recession

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We Keep On Muddling Along

The economic news continues to be mixed. Not bad, but the good always comes with a twist.

Industrial Production:

Take today’s report that industrial production dropped 0.1% last month. The view on the “street” was that it would grow 0.7%. Even if we discount the analyst’s views, as we should given their optimistic bias and rotten track record, to miss the mark by such a margin requires an explanation.

This is especially true when we also read that the Philadelphia Fed’s index of manufacturing activity has reached 43.4, its highest reading since 1984. The Philly Fed’s upbeat report is backed up by the Institute of Supply Management index that has national manufacturing activity at it highest since 2004.

Taking all this together we are driven to odd conclusions. Either Philly is booming and the rest of the country is in dire straits, or, more likely, the data is being muddled up by something. That something being utility activity which is included as manufacturing, but which marches to a different rhythm. Weather matters. The past month has seen some warmer weather and that has cut utility demand. That cut translates into enough of a drop in power plant production that the overall manufacturing numbers decline rather than increase. If we focus simply on factory output we see that it rose 0.4% in February, the seventh straight month of increase and is now up about 7.0% over the past twelve months. The details within this report reveal that the strength is spread across most industries, which a good sign of overall economic health, with hi-tech and automobiles leading the way. Production of cars is up 14.3% over that last year; and hi-tech activity has risen 16.8%.

Inflation:

The news on inflation is much more mixed, and a little concerning in the short term.

It comes as no surprise to read that the headline inflation index rose sharply last month, by 0.5%. This obviously reflects what we all know: food and fuel prices have risen quickly as various crises and supply issues have disrupted markets. Besides those temporary problems, the underlying shift has been towards prices rising in the face of demand driven by the economic recovery well underway world wide. The trick for policy makers is to tease apart the more problematic longer term trend from the fluctuations caused by these short term disruptions. That’s why they tend to use the so-called core inflation rate rather than the headline number. At this core level, inflation is still relatively low: it rose 0.2% last month. This is well within acceptable bounds and is unlikely to prompt an anti-inflationary interest rate increase any time soon.

Naturally none of this will prevent the austerity hawks from jumping up and down and warning of an impending inflation disaster. They are driven by ideology and not facts, so they will see such a disaster under every possible rock. The confrontation between the Fed’s longer term perspective and the austerity hawk’s opportunistic view leads to some awkward moments. One such was last week when Bernanke tried to explain he was not worried by the jump in food and fuel prices – at least not yet – because they appear to be temporary. He and other Fed officials then pointed to the introduction of the iPad2 and its price as an example of the way in which innovation holds the price of goods down and thus mitigates inflation. The Fed has a valid technical point: we should evaluate prices in the context of the service rendered at that price. If we pay the same for new products that outperform the old ones, then the real price has gone down – we are getting more bang for the same buck. Unfortunately this argument gets clouded quickly in the minds of both austerity driven politicians and the media, leading to headlines that read: “The Fed Says Let Them Eat iPads”. This is what we read in the more sensational press the following day, and is not exactly what poor old Bernanke was saying. It can be difficult sometimes to maintain coherence in the face of determined ideological opposition.

Overall consumer prices have risen about 2.1% over the last twelve months, which is a clear acceleration from the annual rate we were reporting back in November and December.

So the pace is picking up. But by not as much as food and fuel prices would indicate.

Wages:

One normal source of inflationary pressure during a recovery is wage increases. Not this time. Real average hourly earnings dropped 0.5% last month because wages stayed flat and inflation rose. Those flat nominal numbers thus were not a source of inflationary pressure. Over the last year wages adjusted for inflation have fallen 0.4% – since the CPI has risen 2.1% this implies nominal wages have risen only 1.7%. This includes the impact of overtime and longer work weeks as employers ramp up output. Clearly workers are not benefitting from the recovery as much as they used to. The huge unemployment overhang has much to to do with that. Employers have no incentive to raise wages when workers are abundant and relatively cheap. Having said that there is no real evidence of employers increasing their workforces anyway. Which all means that most of the wealth generated from the recovery so far is going to profit and corporate cash flows, and not into household pockets.

Unemployment:

The last piece of news to report today is the weekly data for new claims for unemployment assistance. They fell by 16,000 to 385,000, which brings the four week moving average down to 386,250.

Claims numbers have been very volatile recently and so difficult to read for their significance. I think we can say two things: (1) they are moving in the right direction; and (2) they are moving too slowly. There is still no hard evidence of a strong recovery in the jobs outlook. We appear to be stuck in no man’s land. People who survived the crisis, and did not lose their job, are now feeling the threat of dismissal ebb. This gives them cause to spend and start planning a more normal consumption pattern. But those who lost their jobs are facing a very different outlook. There is no spate of new jobs for them to apply for; their savings and other forms of support are dwindling – if not already exhausted; and their skills are steadily eroding. In other words the economy has split into two very different communities. The one struggling to get back to normal, the other struggling simply to survive.

This separation has bred a feeling of complacency in politics where the emphasis is no longer on recovery, but on shaping the economy beyond the recovery. Hence the sudden shift towards discussions about debt and deficit reduction even while millions of our fellow citizens wallow in misery. Since things are no longer getting worse, the assumption has become it is time to look into the medium or longer term future. This is completely wrong. We are not yet out of the woods. At the current rate of growth it will take years to absorb the unemployed workers back into the workforce. But the more likely outcome is that many of them will simply abandon any attempt to find work and will just drop out of the workforce. This has the effect of reducing the economy’s capacity to grow and thus limits our overall wealth accumulation prospect.

This should be a reason to continue our efforts to expand the recovery by pumping up demand to create jobs. Apparently not. The ideologues are winning, and we are abandoning the unemployed to fend for themselves. Ultimately we all lose as the economy’s potential growth path is shifted down. Since that seems hard to explain not many people are bothering any more.

So: the upshot of today’s news is that we are still muddling along.

The economy is growing at a decent, but not great, rate. The fact that wages are not getting their share of the growth suggests that the shape of the recovery will be biased in the same way as the last one. Profits will do well. That means stock prices will rise. Jobs will be scarce and not well paid. And the squeeze on the lower echelons of society will tighten.

And this with a Democratic president. It shouldn’t be this way.

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GDP: Good or Fair?

The initial reaction to today’s GDP report has to be positive. The economy grew at an annual rate of 3.2% in the fourth quarter of 2010, up from a revised 2.6% during the third quarter. So the recovery seems secure and well on track. Here is my usual breakdown of the parts of the economy and how much they all contributed to the total:

  • Consumption: added +3.0%
  • Private Investment: subtracted -3.2%
  • Trade: added +3.5%
  • Government Spending: subtracted -0.1%

The interesting number here is that consumption figure. Personal spending rose at the sharpest pace for four years, driven particularly by a strong showing in durable goods. This is encouraging because these ‘big ticket’ items are normally easily postponed when households are adjusting their balance sheets and when fears of unemployment prevent people making long term financial commitments. So this gain may be a sign that consumers are feeling better bout the future and might suggest the economy will move ahead well during 2011. Notice all those words like ‘might’ etc. We need to wait and see whether the numbers are not revised downward as better information is analyzed. And we need to see this momentum, if it turns out to be real, maintained throughout the year. Even with all these caveats, the news is good. Sales of services seem stuck in a bit more of a rut and grew at pretty much the same pace as they did all through last year. There has been no acceleration in that sector. So we could easily construct a more negative narrative: consumers postponed their big ticket purchases as long as they could but eventually they were forced to buy – things wear out after all – and the underlying rate of household consumption is closer to the growth rate of services than that of durable goods. Hence the need to wait and see. Incidentally durable goods sales jumped 21.6% from the third to the fourth quarters, hence my mild skepticism about the sustainability of that pace.

The picture in investment was also very distorted. Here it was the run down in inventories that muddled things. Non-farm inventories suddenly shifted into reverse as businesses ran down their stocks during the holiday sales, so after several quarters of helping keep GDP rising, inventories actually knocked a big hole in growth. This change masked a very mild recovery in residential investment which managed to record only its third gain in the last nineteen quarters. Having said that the gain was negligible, but that it existed at all is noteworthy.

Trade too was subject to a big shift. Exports have been recovering quite well for several quarters and continued to rise at a decent rate. But imports suddenly dropped which is why the total impact of trade was so beneficial. Given that worldwide demand for commodities is putting a great deal of pressure on prices I suspect that the trend in imports will turn negative again during the summer. Plus there seems to have been a modest amount of stockpiling of imports during the late summer and early fall which meant importers could reduce their activities subsequently. This too probably shifted the numbers around a bit and so the sharp turn in today’s report may not be representative of a ling term trend.

Lastly, the government spending line is something of a warning. The effects of the stimulus are now well worn down, which leaves us with the increasing drag on GDP caused by the continued, and increasing, austerity at the state government level. This is something to watch. As the austerity hawks gain more control we can expect government spending to taper off somewhat. This will press down on growth and harm our prospects during 2011 and beyond. Today’s report could simply be the beginning of that downward trend.

So, overall, the report is good. Remember it is preliminary and subject to revision. Typically those revisions can be quite large. So keep a large asterisk against this data. Having said that it is good to see GDP running at a rate above 3.0%.

One last thing though: even at this pace we will not work unemployment down very quickly. We lost an enormous amount of GDP activity during the downturn. Had we not had a recession the economy would be about 7% larger than it is today. That’s a lot of jobs. Moreover, at a steady 3.0% rate of growth we would need years – maybe a full decade – to get catch up to where we would have been. So although this is a good report, it isn’t really good enough to get too excited over. We need more rapid growth for a while to make that catch up period more tolerable. There’s not much evidence we will see such an acceleration.

Which means we are in for a long, steady climb, rather than a rapid ascent.

Translation: good, but not quite good enough.

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Our Jobs Conundrum

There are always two things we look for first in the monthly payroll release: the change in the number of jobs, and the change in the unemployment rate. Since these two statistics are derived from different sources they can sometimes contradict each other. Very often they simply move to a different rhythm. Today is one of those days.

The optimists, basically anyone trying to sell stocks, will latch onto the quite sharp drop in the unemployment rate, which now stands at 9.4%. This figure is calculated from a monthly survey of households, in which obvious questions are asked about employment history and attitudes. Last month we had a 9.8% unemployment rate, this month we have 9.4%. That’s the sharpest one month decline since April 1998, which we all recall as a great era for job creation.

So this must be good, right?

Not really.

The problem appears to be that a considerable part of the decline can be accounted for by people simply dropping out of the workforce. Once they say they are no longer looking for work, they aren’t considered unemployed. Presumably, according to the folks doing the surveys, such people are now leading a life of voluntary leisure. Maybe they are. There is no reliable way to tell from the data. Or they could be so disillusioned they they have given up the search for work and are making do by consuming savings or living off the wages of a partner or other family member. The fact is that the unemployment rate dropped predominantly for a negative, not a positive, reason. So headlines touting the 9.4% figure are a little misleading. The truth is more nuanced.

The pessimists will latch onto the increase in payrolls. This number is derived from the survey of businesses – called the “establishment survey” – and is a more solid statistic because it doesn’t include any leeway for opinion or attitude. So the increase of 103,000 jobs is a reliable datapoint. Which is unfortunate because it isn’t very encouraging. After the ADP payroll number two days ago – one that I warned was probably an exaggeration – most analysts had been looking for growth in jobs of at least 150,000. So the actual figure is disappointing. The economy is still not generating enough jobs to cut the unemployment rate consistently. Especially when we consider that about 125,000 new employees enter the workforce each month.

In a way this failure to create jobs is nothing new. The US economy has been very poor at creating jobs fro about a decade. The entire period encompassed by the last business cycle, from 2001 through 2008, was the worst in recent history for job generation. This is something I have tried to hammer away at for years. I spent a great deal of time criticizing the Bush regime for not making jobs a greater focus for policy. Their emphasis was on profits. Given that goal, they succeeded mightily. Profits have surged since 2001. They are now at all time highs. Business is flush with cash. The problem is that the cash is being hoarded or used in non-productive ways. Such as paying massive bonuses to CEO’s!

The key point to keep in mind is that the economy simply is not creating jobs fast enough, and that this trend is a decade old. Something is going on, and that something is not necessarily anything to do with the crisis and the recovery.

Tyler Cowan, in his usual antiseptic way, took a stab at discovering the cause of the problem, and all he could come up with was that businesses have finally shed all the marginally productive workers who they had tolerated before. These workers were those who added very little to the profits of their employer, but who were never fired because their cost was buried within a strong profit stream. The late 1990’s were such a period, so businesses had little incentive to purge unproductive workers. Profits were good, sales were surging, and the time and effort to cut costs was seen as exceeding the benefit. That changed after 2001 when the Clinton boom was replaced by the Bush yawn years. The economy grew, but sales were not growing at anything like their previous rates. In order to keep short term profits rising – to meet Wall Street estimates and to justify CEO bonuses – corporations turned inwards and implemented another round of cost control. Hence the gradual elimination of marginal workers, and the increase in productivity.

That’s Cowan’s thesis in a nutshell. It has a great deal of validity. His solution is far less satisfactory. I can sum it up in one word: tough. He seems to think we should expect to see unemployment rates near 10.0% for quite a while as all these marginal or unproductive workers are slowly re-absorbed. His point being that since these workers are less productive they are also less attractive to hire. They will therefore lurk on the fringes of the workforce for a long time.His thesis also rests on the assumption that there are no fast rising businesses or industries to absorb the size workforce we have. Apparently we have reached a point where we can meet our needs with fewer workers than we have. Maybe that’s because we import so much, but let’s not talk about that today.

I have a couple of problems with this as the only explanation of our jobs drought. First, if it were true that only marginal workers have been eliminated, then I would expect to see wages for the remaining, and presumably more productive workers, rising more than they are. This is because there should be competition for those workers amongst businesses searching to hire. Average wages are showing no signs of such pressure. On the contrary they are lagging behind profits by a very long way. Second, I would expect to see a similar pattern within industries as well. By this I mean if the shedding of jobs is productivity related, then where there are whole industries whose competitive position has deteriorated relative to others, so we should be seeing sectoral shifts in employment as weak industries are pressured by stronger ones. It is hard to detect such shifts going on.

So I am skeptical of the Cowan thesis as a single or primary factor for our malaise. It may well be one factor, it is not alone.

So what is the problem?

I still maintain that the lack of demand is the dominant issue. With aggregate demand so low, as compared with its peak years, there is little or no incentive for businesses to hire. They are managing to meet current demand from their reduced workforces and an increase in productivity. To add more workers would threaten profits and is seen as a high risk proposition given the outlook.

To put all this into perspective, consider this: total employment, that is the number of jobs in the entire economy, is now at about the same level it was in late 2001. We have labored away for a full decade and not added to the number of jobs we have. So talk of a prospective “lost decade” misses the point entirely. We have just lived through one. The next decade would simply be the second such. Fairly soon we will be talking about a lost generation. Or a lost era.

That’s something we should avoid. But the current outlook for policy is antithetical to job creation. Instead it seems to center on making matters worse in the name of fiscal rectitude.

Too bad, because another of the figures in today’s report that needs more attention in the media is the fact that about 44% of all our unemployed have been without work for 27 weeks. That’s a terrible statistic and points to a growing crisis that could destabilize the recovery by undermining demand even further.

Ah. But according to our neoclassical economist friends and their right wing political allies, no one is voluntarily unemployed. They are simply resting up, or are too lazy to get a job. So there can be no negative ramifications from long term unemployment.

Think of it as a holiday. There. That makes it all better. No? Who needs to boost demand when we have managed to get so many people such long vacations?

Ugh.

Addendum:

I want to point you to this chart from Paul Krugman’s blog, I came across it subsequent to finishing my post.

The story it tells is a visual representation of the point I was trying to make above. The ratio of people in the workforce to the total population has dropped precipitously during the recession. But take a look at the period between 2001 and 2008. Payrolls scarcely kept pace with population growth. Early in the decade the ratio fell as job generation lagged population growth. Later in the decade jobs were at last sufficient for the ratio to increase.

This is not a pretty picture. In fact it’s pretty awful.

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The Republican Problem: Reality

Having made all sorts of promises, some specious, some serious, the GOP is finally on the clock. It has to do something rather than object. First up, apart from the ridiculous reading of the constitution on the floor of the House, is a move to repeal the health care reform passed so agonizingly last year. Nothing of much substance will come of all this huffing and puffing since any repeal won’t get far in the Senate, but the GOP hopes to look good in front of its more rabid supporters and stir up trouble for Obama.

The problem is that health care reform, as I ranted on about at the time, is all about cost saving. Health care, apart from defense spending, is our one big budget buster over the next few years, and sensible government action is the only viable hope to reduce that budget burden. Which is what the reform, however flawed, does.

This means the GOP has a bit of a problem.

On the one hand they continue to moan about the budget deficit. On the other hand they want to repeal one of the more plausible ways we have for reducing that deficit. This dilemma was brought into sharp focus yesterday by the Congressional Budget Office, the non-partisan financial watchdog for Congress. The GOP had asked the CBO to opine on the benefits of repeal. The CBO responded by saying that there aren’t any. Further, according to the CBO, the GOP repeal act, provocatively called H.R.2 “Repealing the Job Killing Health Care Law Act”, will raise the Federal deficit, not reduce it.

Whoops.

This is what happens when facts meet opinion.

The reform was designed so as to cut the long term budget. The CBO said at the time that it was successful in that aim. So why the GOP thought that the CBO would suddenly change its mind I have no idea. Perhaps bravado addled their brains. Naturally this rebuff was met with bluster and stutter. John “The Ever Tanned” Boehner, our new Speaker of the House, muttered something about the CBO being entitled to their opinion, and how they were hobbled in their analysis by the 1970’s law establishing the rules within which they have to work. Rules like staying within existing legislation, and being non-partisan. Nasty that. Having to be objective and balanced. Especially when the result is not what you want to hear.

It’s odd that the GOP even went down this road. They knew what the answer would be. Perhaps they want to discredit the CBO ahead of more tricky questions like those surrounding the impact of tax cuts on the deficit. The CBO has been notorious for arguing that if you reduce revenues and not spending then the deficit will go up. That sounds eminently sensible. Since that is also unacceptable in the GOP alternative universe where tax cuts reduce rather than increase deficits, as in supply side economics, it makes political sense to destroy the credibility of any organization who might dare speak up. Even if that organization is specifically set up to be the neutral scorekeeper for Congress. Neutrality is a nuisance for crusaders whose aims contradict their own stated goals. Thus the GOP is firing off a pre-emptive strike against good sense and reason. I suppose this is better than the Bush era when no one bothered to deal with the truth if it got in the way at all.

In any case I expect the Republicans to thunder onward and make more fools of themselves.

They already have bent their own budget rules to make sure no one counts tax cuts as a deficit creating issue. Apparently only spending is a cause of a deficit. Cutting income isn’t. There are plenty of unemployed people who wish they could use that kind of accounting before their homes are foreclosed on. Only in the alternative universe does funny accounting substitute for reality.

After two years of merely saying “no” and whipping up the passions of their oddball supporters, who genuinely believe in funny accounting, the GOP has met its match. No not Obama, he’s as inept as ever. No. The true enemy of the GOP crusade to role back history and reconstitute the 1800’s in the here and now is none other than that nasty concept: reality.

Sit back this will be fun.

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Sticky Unemployment – Okun’s Law

A regular correspondent of mine – Stephan – suggests that I add an addendum to my comment yesterday about the current hyperbole in the media. To refresh your memory, one of my points was that even rapid GDP growth in 2011 is not likely to reduce unemployment significantly, and that to restore the economy to more normal levels of unemployment, or to reach the level economists call full employment, could take years. Lots of years. The point being that we should not get carried away by all the current breathless talk of “surges” or “booms”. That seems just to be Wall Street speak. Stocks may do well. Regular folks less so.

At any rate the basis for my assertion is something called Okun’s law, and it is to this that Stephan thinks I should make specific reference. So here goes.

Like many so-called laws in economics Okun’s law is really more a rule of thumb based upon a detailed review of history. The essential conclusion is that there is not a one-for-one relationship between shifts in GDP and changes in unemployment. For unemployment to move by 1% the typical shift in GDP has to be about 2%. Interestingly one of the authors who has articulated this relationship in detail is none other than Ben Bernanke. So we should assume he is well aware of the hill we still need to climb to get back to health.

Putting this in our current context we can see that growth has to do two things. First it has to cover, or absorb, growth in the workforce due to population changes. A good rule of thumb in the US is that GDP needs to rise by about 2.5% for unemployment just to stay even with such changes. Only after that does Okun’s law kick in. This suggests we need to see GDP growth of 2.5% + 2.0%, i.e. 4.5%, per annum just to bring the unemployment rate down by paltry 1%. And we need to keep repeating this for years on end to undo the terrible damage wrought during the crisis.

So movements in unemployment are “sticky” with respect to overall economic growth. The two do not move in tight lock step.

Growth at those heady 4.5%+ annual rates is well above the long term average for the US.The last time we saw such a string of years was at the end of the 1990’s. For the four years 1997 through 2000 GDP grew at an average of 4.45% per year. We remember those years as exceptional rather than the norm. Given the hobbled nature of our economy and its financial imbalances, not to mention the possibility of anti-growth government spending cuts at the federal and state levels in the near term, I just don’t see the economy making the headway we need.

Most forecasts are for the economy to grow around 3.5% to 4.0% this year, and then to taper off beyond that as various stimulus efforts fade, the atmosphere of crisis gives way to the need to rein in debt, and the emphasis turns to spending cuts or tax increases. It is very difficult to construct a credible forecast for growth sufficient to bring unemployment down to acceptable or more normal levels during this entire decade. Our economy is mature and still very vulnerable to the whims of an unrestrained banking sector. Also, the likelihood, in my opinion, is that somewhere in the next ten years we will see another recession caused by financial instability, an event that would undo all the good work up to that point.

So, putting this all together: Okun’s law provides us with an empirical basis for making the assertion that we will not return to normal unemployment rates during this decade. Further, current and likely policy will make matters worse. This is the reason some observers, like Paul Krugman, talk of a Japanese style “lost decade”. History supports that pessimistic view. The counter view, the more optimistic spin churned out on Wall Street and similar upbeat places, is not based upon a review of facts, but is simply opinion. There is no hard evidence to support the optimists, and no amount of wishful thinking can substitute for empirical study.

In the absence of such hard evidence to the contrary I will go with Okun and his law.

We are in for a long slog. Get ready.

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