There's a big change happening in business that doesn't show up in the daily headlines. It's about the foundation cost of capital in the economy, and some of its biggest effects will be on the labor market and how companies use it.

What is changing is what economists call the “real interest rate”: the basic cost of borrowing after adjusting for inflation. In most growing economies, the real interest rate is positive, as there is a tangible return to invest in new capital. But for years, the real interest rate in the US was close to zero – and even negative – as the Fed injected trillions of dollars into the credit markets.

Those days are over. Even with interest rates on hold, the Fed continues to pull money from the credit markets sale of long-term securities. At the same time, governments around the world are holding back historically high levels of debt, a large component of credit demand. Together, these factors make financing more difficult for businesses.

Recent Fed estimates suggest that the real interest rate on the 10-year safe-haven is up close to 2% after moving about 0.5% before the Covid-19 pandemic. The current interest rate that companies have to pay to borrow money starts at this number of 2% and adds inflation on top. So with 3% inflation – where the economy seems to be stuck now – the total rate comes out to at least 5%. And that's just for the safest borrowers; growing companies will have to pay more.

Despite the Fed's best efforts, inflation is expected to persist just above its 2% target for several years to come. So unless the truth interest rate falls, companies borrowing to raise capital can expect to continue paying high rates for a long time. Here's what this means for the way they do business.

Connected: How small businesses can master a complex labor market

More labor, less capital

A rise in the real interest rate makes capital—productive items such as buildings, machinery, and computers—relatively more expensive than labor. In response, companies will probably shift the mix of inputs they use to produce goods and services. Growing companies especially will be more likely to hire and less likely to borrow. Companies that are not growing can slow the loss of staff. With greater demand for labor in a market that is still tight by historical standards, workers may be regaining some of the bargaining power they lost over the past year or two.

Automation pending

With more labor-oriented inputs, trends in production processes will also change. Movements towards greater automation in both manufacturing and services will be slower, all other things being equal, as will the adoption of new technologies such as artificial intelligence. Automation was an important long-term play for companies dealing with labor shortages over the past several years. For companies considering it now, that game could be much more expensive.

Slower wage growth

If companies invest less in new capital, then their workers will have less productive things to work on. As a result, their productivity will not increase as quickly. So although higher labor demand may push wages up, the economic fundamentals that drive wages up in real terms over long periods may be weaker. On balance, the economy may have lower unemployment, but without the rapid wage growth that often comes with a tight labor market.

Connected: 4 How the job market is changing now

Greater stability in the workforce

Real interest rates are usually high associated with higher savings rates. When people and businesses have more savings, they are better able to weather economic and financial shocks. There is also some evidence that prices are less volatile when real interest rates are higher. So the coming years may show a bit more stability, at least as long as the economy is driven by fundamentals rather than external shocks.

This will be a welcome development for the labor market, which is finally finding a measure of stability after the dramatic fluctuations of the pandemic. An unstable economic cycle means high rates of hiring and firing—as well as increased recruitment costs, increased friction in production, and less investment in training and employer-employee relations. If the economic cycle calms down, the negatives will turn into positives.

All these trends will occur simultaneously and may reinforce or counteract each other before the economy settles into a new equilibrium. (Who said economics was simple?) But the general trend is pretty clear: a greater focus on work, with a more stable, perhaps less dynamic, labor market. After the wild ride of the past few years, this is something workers can welcome.

As for businesses, those who need to borrow to raise capital may want to reconsider some of their plans. Relying more on manpower and less on technology may seem like a step backwards, but it doesn't have to be one; new and cost-effective tools for workers, such as generative artificial intelligence, can offer the best of both worlds. At the very least, businesses can benefit from labor market stability by making deeper investments in staff who will stay for the long term.