unemployment

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Manufacturing Keeps Growing

There are two points to make about manufacturing. First is today’s Institute of Supply Management report on manufacturing activity. The second is my take on an ongoing discussion at fivethirtyeight.com where a great post on the decline in US manufacturing has generated a great deal of discussion.

First the ISM report.

The index of manufacturing activity dropped from 58.4% in January to 56.5% in February. While the decline is disappointing, I don’t think it signals a new cyclical downturn because there were a number of extenuating circumstances last month, not least bad weather causing a few slow days of production. If the decline continues into March and beyond as the weather improves, then we should be concerned. In any case, any reading on the ISM index above 50% indicates overall growth, so we have now experienced a few months of steady expansion in activity in our factories. Late last year I was a little skeptical about this pick up: the much ballyhooed inventory adjustment could be sufficient to have spurred it. Now that the adjustment is over – or appears to be – we will start to get a good look at whether there is sustainable growth developing in the manufacturing sector.

One bright spot in the ISM news stands out: the sub-index for employment rose to 56.1% from 53.3%, indicating that factory hiring is starting to increase. As long as this index stays above the magic 50% mark, jobs will steadily become more available.

Now for that Fivethirtyeight.com discussion.

The thrust of the discussion is that there is a misunderstanding about the state of US manufacturing. It is commonly stated in the media and politics that the American manufacturing sector is in decline. This sometimes shows up as statements such as ‘we don’t make anything in America anymore’.

This is simply not true. US manufacturing production has risen steadily for decades. So has industrial capacity. Setting aside the normal downturns during recessions, this increase in output has gone on throughout the post-World War II era.

The problem is not production so much as employment: the pace of productivity growth in manufacturing has been so strong that it has outpaced output by a mile. That means the US produces much more using far fewer workers than ever before. So there has been a steady loss of jobs, a loss made particularly stark by the current crisis, even though our factories have been busily making more stuff. The result is that industrial areas of the country have lost jobs throughout the last few decades, and that older less efficient factories have been closed. This elimination of the older less productive factories has caught the attention of pundits, but the establishment of the newer factories, often with much smaller workforces, has gone less noted.

The auto industry is a case in point. The loss of jobs in and around Detroit is well documented, and is the constant cause of political and media based commentary. Meanwhile many states in the South are now littered with new auto factories churning out cars for companies like Nissan, Honda, and Toyota.

So why the angst?

The lost jobs tended to be high wage blue collar jobs that a less educated worker could perform well in and support a decent lower middle class lifestyle on. The abundance of factory jobs combined with the safety net of the New Deal provided the major underpinnings for the rapid rise of the American middle class in the 1950’s and 60′. As those jobs diminished a section of society found itself incapable of maintaining that lifestyle: the replacement jobs that were available, and sufficient to make ends meet, tended to require more formal education; while other jobs, those more fitted to the displaced worker’s educational levels were insufficient – wages were too low. So even when an ex-factory worker could find a new job in the same locale as the factory, it often failed to provide a good enough income. Hence the steady decline of Detroit and other older industrial areas.

This story is actually one of success for our manufacturers, who have been able to keep their businesses humming despite intense global competition. We all benefit from this in the form of lower prices for the things being produced in the better factories, which leaves us with cash to spend on other things. Obviously the workers who produce those other things now have jobs that were not there before, so the benefit ripples out well beyond the immediate impact.

The down side to this is that the displaced factory workers have to be re-absorbed into the economy somehow. And that is where much of the angst emerges. We have no been very effective at re-training large enough numbers of these people. The result is that there has been a steady attrition from the working population: the number of people at work as a percentage of the adult population has drifted down in recent years, and one major cause of this drift is the decision of many ex-factory workers not to seek full time employment any more. The impact has been felt particularly on the adult white male population, whose workforce participation rate has dropped away strongly over the last decade or so, and is now at historically low levels.

In many ways this is a long term adjustment process intractable to short term measures. As the factory workforce continues to shrink, other employment opportunities dominate for the next generation of workers, and the problems of the older generation simply disappear.

Then there is the problem of wages. One reason why wages have been practically stagnant in America for the last decade is that the number of high wage factory jobs is steadily declining, and that the newer, replacement, jobs carry lower wages. This produces a squeeze on family earnings and, since the cost of living has not declined, the standard of living has tended to drop along with the wage stagnation. It is this squeeze on disposable incomes that has spurred all most of the angst, and the constant references to the decline in manufacturing. The lower middle class has been subject to a long term vicious squeeze that will not abate any time soon. I attribute much of the rise of extreme politics to this trend: people are working hard and yet are unable to maintain growth in living standards. This, naturally, translates into a feeling of alienation from society or government, and hostility towards other groups who become the targets of envy or suspicion. Illegal immigrants are an obvious such group.

The productivity spurt was associated with the growth of, and industrial application of, new technology, especially information technology. The advent of robotics on production lines is a good example of this. This is not an unprecedented process. American agriculture has gone through similar waves of change, with exactly the same results. At the turn of the twentieth century American agriculture was in crisis: yields were declining and profits were being severely reduced. Innovations in production, largely promulgated by the newly created Agricultural Department in Washington, arrested and reversed the decline with such success that agricultural production rose rapidly at the same time the employment on farms dropped – an exact analog to the manufacturing situation today.

The analogy breaks down, however, in one crucial respect: the wage differential between the lost jobs and the gained jobs. When agriculture went through its technological revolution the displaced workers were able, eventually, to find work in unskilled factory jobs that often carried a higher wage than they had been earning before. This coupled with the burst of agricultural productivity gave a significant shot in the arm to the economy as a whole: the newly growing mass of factory supported households not only had better wages, but those wages were able to buy more produce because the cost of farm goods dropped. Today we see a different and more difficult transition taking place: the new jobs do not offer wage increases, so the standard of living increase brought about by the abundance of cheaper manufactured products is offset by the lower wages – there is no kick to growth in our standard of living.

This is, of course, not universally true. Some parts of the workforce, those with a higher level of education, have seen strong growth in their standard of living. They have been able to take advantage of the lower cost of manufactured goods and thus they have been able to allocate more spending on peripheral services. The problem is that the provision of those services is not a high wage activity.

The productivity revolution in manufacturing has, thus, not had the same impact as it agricultural analog. It has been much more specific in its benefits and has tended to undermine rather than encourage a general growth in our standard of living – the enormous separation in incomes and wealth in modern America is, in part, attributable to this problem,.

The solution is both difficult and long term. We need to encourage the creation of new high wage manufacturing jobs in industries that have lasting potential: energy conservation and ‘green’ technologies are examples as is biotechnology. Plus we need to provide a better transition for displaced workers. What we need to avoid is protection, which only absorbs money and prevents us from reaping the benefits of productivity advancement.

In a nutshell: our manufacturing ‘problem’ is not one of decline, but of success. We are producing more and using less to do it. Unfortunately that means a lot fewer jobs. So, our issue is not industrial, it is post-industrial. We have failed to adjust adequately to our own success and, especially, we have failed to create the kind of jobs we need to prevent a decline in the lower middle class. Until we do it will remain commonplace to see a problem in manufacturing where, in fact, there is none. And the likelihood of a drift towards extreme, and volatile, politics will continue.

That’s something worth trying to avoid.

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Orders and Jobs: Have We Hit A Wall?

Durable Goods Orders:

On the surface this morning’s durable goods orders report is a good one: they rose 3.0% in January, which is a much better performance than most folks had expected.

However, when we dig beneath the surface the story is reversed quite dramatically. If we exclude aircraft orders, which shot up over 15%, everything else declined by 0.6%. The decline was fairly widespread across the economy so we cannot pin the drop on a specific, and compartmentalized, sector. Were February’s report to be a repeat of this news I would start to get a little more nervous about GDP later in the year. Durable goods are generally taken to be a decent, though not hugely accurate, indicator of the near future in the rest of the economy. This is because factories and other businesses place their orders for the big investment items that fall into the durable goods category in advance of expansion. So durable goods orders rise as businesses conclude that their future sales are likely to rise.

Conversely a drop in orders signals a hesitancy on the part of business to invest. So toady’s news is not a good sign. Having said that we should not leap to dire conclusions on the basis of just one data point or month’s worth of information.

As I said above: February’s report now takes on more meaning.

Obviously the fact that total orders rose is not a bad thing at all. My guarded reaction stems simply from the fact that the momentum was contained solely in the very volatile aircraft sector. Because of the huge cost involved in aircraft orders that part of the data bumps all over the place and so we generally remove it to get an idea of what is going on across the economy. January is one month where that decision reveals something we all wish was not happening.

Claims For Unemployment Insurance:

One of the reasons we are all hyper-sensitive to the monthly blips in the various economic reports is that the employment situation depends so strongly on our ability to get general economic activity going at a sustainable positive rate.

This mornings report on claims for unemployment assistance simply underline the need we have. Claims rose again, by 22,000 to 496,000. This is the sixth week, out of eight, that claims have risen this year, and we are perilously close to having given up all the good gains we saw at the end of 2009. Clearly the job market is stalled. Almost every subcategory of the report tells the same story and so , just as in the durable goods data, we cannot place the blame on any particular sector. This is a generalized problem.

Some analysts are claiming that the great wave of firings is now over, and that implies the next wave, that of hiring, is just around the corner. I have a more jaundiced view: the wave of firings may be over, but it isn’t yet finished. The new claims data is rising slightly which means there is still a steady trickle of people being fired. And we seem to be a very long way from a hiring ‘wave’. So far away that it is hard to envisage one this year.

My argument goes this way:

Employment is a lagging factor. This means that businesses both fire and hire after they see a turn in the economy. The durable goods index I talked about above is a leading factor meaning that businesses place orders ahead of a turn.

Let’s put both today’s reports together: the leading indicator, durable goods dropped. I know it only one month so let’s wait for a month or two before we get to firm in our conclusions, but for the sake of my argument I am going to say that the drop in orders suggests a drop in business expectations about sales later this year.

That pull back in expectations is based among other things on the poor consumption data we have been seeing which the very poor consumer confidence numbers released this week support.

So businesses see no reason to build capacity to meet future sales since they don’t expect sales to surge.

Plus current capacity is more than sufficient to meet any increase in demand: the economy is operating between 6% and 8% below capacity. Consumption would have to soar for businesses to hit a ceiling and need to add to capacity. And soaring it is not.

Now, back to employment.

Since hiring is something businesses do after they face an increase in sales, and since I see no indication of a surge in demand sufficient to drive businesses close to their capacity constraints, I have to conclude that the jobs market is going to fester in its current limbo.

I think my slightly jaundiced view is backed up by the data, and that the optimists are selling us a story they want rather than one they can justify on the facts.

In view of this argument it is easy to see, I hope, why I think the so-called jobs bill that just squeaked by in the Senate is a derisory waste of time. It weighs in at $15 billion. Which is tantamount to zero in the context of both the size of the economy – which is the region of $14.5 trillion – and the size of the problem. The fact that it is next to impossible to get legislation passed to get help out where it matters suggests to me that Congress either doesn’t realize what’s going on, or it doesn’t particularly care. Given the invective spent over the last two years and the blather about the crisis I can only conclude that it is the second of these two explanations that is true. For some reason Congress doesn’t care.

Which is a shame, since all this week’s reports should be flashing a great big warning sign: this recovery, such as it is, remains on life support.

All the risks – the factors that could change the course of events – are negative. Meaning it is far more likely that the economy will slow down than it will speed up.

All in all this week has produced a stream of data showing an economy that has moved up from the nadir reached last year, but which is now struggling to maintain any kind of forward momentum. We need a boost from somewhere, but it is hard to see where it could come from.

So I stick with my forecast of 1.5% to 2.0% growth in 2010 GDP for now.

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More Jobs Frustration

This is probably the way it will remain for a while: the jobs market is clearly stuck and shows very little sign of improvement no matter how much huffing and puffing the Wall Street boosters and financial media try to parse the numbers.

Last week initial claims for unemployment insurance rose by 31,000 to 473,000, while the four week moving average fell very slightly – by 1,500 – to 467,500. Basically this means that any gains we saw at the turn of the year are gone and we are in a fluctuating sideways movement of sorts. Which is not good. And before anyone gets too worked up over the drop in long term or repeat claims, which fell to 4.59 million the lowest in a year, we should all realize that the main reason for the decline is that people are giving up the search for work.

By any modern, post-war, standards the employment market is awful and looks as if it will stay that way. There are six workers looking for a job for each vacancy, and 41% of the unemployed report that they have been looking for more than six months. This makes the average period of unemployment the longest on record, and the long term unemployment figures set new records almost weekly. How can I say ‘awful’ in a new and imaginative way?

To put this bleak situation in perspective: we need to start adding jobs at around 125,000 a month to keep up with population growth; and we will need to generate around 425,000 jobs a month additionally to clear out the backlog of unemployed within two years. That means we need 550,000 new jobs a month sustained over twenty four months just to pull the unemployment rate back to ‘normal’.

Not going to happen.

We haven’t seen that kind of vibrancy for decades – even the go-go 1990’s managed only around 400,000 a month, on a sustained basis, at its peak.

So we have dug a formidable hole, from which we will emerge only very slowly.

We got there through our own foolishness: stupid allocation of capital to housing which was subsequently wiped out; an anti-social banking system that syphoned off capital away from innovation and productive – i.e. job creating – activities; and antiquated and unresponsive political structures incapable of dealing with the crisis. It is important that we all absorb the enormity and inter-connectedness of the issues. The failure is not isolated to one part of society it is a complete systemic failure. Nor is it a new phenomenon: the entire last decade has been a disaster for economic policy, the financial system’s implosion merely exposed how terrible the extent of the rot was.

The ‘fix’ won’t be cheap or easy. Getting the economy healthy is a long term project that will entail cutting back the banks, investing in infrastructure, encouraging innovation, and re-educating loads of workers. Along the way we will need to get the budget under control which will cramp consumption. To offset that we will need to pump up investment and explore new industries.

The gridlock in Washington, which is now our biggest single problem, is stopping us from making headway in many of these key areas. We need government leadership in some of these projects because at their inception the risk/return trade-off is too poor to attract private capital. The internet is a good example of the kind of research and project management that we need to replicate. It was all sponsored by the US government in its early stages, with the World Wide Web being invented in Europe by scientists at CERN, together these two activities then allowed private capital to move in and exploit the opportunities that have made the internet so profitable and commonplace. But now we cannot get anything like that started because the political situation prevents government spending on research at the level we need. Not just this, but we haven’t even managed to get agreement around things like the environmental problems facing us – meanwhile other countries are taking the lead in alternative energy, waste management, and environmental protection industries, all of which are likely to generate flood of jobs in the future.

My favorite example in this context is solar energy: the world’s largest manufacturer of solar panels is an American firm based in Michigan – a state in sore need of jobs. The business relied on government research and other assistance to maintain its leadership as it developed its product line. In the early 2000’s the Bush administration eliminated that support in the name of government spending cutting. The firm promptly moved its operations to Germany, where support was forthcoming, and now has eliminated its production in Michigan. Germany is now the world’s leader in solar panel technology and the US is trying to catch up.

All of this is by way of explaining how difficult it will be to get the job market back to health. We cannot spend months or even years in a self-indulgent political process that produces absolutely nothing. Global competition won’t wait for our dysfunctional system to work its way through issues at it 1700’s focused pace.

In the face of an enormous jobs crisis we cannot even get a jobs bill passed through the senate. Just how bad does it have to be before we reform ourselves?

No wonder some folks think the country is going down the drain. The way things are it looks as if that’s what we all want.

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Jobs: That’s Better!

Amidst all the stupid hysteria about the weather – as if we haven’t seen big storms before – news about the economy has been hard to find. Perhaps that’s good after all the rotten news we’ve been deluged with for the last couple of years. Still it’s nice to emerge from the igloo and read that there has been a slight pick up in the jobs market. It is slight, and it is one data point, but maybe this is good news.

This morning we learned that last week new claims for unemployment assistance dropped by 43,000 to 440,000. Now that is much better. The last few weeks have been worrying because the improving trend in claims for unemployment that had appeared last fall stalled from November through late January. Indeed the numbers had started to back up and reverse some of the earlier gains. At the time there were a variety of very credible reasons given for the adverse trend: bad reporting, administrative delays at the state level, and possibly flawed seasonal adjustments were all cited its potential cause. Obviously each week that went by without an improvement undermined the notion that there was a technical reason for the ‘bad’ data, and we were forced to confront the idea that, maybe, the data was correct: things were stalling.

Today alleviates those fears and allows us to take a more encouraging view: the labor market is showing signs of ending its dismal run.

This does not mean that it will suddenly break into a canter and run away into growth. Far from it. But we need these early steps towards better times if we are to see overall improvement throughout this year. At the moment the White House is predicting job gains of about 95,000 per month, on average, for the year. Since we are through January and lost 20,000 so far, that looks like a stretch. Even if we meet that prediction unemployment will not fall much because the labor force grows by more than that much. Each month we fail to add about 100,000 jobs we fall further behind population growth. Remember this comes after the last decade which was the worst on record: a mere 400,000 jobs added in ten years while the population grew 33 million.

So, what do we make of this morning’s news?

If we were at school: “shows improvement”. We all know that means “not good enough, but better”.

That’s where we are right now.

But, definitely showing improvement.

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Midweek Mash-Up

The winter blues have hit, not just in the form of a big snow storm, but also in the form of a steady drizzle of mediocre news. There is nothing much to report, so let me collect a few small items into one.

  1. House Prices: There are reports from around the country, most notably on internet real estate listing sites, that home prices are headed down again. This is after a few months of firming. This cannot be a surprise, yet it is being greeted by the financial media as an ominous sign of imminent worsening throughout the general economy. That’s not true. The cause and effect runs the other way round. It is because the general economy remains sluggish that the firming trend in home prices is giving way. I have been talking about this for months. Here’s the story: last summer and fall the housing market revived slightly because of the stimulus package – there was a ‘first time buyer’ tax credit. That brought a steady trickle of buyers onto the market at a time when they probably would not have been there without the stimulus. Demand was artificially bumped up from whatever its ‘natural’ rate was. That little boost to demand was sufficient to arrest the slide in home prices and even reverse it in some places. But the underlying, non-stimulus, price movement remained downwards. I suspect there was also a short burst of ‘pent-up’ demand – people who had money and had postponed moving while they waited to see if prices dropped some more. When these people saw prices firm they jumped into the market and bought. All that ‘pent-up’ demand does is to move the transaction from one time period to another – it does not add to total demand. With both these effects exhausted, and with aggregate demand in the economy still weak due to laggardly employment and wage experiences, there is only one way for prices to go: down again. And that’s what I expect to happen as we move into spring. Whether the normal spring surge in home buying materializes is the key factor we all now watch for. If it does prices will stop falling. If it doesn’t prices will drop throughout the year.
  2. Trade: The trade deficit widened in December. That will take a bite out of fourth quarter GDP growth, when it revised later this month, and is the most likely trend this year for trade. Our basic problem: oil imports, re-emerged as the driver of rising imports. Both the price and consumption of oil rose sufficiently to overcome a 3.3%increase in exports. Overall, imports rose by 4.8% to $189.2 billion, with crude oil imports rising 9.2% by volume and about 1.0% in price. Exports reached $142.7 billion. Our problem now is the turmoil in Europe and its knock-on effects on world trade and currency movements. Throughout 2009 trade had been a very positive factor for GDP, and now it looks very much as if that trend will flatten out if not reverse. This means that our reliance on imports could dampen growth significantly this year making GDP growth of over 2% difficult to maintain.
  3. Interest Rates: I must admit the nonsense spoken about interest rate can get tedious. All weekend long and throughout this week so far there has been talk of the Fed’s imminent release of its ‘exit strategy’. This is the magical plan that will, according to the pundits, set out the way in which the Fed undoes all the support that it gave the economy in 2008/2009. Don’t forget that to most of these pundits we are in dire danger of a massive burst of inflation due to the huge injection of cash that resulted from the Fed’s support. That overhang of cash is thought to be waiting in the wings to flood the economy and drive up prices unless the Fed can drain it beforehand. Setting aside the theoretical issues I have with this notion, the threat of inflation is so remote currently that I find it odd we even have to have this conversation. But such is the prevalence within the financial markets of the incorrect thinking underlying fears of inflation that the Fed seems compelled to announce such a plan. Guess what? Bernanke says that his concern is too little growth not much and that we will maintain low rates for the foreseeable future. Well duh! People who fear inflation have to be the same ones who imagine a rapid recovery. Since such a recovery is unlikely – I would argue it’s impossible – inflation simply will not be a problem this year or next. In fact there are still traces of deflationary pressures lingering – notably the enormous unused capacity overhang yet to be re-absorbed by growth. Until that overhang is gone businesses in most industries will have very little opportunity to pass along price increases to consumers. Therefore any price increases at the wholesale level will have to be absorbed by reducing profits. Besides I see no evidence of a boom in final, and especially consumer, demand. As Bernanke says: the threat is of too little activity, not too much. So short term rates are likely to stay flat. As for the longer term rates: the punditry is talking up the prospect of a bond market revolt over our budget deficit. If such a ‘revolt’ takes place we should see a sharp drop in demand for US bonds and hence the need to raise rates to offset that drop. So far there is no sign of such a movement. In fact US bonds are selling well. Why? Because everyone else is in the same hole. Which means that US bonds retain their relative – rather than absolute – attraction. So look for long term rates to stay where they are for a while, but also be aware that the trend will be upwards as the economy improves.
  4. GDP Growth: Lastly, I should update my forecast for the year. The last quarter of 2009 saw a sudden burst of GDP growth, most of which was due to one time effects like the inventory switch I spoke about at the end of the year. Those one time movements have all washed through the numbers and some of the more lasting trends such as the trade improvement I mentioned above are due for a downward revision. It will be no surprise if the fourth quarter figure is reduced somewhat as better data is collected. Such revisions are normal and are particularly likely at times of changes in direction. Looking forward we must all disregard last year’s odd fluctuations and ask what growth is sustainable. The answer seems to be ‘not much’. As long as consumers continue retrenching their balance sheets by reducing debts, and the drop in consumer debt loads is now the biggest in history, I see very little impetus for strong growth. Ours is a consumption economy. Indeed our entire culture is built around consumption. We are not about to change that sufficiently to alter the shape of the economy in aggregate – it will take years to instill a thrift based mentality here. So if consumption fails to ignite so does the economy. While there are signs of the severe drop in demand of 2008/2009 ending there are no signs of acceleration either. With credit markets weak as the banks rebuild capital and avoid making bad loans, with state governments cutting spending in order to balance local budgets, and with trade flattening out or even weakening, projecting GDP growth of over 2% becomes very difficult. Odd movements in inventories could occur, but the underlying economy looks set for a very slow year. So I am sticking with my forecast of 1.5% to 2.0% growth for now.
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