Preparing for a Future Labor Shortage
How to stay ahead of the curve
Despite the current rhetoric, demographic trends suggest the potential for a shortage of skilled workers as the baby boomers retire. What can you do to ensure that you maintain a productive enterprise?
Is a Systemic Labor Shortage Developing?
A systemic labor shortage occurs when the overall number of new job openings exceeds the number of qualified new entrants in a national economy for a sustained period of years. By definition, systemic labor shortages spread across a wide range of occupations and skill groups. Systemic labor shortages have been recorded historically when nations transition from wartime economies to peacetime economies, when widespread health problems or plagues devastate an economy, or when major innovation cycles such as the Industrial Revolution transform work organizations. Today, national and global demographic changes are a potential catalyst for a long-term systemic imbalance.
According to the Employment Policy Foundation (EPF), a systemic labor shortage is expected to transform the workplace over the next 25 to 30 years as the gap between baby boomers and entrants of college-educated workers widens due to the boomers’ mass retirements. If the U.S. economy continues to grow at three percent per year—the economy’s consistent average since 1948—the workforce will have to increase by 58 million employees over the next three decades if the same rate of productivity is maintained. Yet, if the current population trend continues, the number of workers will only increase by 23 million. This trend would create an overall U.S. labor shortage of 35 million workers. Most of these projected shortages are expected to involve workers having specific skills.
The consequences of such a skilled worker shortage at the national level would be substantial. Results would include: reduction of the growth in the standard of living, compared to historical trends; higher wage-push inflation; potential decreases in international competitiveness, and even the erosion of future domestic production capacity.
While recognizing that there are many economists who do not necessarily share this perspective, we address the arguments for a potential systemic shortage, show why managing shortages in specific industries will be more difficult during such systemic shortages, and document management techniques and options to minimize the negative effects of shortages on business performance.
The Causes of a Potential Systemic Shortage
Three primary factors have been identified as the reasons for a pending systemic shortage: demographic changes, changing labor force participation patterns, and the need for productivity increases. These three factors are important signals that business must track in order to determine the ultimate size and depth of a systemic shortage. As with any national system, the U.S. economy works within the boundaries of its resources and production potential. The U.S. economy’s boundaries are expected to be much narrower than in the past, thereby limiting future growth potential.
In the next 30 years, the primary demographic change in the U.S. will be an increase in the number of Americans over the age of 65. According to the middle population forecast of the U.S. Census Bureau, this number will surpass 70 million. If one assumes that that retirement and entry rates into the labor force will continue to follow established trends over the next 30-year period, then the number of retired older Americans will grow by almost 25 percent, while the number of people aged 16 to 64 will grow by less than 15 percent. In such periods, the number of consumers grows faster than does the number of workers. Such a change in the workforce balance will exert pressure on businesses to provide products and services more productively.
The Bureau of Labor Statistics (BLS) reports that participation rates of working-age men have actually fallen from 87 percent to 75 percent over the past 50 years. During the same period, the participation rates of working-age women have increased from 32 percent to over 60 percent. Robert Szafran has shown that by 2015, the projected participation rates for men and women are expected to be equal. However, to attract more working-age women, businesses must transform recruitment and hiring programs.
Given the EPF and Census Bureau demographic projections for the U.S. as well as the changing labor participation patterns predicted by Szafran and the BLS, one can easily see why productivity has gone from being a need to becoming a passion. Studies show that increasing productivity by an average of two percent would decrease the projected systemic shortage by 44 percent. One of the most controversial productivity enhancement programs in progress is the outsourcing of skilled jobs. Business, labor, the government and the voting public are actively discussing the pros and cons of sending such jobs offshore. In the public debate so far, no one maintains that outsourcing efforts are the solution to future systemic labor shortages.
Finally, as shortages expand over time, there is a natural tendency for businesses to try to recover lost productivity from past job postings that went unfilled. Businesses do this by redesigning the positions so that fewer, but more highly skilled, employees can accomplish the work that must be done.
Understanding the Phases of a Shortage Cycle
Systemic labor shortages ripple through industries and skill groups at different times and rates. Industries that enter early in the process provide to those that enter later opportunities to learn which managerial programs are effective. Researchers have shown that labor markets can take as long as 35 years to stabilize when major innovation cycles occur.  Basing their observations on the patterns of events recorded in other systemic change sequences, the authors have identified three stages that the current demographically driven cycle can be expected to go through. The three stages are provided here to assist managers in determining where their industry is and how effective tactical programs tried earlier in the cycle by other industries are in slowing the effects of labor shortages.
The Formative Phase
The early, or formative, phase consists of a series of changes that creates a gap between demand and supply. For example, the current nursing shortage is the result of several changes:
- substantial increases in demand for nurses due to the aging of the population and the requirement for higher nurse/patient ratios;
- increased time required to obtain nursing degrees.
The early phase, which begins with the knowledge that a shortage is emerging, usually lasts three to five years. In this phase businesses tend to increase compensation to attract skilled workers. This solution creates problems for managers since it increases overall costs of doing business. Managers seek other options as the labor shortage enters its middle, or accelerated, growth phase.
The Middle Phase
This middle phase, which can last five-to-ten years, begins with new information that indicates the shortage will become substantially larger than first anticipated. In this middle phase, businesses typically turn to automation and information technology to reduce the required numbers of workers and slow the market demand. However, technology responses often require substantial upfront costs and substantial execution risks. In the Standish Group’s 1995 landmark study of IT projects, executives representing more than 8,000 IT projects for 385 companies stated that over 30 percent of the projects would be cancelled before they were completed. The executives went on to say that over half the projects would exceed their costs by 189 percent.
The Final Phase
The third and final phase of a shortage cycle begins when technology investment options are replaced by process re-engineering and structural market changes. Changing work processes to reduce the number of skilled workers needed is often more expensive and is riskier than making technology investments. More options are available than managers realize due to changes in the structure of the labor market, which also take place in this phase. Sources of new workers emerge as the costs of worker shortages become large enough to attract new resources.
In this phase, increased costs from compensation, technological investments, and re-engineering processes have elevated business costs, but often have not met expectations. Consequently, less financially stable companies exit their industries. As companies begin to exit the market, the demand for workers decreases and the shortage diminishes. The businesses that endure are ones that apply the right combination of solutions and adapt to change quickly and cost effectively. This phase can last more than ten years in a systemic shortage cycle. At the end of the cycle, the question becomes when the next shortage will emerge.
Learning from Current Shortages: The Nursing Shortage
In a systemic shortage cycle some industries will be drawn in earlier than others. A good example is the shortage cycle for registered nurses. The lessons learned can be valuable for all industries if the U.S. goes through an overall shortage cycle in the next 30 years.
Today, the current shortage of registered nurses is estimated to be 200,000. The shortage is expected to grow to between 800,000 and 1,000,000 by the year 2020. This shortage first emerged in 1995 and is already well into its accelerated growth phase.
In the early or formative phase, hospital managers recognized that there were multiple reasons for the shortage to be substantial. The reasons included the following: an age demographic pattern featuring more nurses retiring than entering the profession; shrinking sources of new nurses; substantial increases in demand for patient care as the population continues to age, and new work options emerging for nurses, including in-home care and assisted living. The shortages led in time to rising vacancy rates. Vacancy rates for registered nurses in Maryland rose from 5.5 in 1996 to 13.9% in 2000. The average hospital having a nursing staff of 480 nurses in 2000 was projected to need an additional 71 more hires than it had had five years earlier in order to sustain an average 10 percent growth rate. . In time, compensation rose dramatically. The National Sample Survey of Registered Nurses in 2000 showed that the annual average salary of Registered Nurses had increased to $46,782. In 2002, starting nurses in the San Francisco Bay area were being offered salaries up to $65,000, plus signing bonuses of up to $5,000. 
In the middle phase, policy and research institutes carried the shortage message to the state level. In 2002, the Health Policy Options at Michigan State University reported that the nation was facing a nursing shortage predicted to reach a 20 percent deficit by 2020. The report stated that at the same time, the number of newly licensed nurses in Michigan had dropped 24 percent between 1997 and 2002, while retirement rates had moved up to 15 percent. The authors noted that “Michigan is not exempt from these trends.”
Armed with this information, managers have tried a range of different programs in the middle phase. The programs have included the following: technology initiatives to reduce the number of nurses needed in the future; retention programs that focus on making managers accountable for retention; hiring of offshore nurses from India, the Philippines, the United Kingdom and Mexico; new hire programs to reduce first year losses, and high-performer programs to target retention. Programs have even recently begun to track retention and report results on decision making dashboards. The nursing shortage has now entered the third and final phase, and the shortage is still estimated to last another 20 years. No single program is viewed as capable of eliminating the wave of shortages that are expected to ramp up again in 2005.
Now in the late phase of the shortage cycle, managers are looking to new paradigms. Among the approaches being examined and implemented is a crash program to decrease the amount of time required to earn a nursing degree and to increase the number of available openings in nursing classes by increasing the number of teaching faculty members. For example, a $15 million grant from Long Beach Memorial Hospital Foundation to California State University Long Beach is based on this approach. The money will be used to increase the flow of new nurses and to provide an accelerated bachelor’s program for current nurses. Another approach is to develop flexible scheduling programs, such as is being done in South Bend, Indiana, and to create flexible, remote learning college offerings.
The ultimate lesson to be learned from this cycle is that looking for a silver bullet to solve significant shortages in a systemic shortage period is not realistic. Tactical combinations of programs and new paradigms will become the standard as the U.S. economy produces increasing labor shortages in many areas for the foreseeable future.
Effective Management Choices
In a systemic shortage cycle that is expected to last over the next 30 years, managers faced with skilled labor shortages in their industries are encouraged to take actions that put them ahead of the shortage cycle. The steps noted below can be useful even in a briefer or less pronounced shortage than the authors anticipate will occur. If managers begin to see signs of a skilled labor shortage developing in their businesses, they can assess and choose from the list of options below that are featured in the three phases of a shortage cycle.
Early or Formative Phase, of a Shortage
- Be prepared to pay more to attract and retain employees. Increased compensation is a fact of life in the early phase. By being prepared, managers can ensure that they are not the last to increase compensation and thus end up with the worst of the labor shortage, i.e., either the worst candidates or no candidates at all.
- Look for substitutes, such as student interns and offshore employees to minimize the labor shortage in your organization.
- Distinguish your organization. Branding is not only for products! A great company brand will both attract and retain employees.
- Try several different programmatic innovations to find out what works for you. These innovations can include such things as the following: compensation increases, automation efforts, improved working conditions, improved image, increased fringe benefits, increased learning opportunities, increased diversity, employee safety, and flexibility.
Middle or Accelerating, Growth Phase
- Address a mix of choices and programs. Look for the mix that yields the best return possible on investment. Look to see what others in the market are doing. If most companies have the same program mix, try something different and target a different kind of employee.
- Don’t do things one at a time. Sometimes slow and steady does not win the race. Managers need to quickly decide the course of action for each phase of the shortage cycle. It is possible to combine compensation increases, technological investments, and re-engineering processes and implement them together.
- Conversely, remember that one does not always have to combine processes or programs in order to begin implementing them at the same time.
Late or Market Restructuring, Phase
- Adjust your programs to fit the changing market. Remember that the assumptions used to project the changes will progress during the cycle.
- Be prepared to take advantage of new sources of employees, technology, and re-engineering concepts that will appear throughout the shortage cycle.
- Maintain financial stability. You do not want to be one of the companies exiting the market in the late phase due to financial contingencies.
- Retain flexibility. Flexibility will allow your company to transition effortlessly through the three phases. Not adapting swiftly enough to the next phase can leave you paying hefty sums for technology when the rest of the market has re-engineered. You don’t want to be left behind.
Managing a shortage is a tactical problem that most, if not all, managers will have the opportunity to face during an upcoming system labor shortage cycle. Be prepared.
 Employment Policy Foundation, “Future Labor Skill Shortages Jeopardize American Prosperity,” October, 2001.
 Robert Szafran, “Age-Adjusted Labor Force Participation Rates, 1960 – 2045,” Monthly Labor Review, September, 2002.
 Gerhard Mensch, “The Co-Evolution of Technology and Work-Organization, Work, Organization and Technology, G. Mensch and R. Niehaus Editors, NATO Conference Series, System Science, volume 11, Plenum, June 1981.
 IT Cortex Editors, “Failure Rate Statistics”, IT Cortex web site, April 2000.
 Maryland Hospital Association, Statewide Vacancy Rates 1996-2000, July, 2001.
 National Hospital Indicators Survey, available at: http://www.hcfa.gov/stats/indictr.(no longer accessible) August 2001.
 Reuters, “High Salaries, Signing Bonuses Greet Nursing Grads”, San Jose Mercury News, June 2002.
 Marilyn Roberts, Judith Andre, et al., “Nursing Workforce Requirements for the Needs of Michigan Citizens,” Institute for Policy & Social Research and Institute for Health Care Studies at Michigan State, Informing the Debate, June, 2002.
About the Author(s)
Donald M. Atwater, PhD, is a practitioner faculty of economics at the Graziadio School of Business and Management. Previously, he served as chief executive for a southern California technology company, the chief financial officer of an international, value-added software company, a principal in the human resources and compensation practice at William M. Mercer, and a director and co-founder of several start-up companies. He has created decision-support technologies and implemented them in a number of Fortune 100 companies, including AT&T, Intel, Dell Computer, Apple Computer, and Nestle USA. Dr. Atwater has also worked with many public organizations, including the U.S. Navy, the General Accounting Office, the state of California, and both the county and city of Los Angeles. His work has been published in the Monthly Labor Review and he has co-authored numerous papers. Today he owns and operates a company dedicated to building goal-driven communities.