Jobs – Where to Next?

This week we will get our next insight into the employment outlook. Today’s ADP employment report – they tell us about the number of people added or subtracted from all they private sector payrolls they process for businesses – gets us off to a good start.

ADP managed payrolls added 216,000 new jobs last month. That’s a lot better than the consensus forecast of 170,000, and a significant step up from January’s revised 173,000. It brings the three month average to 223,000, which compares with last year’s monthly average of 156,000, so clearly things have improved. It is also the twenty-fifth straight month of job growth, and reinforces the overall impression that the economy is enjoying a solid, if unspectacular, period of growth.

The expansion was spread across the economy, so growth appears to be well balanced: small business accounted for about half of the new jobs; the service sector added 170,000, while manufacturing added 46,000. It is this balance that suggests the recovery is sustainable at least as long as events in Europe or the Middle East fail to disrupt it.

With this is mind it is useful to reflect on how the job market might develop through the year – an election year no less.

One issue that immediately comes to mind is that much of the improvement so far has not come from the addition of new jobs, so much as from the steady decline in the elimination of existing jobs. In other words it is a decrease in the rate of firing that is driving the increase in payrolls. As we all know, even in good years businesses are busy both hiring and firing, it is the balance between the two that matters. For the current improvement to continue at the same rate we need to see a shift from an emphasis on fewer firings to an increase in new hiring. That will depend a great deal on business expectations for sales in the upcoming months. That, in turn, will depend on the outlook for wages, and the continuance – or lack thereof – of the debt reduction households were forced into by the banking crisis that started this whole cycle. Unfortunately the prospect for sufficient activity translated into sufficient spending is less bright than we need. So I suspect that the current rate of improvement will falter somewhat as the year progresses. We will still be adding jobs, but nowhere near the rate needed to bring the unemployment rate down to a respectable level. It will be a few years before the economy has restored an unemployment rate within the bounds of normality. That is as long as nothing crops up to ruin the recovery.

One factor that will play a key role in the next few months of job creation is the productivity rate. Much of the initial spurt – such as it was – in growth came not from job creation but from businesses squeezing extra output from current payroll and capital levels. This showed up as an acceleration in productivity. Today we heard that the productivity increase for the fourth quarter was revised up to 0.9% bringing the year as a whole to 0.4%. This is the lowest rate of growth since 1995, and way below 2010’s 4.1%. This suggests that sustained growth in business will now have to come from increasing workforces as it appears businesses have squeezed that last drop out of the current workforce.

Tellingly along side this productivity slow down is a rise in labor costs. There was a sharp spike in the hourly wage rate in the fourth quarter, most likely driven by an increase in overtime pay. The first estimate of fourth quarter unit labor costs had shown an increase of 1.2%. This has now been revised to 2.8% and brings the annual increase to 2.0%, the fastest rate since 2008.

This brings us back to business expectations. With the current workforce fully utilized 0 as suggested by the declining productivity numbers and rising labor costs – the stage is set for a round of new hiring. This would be the best case, and would support a continuance of the current rate of job growth. It is my view that business still has a relatively pessimistic outlook – the various indicators of business confidence are improving but not that rapidly – that drives my forecast of a slight weakening from that current pace rather than a continuance of it.

All this could be cast aside later this week when we hear from the Labor Department. The current best guess seems to be that overall payrolls, both private and public, added slightly less than the ADP figure – in the 200,000+ range. That is decent, but insufficient. The unemployment rate may drop a little, but not by much. This could be the new trend that extends through the summer. We can discuss that Friday.