Add a stunning surge in the demand for workers; wages skyrocketed. Job openings soared to record highs along with the ratio of job openings to job seekers. There were two jobs for every job seeker in the Spring and early Summer of 2022. That ratio eased to 1.7 in November. That is still well above the one-to-one ratio that the Fed believes is necessary to align labor demand with supply. 

Why such an extraordinary demand for workers? Our analysis suggests that more than half of the run-up in job openings could be explained by the jump in the number of high-quality new business formations since reopening. Those formations only include businesses that plan to hire workers. Lower barriers to entry with work-from-home, easier credit conditions and venture capital funding fueled that jump. (See Chart 2.)

Tighter credit market conditions and caution by venture capital funds are expected to take a larger toll on new business formations in 2023. That will cool demand but will not eliminate the gap between the demand and supply of workers.

Chronic Shortages

The most recent forecast from the Bureau of Labor Statistics shows the labor force growing at a 0.5% annual rate between 2021 and 2031. That is half the pace of the 2010s and follows a virtual standstill in labor force growth between February 2020 and December 2022. (See Charts 3 and 4.)

That is important for employers to keep in mind as they make tough decisions on layoffs. They may want to keep more workers than usual so that they can more rapidly ramp up once the economy rebounds. That is called labor hoarding. 

The shifts have intensified the desire by employers to boost worker productivity. The most recent KPMG Insights on Inflation survey revealed that more than three quarters of the firms intend to invest in laborsaving technologies to reduce labor costs.

Firms often rely too much on substituting capital for labor rather than leveraging technology to bridge skills gaps. The bulk of the “savings” associated with those technologies accrued to the owners of capital, while workers were displaced. That fueled distrust of technological innovation and its implementation.

Making matters worse is our starting point. Research done prior to the pandemic shows that ultra-low interest rates discouraged business investment. Large industry leaders took advantage of low rates to invest more aggressively than smaller competitors. That left their followers so far behind that competition eased. The largest and most dominant firms were deemed “lazy monopolists,” which set back the whole economy.

More than two thirds of employers in the KPMG Insights on Inflation survey hope to improve worker retention to keep costs in check. That is where ESG targets and hybrid work schedules play a role. Firms that walk the talk on ESG targets rate higher on worker engagement and profits than firms that do not.

A joint study by Indeed and Glassdoor revealed that 72% of workers aged 18-34 said they would consider turning down an offer or leaving a company if their manager (or potential) manager did not support Diversity Equity and Inclusion (DEI) initiatives.

The ranks of those valuing DEI initiatives waned with age. Baby boomers over 65 were the only group unlikely to turn down a job or quit when managers did not support DEI initiatives.

Economists Nick Bloom, Steve Davis and Jose Mara Barrero started the largest survey of workers and managers on work from home in May 2020. Their research is the most comprehensive since the onset of the pandemic. They identified several important trends: 

    • Work from home is here to stay but preferences vary wildly from those who never want to return to the office to those who prefer office work; younger workers lean into returning.

    • Workers value the flexibility of working from home more than managers; working from home 2-3 days a week is worth 8% of their pay, or $8,000 on a $100,000 salary.

    • Hybrid work is better than fully remote for those who work in teams.

    • Managers need to be explicit about when and how work gets done; no one wants to take a zoom call alone in an office with their team still fully remote.

    • Women with small children and underrepresented minorities are the least likely to want to return to offices.

Bloom and his colleagues have used that last point to underscore the role work from home needs to play in meeting DEI initiatives. I have a slightly different take. It is important to understand why women with young children and underrepresented minorities prefer more fully remote options. Both groups have unique hurdles to showing up in an office, including systemic bias and microaggressions.This gets closer to the core concerns of younger workers, who now dominate the labor force. 

Chart 3: Employment Growth Slows

Civilian Employment, 16+, SA, Millions

Chart 4: Labor Force Has Been Stagnant Since 2020

Civilian Employment, 16+, SA, Millions

Implications for Inflation

Core PCE inflation peaked in early 2022 but remained elevated at the end of the year. We do not have the data for December yet, but it is a good bet that core PCE will remain well above 4%. That is more than double the Fed’s 2% target.

The deceleration from above 4% to 2% takes longer – two years – than the move off the peak. Wages and prices get sticky, especially in the service sector, where wages play a larger role in setting prices.

Our forecast shows a more rapid cooling in inflation than the Fed. A shallow recession and a faster retreat in shelter costs are the primary reasons.

More Balanced Risks. The December employment report was about as close to a Goldilocks scenario as we could have hoped. Unemployment plummeted, average hourly earnings cooled and earlier wage gains were revised down. Those shifts, combined with an easing of supply chain disruptions, could cool inflation faster than is currently forecast.

The hard part is the risk of yet another supply shock. China’s abrupt abandonment of its zero COVID policies could further disrupt supply chains, while Russia could make good on its threat to retaliate against NATO countries for sanctions. Another spike in food and energy prices cannot be ruled out.

A Marathon for the Fed

The Fed sees fighting inflation as more of a marathon than a sprint. The first half goes by quickly. The hardest mile falls somewhere between 18 and 21. Around then, even the most seasoned marathoners hit a wall. That is when they sharpen the focus on crossing the finish line.

History is littered with central banks that quit too soon and failed. The Fed is determined not to be one. The fed funds rate is expected to peak in the 5% to 5.25% range in early 2023, but the Fed will not hesitate to go higher if necessary.

The economy is much more sensitive to rate cuts than hikes, which means that rates need to fall more slowly than they were raised. The fed funds rate is forecast to drop from a peak range of 5% to 5.25% in the Spring of 2023 to 4% to 4.25% in December and 3% to 3.25% in 2024. That is still well above the 1.5% to 1.75% range we were at in February of 2020.

The question is when the Fed will pivot and cut rates. The Fed has rejected the push by some to stop with inflation at 3% instead of 2%; it can’t risk the blow to credibility that a shift in the goal posts would represent. That suggests that it will not start cutting rates until the 3% handle on inflation is breached, which is not expected until late in the fourth quarter.


Bottom Line

David Bowie had it right all those years ago; he was just ahead of his time. The children that we bore “...are quite aware of what they are going through.”

Change is the only constant. Younger workers are ensuring that by refusing to track right instead of left in their views about social issues, the economy and the environment. They will rebel against those who wish to turn back the hands of time. They have no desire to return to a world which delivered the economic outcomes they are living on a real-time basis.

I find hope in that even if I do not agree with all of their solutions. Decisions by more diverse groups are inherently better than those made by more homogeneous groups. I look forward to the color that younger generations will add to our economic landscape. The picture they paint is likely to be brighter than the one we gave them.