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Sunday, July 20, 2003

Part I THE PROSPECTS OF THE US ECONOMY CONTINUED: WHY THE ODD JOBLESS RECOVERY SO FAR? (Final Version)

With a few updated comments and new data, this article --- a re-run of one originally printed on June 6, 2003, but still missing thanks to the incomplete buggy archives --- is the latest in a series, started in May, that deal with the US economy's prospects. Thanks to the earlier theoretical work, we can now take up a host of more practical matters --- particularly the problems and opportunities now facing the economy.

 

Economic Performance the Last Year and a Half. A Strange Jobless Recovery

Officially, the recession of 2001 came to a halt in the fall of that year, with economic growth picking up rapidly in the fourth quarter after the 9/11 attacks, and then surging off and on throughout 2002. In the end, overall GDP growth --- real, after adjusted for inflation --- was a disappointing 2.4% last year: not enough to reverse the job losses that the recession caused, and in fact, not enough to stop unemployment from rising throughout 2002 and through the winter and spring of 2003. In more concrete terms, since March 2001, the US economy has experienced a loss of 2.1 million jobs: that leaves the official unemployment rate at around 6.0%, compared to the low-point of 3.9% at the end of the 1990s --- the least unemployment we've had since the mid-1960s. That 6.0% in April was actually slightly worse than the 5.8% recorded for March of this year. (In May, the level of unemployment climbed, it turns out, to 6.2%). A longer-term perspective might be helpful here.

On the face of it, an overall 6.0% unemployment rate doesn't seem too bad, especially if the comparison is with the 1982 recession when unemployment jumped to 11%, something not seen in post-WWII America --- in fact, the highest level since the Great Depression (when unemployment was over double that). But note: the 1982 recession, when it ended, was then followed by a big surge in GDP growth of 4.3% in 1983, then 7.3% in 1984, and an average of close to 4.0% in the years 1985-1989 of almost the same annual output (3.8%). Jobs were being created galore each year, even though the decade ended with slightly more than 6.0% unemployed. By contrast, to repeat, GDP growth the last year was around 2.4% (see Bureau of Economic Analysis)---- far better than the EU and Japan, both of which grew less than 1.0%; but not enough to create new jobs fast enough to hire back those who lost their jobs in the recession of 2001, or new entrants into the labor force. Even apart from a recession and lay-offs, the new entrants require that GDP grows fast enough to absorb about 1.0% more workers each year, on top of the lay-offs. Since the total US labor force is about 140 million (seasonally adjusted, that means creating at least 1.4 million new jobs each year.

Add in the unacceptable 1.5 - 2.0% of the labor force that's lost jobs since 2001's recession began, and we need to find a way to accelerate GDP growth from 2.4% to 3.5 - 4.0% in the next 18-24 months to bring unemployment back toward 4.5% . . . the level of full employment, thanks to big productivity improvements as we'll see, that the economy is now capable of sustaining without setting off an inflationary spiral.

 

And there's worse news for job-seekers.

To the total number of people who are officially unemployed, you need to add those who say in Bureau of Labor surveys that they'd like to work but have been disappointed and stopped looking. That brings the unemployed to 9.2 million Americans. Some of those who stopped looking might, it's true, decide to retire; others will likely want to try finding a job again when the prospects look better. Nor is that all. Another 4.8 million people are working part-time but would prefer to work full-time --- up 46% over the last 27 months. All this points to what a good Wall Street Journal article calls the "most protracted downturn since the4 Great Depression" --- a kind of jobless recovery. (An article by Jon Hilsenrath, a WSJ journalist who did a lot of good footwork for his article, including stats and interviews, is well worth reading in full. See Hilsenrath)

For some good charts and graphs on the job situation, go to the White House economics section.

 

Why the Jobless Recovery

There's no one reason itself that overwhelmingly accounts for the poor performance in the job market the last 2.5 years: rather, several more mundane mishaps and misfortunes that have come together and done their dirty work. As we sort out these diverse minor-league reasons, though, keep in mind that the economy's prospects have improved noticeably in the spring and into the early summer of this year --- something we emphasized in an earlier article published a few days ago (in early June). More precisely, as that article indicated, it'd be surprising what with the improvement in the stock market, certain reports of growing business profits, the big fiscal stimuli caused by the huge federal deficit this year (and into the next for certain), and rock-bottom interest rates --- with the boom in housing construction still going on --- if the pace of GDP growth doesn't accelerate to 3.0 - 3.5% the remainder of the year. An even higher growth rate can't be ruled out.

Whether, oppositely, that likely acceleration in GDP growth will help Bush much in the 2004 presidential election is another matter. By the time November 2004 rolls along, unemployment will still be stuck in all probability above 5.0%.

 

FIRST REASON

One clear reason is indicated by the BEA stats below: shallow recessions, it appears, create, shallow growth recovery in GDP, whereas big recessions like the one in 1982, once they end, are followed by a big burst of investment, consumption, and new job creation. See the annual changes in GDP for the 1980s and 1990s at the BEA site. Then move on and compare GDP growth coming out of the shallow 1991 recession --- an overall dip for the year of -0.5% (the recession lasting 9 months) --- with the growth since 2001's even shallower recession. No big jumps in GDP in the early 1990s: 1992, in fact, looks almost indistinguishable from 2002, and projected growth this year --- around 2.3-2.5% doesn't seem much different from the second year of recovery at the start of the last decade, 1993's 2.7%.

By contrast, the huge recession of 1982 (when GDP fell 2.5% and unemployment leapt to 11.0%) could be expected to generate a faster cyclical recovery . . . exactly what it did. (Sidebar note: the left hand columns at the BEA site are where you'll find annual changes in GDP: ignore the center column (unadjusted for inflation) and instead look at the right hand column there. The columns to the right deal with quarterly changes.) Note that until 1983, the US economy experienced a recession about every 4 to 5 years, and since then only two and those shallow and fairly short-lived.

What explains this big reduction in recessions --- their frequency and their depth, and themselves highly desirable trends compared with the past?

 

The answer: big structural and policy changes in the US economy that have made it far more flexible and adaptive in the last 25 years: deregulation, more pressures from foreign firms, the globalization of the US economy, the remarkable restructuring of US firms to become more competitive, new technologies for managing inventory and firm-to-firm business (the internet), a more flexible and better educated work force, and better management of the country's monetary policies by the Federal Reserve.

As Alan Greenspan noted today (early June 2003), the multiple shocks the US economy suffered in 2001 and 2002 --- a big stock market bust, the 9/11 terrorism, the accounting scandals, the war in Iraq (short-lived, but hurting the stock market revival and business confidence in the run-up) --- would probably have created a huge recession just a generation ago. No longer, and it's something we'll return to later. In particular, as we'll see --- the flip side of the remarkable "resilience" of the US economy --- the big growth in US productivity and the constant pressures on firms to become more competitive have changed the nature of the US economy and left firms more reluctant to hire back laid-off workers.

That's good news for the long-term prospects of the US economy: higher future growth and higher real incomes. How about the short-term, particularly the growth in jobs right now?

It seems to be a different matter, indicating that aggregate demand --- the total of private consumption, business investment, government consumption and investment, plus the trade sector (a current account deficit is a drag on US growth in the immediate year it occurs) --- might be insufficient to overcome the restructuring tendencies of US firms: prompted not least by the fact that since productivity is now much higher than in the past, managers find they can get along with less labor than before. This is a key point. It's worth rephrasing in different terms.

As long as firms can get by with less labor than in the past, then they won't begin to hire more labor --- including formerly laid-off workers --- unless their sales and profits start bounding ahead at a faster clip. Note: Translated into technical terms, this key point would read: the output gap for full employment is now greater than before --- even if full employment now means roughly 4.0 - 4.5% unemployment compared to 6.0% in the 1980s --- precisely because potential output, set by levels of productivity growth and of the associated growth of the labor force, business and government investment, and technological progress, is now much higher than it was in the 1970s and 1980s. We'll take up this point, both in its common-sense and technical meanings, later on here and in the next article.

  A SECOND REASON

There are other if related causes here that seem more specific to the last 10-20 years: in particular, the US has been pioneering the latest phase of creative-destruction in industrial capitalism--- when new kinds of radically restructuring technologies suddenly come into existence, render obsolete older, less competitive industries (most of which migrate to lower-productive, lower-wage economies), and alter markedly the ways we work and live.

In this latest phase, a new knowledge-based economy has emerged . . . forged the last couple of decades or so by leading-edge breakthroughs, one after another, in [1] ICT (information and communications technologies like computers and the internet and networking and e-commerce) and [2] in bio-tech, with [3] nano-technology, the most radical of all, looming on the horizon. (Nanotechnology refers to the restructuring of materials at their molecular base, and far from being a pipedream, UCLA and UCSB, together with private business, are funding a $500 million project to accelerate the practical applications of its promising technologies.) To this list, add [4] the growing impact of globalization --- an accelerated pace in the integration of the world economy, itself caused in no small part by these new technologies such as the fax, the cell phone, the Internet, and 24 hour investment business; but also by the end of the cold war, the triumph of liberal capitalism, and the increased relocation of production by multinational firms. In the process, the leading-edge technologies have diffused more rapidly around the world, and intensified the competitive pressures on all economies, the US no exception, to continually restructure and update their production and distribution systems to enhance their competitiveness. And in the case of the EU welfare-states, say, to reduce their runaway taxes and welfare-payments and free up their labor markets, now bogged down in rigidity throughout the Continent save in three or four small countries in the northern half. (See "Hard Lessons in Capitalism for Europe's Unions," L.A. Times July 21, 2002)

 

To shed more light on this recurrent, revolutionary process of creative-destruction, consider the historical record.

Essentially, since the industrial revolution of the late 18th century --- very much a reality, despite some recent efforts by quantitative economic historians to play down the big breakthroughs that converged especially in Britain after the 1770s --- has experienced five such phases of revolutionary technological breakthroughs all clustered and occurring about every 50-60 years:

1770 to 1830 or so: textiles and iron-and-steel, along with the modern factory system and the exploitation of new metallic and energy resources driven by machines, with Britain the big pioneer.

Then, 1830-1890 or so, big changes in the technologies of communication and transportation: railways, steam-ships, the telegraph, the telephone, eventually the wireless radio, with Britain and France and the US the lead countries.

Then, 1890 to the 1930s, with the US pioneering electrification and automobiles and road-building, along with systematic R&D and mass production techniques (think of Ford's assembly-line production) and new credit facilities for buying durables over extended installment periods. Next, the fourth big phase, 1930s - 1980 --- again pioneered by the US ---- was marked by big breakthroughs in synthetic materials, nuclear weaponry and energy, air travel, modern tourism, the mass media (radio, movies, TV), consumer electronics, modern advertising, and further forms of credit for houses and durables, all changing greatly the ways we lived and work . . . and again, the ways we fight wars.

The late 1970s on, the fifth and still ongoing clustered breakthroughs that ---- themselves all largely matters of information and knowledge --- may not sputter out and be replaced by an entirely new wave of technologies, but instead be spun out for decades or generations. Soon, revolutionary non-carbon energy systems, already foreshadowed by nuclear energy, will likely join these radically restructuring science-driven technologies that have so noticeably marked our lives the last two decades.  

The Relevance to The Job Market Now?

What's the upshot of this new phase of ICT, bio-tech, and likely nanotech and non-carbon energy systems on the US employment situation the last 30 months or so?

As mentioned briefly in a fast, top-skimming manner a moment or two ago --- starting in the 1980s and masked in part by big growth booms in that decade and the 1990s --- there has been a painful, far-reaching restructuring of national economies like the US's and the EU's and maybe Japan's ongoing, full of dislocations and other economic turbulence that are also associated with the changes in the international economy that we dub "globalization." As the pioneer economy, the US has made biggest changes in our production and distribution systems, not to mention the kinds of jobs we find as a work force.

Why our pioneer role? For the same reasons that we've been the lead country with the highest levels of productivity and per capita income since the 1880s, through the last three phases of revolutionary changes . . . disruptions, dislocations, pain, flux, and all: the remarkable and matchless adaptability of our economic institutions, including the flexibility of our labor markets, our abundant entrepreneurial energies, and our innovative forms of financing new firms and products, not to forget the high quality of our R&D base together with the exposure to international and domestic competition alike that force changes through our economy in a relatively quick manner. As one example, 75% of the Fortune 500 companies in the late 1990s hadn't existed in the mid-1970s.

The equivalent new firms in Germany or Japan was virtually nil, and still is. Still, with country variations, the EU economies will continue to try adapting too --- they really have no choice, given the globalizing nature of capitalism and innovation in North America, East and Southeast Asia, parts of Latin America, and no doubt soon parts of East Europe and India. Scandinavia and maybe Holland and Ireland and to an extent Britain will probably adapt faster than France, Italy, Spain, and Germany, all burdened with big welfare states and large resistance to change in their population and political systems. As for Japan, either it finds political leaders willing to deregulate and open up the economy more and force through institutional and structural changes that will be particularly painful for those hugging the status quo, or it will continue to stagger on toward a rapid descent out of the front ranks of the advanced countries, with its better half dozen giant corporations becoming more and more detached from their Japanese base in order to stay competitive.

  Can we be more concrete?

Sure. What the above general analysis implies about the slow job recovery is clearly showing up in the problems of the job market since March 2001, and for that matter a decade ago. Each time long booms end --- the 1980s' seven year boom, then the ten-year one in the 1990s (the longest in US history) ---you get all sorts of excesses, including ballooning stock markets, that need to be pruned out and compensated for, resulting in major efforts by the surviving firms to become ever more competitive as new technologies or improvements in existing ones continue to materialize, and --- no less important ---global capitalism intensifies the pressures on all national economies, the US's included, to become ever more competitive.

That was the case, to repeat, in the early 1990s, when "downsizing" and "restructuring" first became popular terms. For the first time, masses of white-collar workers --- especially in supervisory positions --- saw their long-time jobs eliminated, as they joined the ranks of millions of assembly line workers who had lost their jobs in leaner, meaner industries like steel, autos, and textiles. Autos and steel, for instance, drew more or less apace of Japanese levels of technology and quality by the start of the 1990s, but in the process had scrapped about half their work forces. Most of these jobs were lost, note, in the Mid-West, which transformed itself in remarkable time, for all the pain incurred by those workers who never recovered union protection and good pension and other benefits, into a high-tech region, where each city is eagerly courting new national and foreign firms to locate . . . even as these cities seek to improve local universities and colleges and foster closer governmental, business, and higher-education cooperation. And the pace of restructuring was intensified not just by national deregulation and hence more competition, or even by more and more internationalization of the US economy, but also by the leap in corporate mergers and takeovers, with the outcome of such corporate moves --- often by outsiders taking control of underperforming companies --- leading to a big changes in CEO's and other top managers, including lost jobs for middle-level management, supervisors, and assembly-line or desk-workers.

If you go back to the media coverage of those restructuring industries and firms --- which tended to ignore the new dynamic firms emerging in the Fortune Five Hundred (Microsoft, Intel, Cisco, Amazon, Yahoo, Wal-Mart, and CNN and so on), at any rate until the latter half of the decade --- you'll find gloom and lamentation galore . . . as there is now. In some respects, even more.

As for the concrete data, consider what the labor economist with the Federal Reserve of New York, Dr. Groshen"found. She examined the job trends in 70 industries going back to the 1970s and 1980s and what happened after recessions. Essentially, this: people laid off in those decades were reassured that "we'll call you back when we need you." What's more, the reassurance was backed up by reality for about half of the workers. The other half would find that their jobs were eliminated for competitive reasons --- a restructuring to become leaner and more competitive, especially as new technologies meant that the heads of companies could increase productivity (output) by replacing workers with machines and better organization of the work force, and mergers and takeovers in underperforming companies became commonplace. Now the bad news for short-term job creation in the upswing phase of the business cycle after a recession, initially anyway: that pace of structural change clearly intensified in the 1990s. The result? It's no longer only half of our jobs coming out of a recession that are in industries undergoing big restructuring: rather 75%.

By way of illustration, consider these examples found in the Wall Street Journal article by Hilsenrath". "Payrolls in the electronics sector, and for producers of industrial equipment, have fallen for 28 straight months. In communication, payrolls have fallen for 24 months. In the securites and airlines industries, they have fallen in 16 of the past 24 months." (Sidebar comment: it's not clear whether this data was dug up by Hilsenrath or by the Fed labor econoimist, Erica Groshen. If you go to her site at the New York regional branch of the Federal Reserve, the study Hilsenrath refers to isn't available . . . not even in her work-in-progress. A good reporter, he was able no doubt to get her to give him lots of the data she's grappling with, but he might have uncovered these payroll examples on his own.)

  THIRD AND OTHER REASONS FOR THE JOBLESS RECOVERY

[1] The unusually strong dollar after 1995 until last year --- especially against the Euro and earlier the German Mark to which the eurozone currencies were tied, about a 65% rise --- might be a reinforcing influence in holding back job growth since March 2001 . . . mainly by slowing dowthe growth in GDP, an aggregate matter, but also by reducing US demand for import-substitutes as Americans bought more and more Toyotas and Mercedes rather than Detroit SUVs. Of course, a strong dollar would have held back GDP growth in the late 1990s too, because large trade deficits detract from aggregate GDP, at any rate in principle; but the strong US growth performance and the booming job market would have masked that. (Note the qualifier: "in principle." If anything, the high value of the dollar sucking in so many imports from Europe and Asia might have sustained the boom because it reduced inflationary pressures that might otherwise have built up in the US economy, and reinforced at the same time competition that kept wages from rising excessively as the job market tightened to its greatest level, 3.9% unemployment, in 1999.)

But, you might ask, how could the trade sector's huge deficit, nearly $400 billion last year --- 4.0% of overall GDP --- be doing that if the dollar has sunk so much since the start of 2002?

The answer is multiple.

First, the dollar hasn't fallen against all currencies, rather only the euro and the Canadian dollar: the former by about 40%, bringing the euro/dollar rate back to what it was when the euro was introduced in 1999, and the latter by about 12%. Against the Mexican peso, by contrast, the dollar has risen, and it's about the same for the Japanese Yen (mainly because the Japanese government has intervened actively in currency markets and continually sold Yen to buy dollars). As for the Chinese currency, the Yuan (the Renmimbi in exchange markets), it's fixed in terms of dollars and hasn't risen or fallen. Essentially, to put it bluntly, on a trade-weighted basis --- which takes into account that the fall, say, of the US currency in euro-terms has been 40.0% but US-EU trade is only 14% of total US trade (hence .40 x .14 = a trade-weighted fall of 5.6%) --- the US dollar has fallen only about 9%. See the chart on the US dollar's value in currency markets, adjusted for trade-weight, at the Federal Reserve of Minneapolis. Observe that the dollar is still higher on that basis than it was at the start of 2000.

Secondly, any depreciation of a currency like the US dollar can take anywhere from 8 to nearly 20 months or more to be translated into fewer imports bought and more exports sold abroad. There is even a J-curve effect, in which the initial fall of the dollar for several months --- given that contracts written before the fall call for so many euros to be delivered by, say, Chrysler to its German suppliers in Germany, will worsen the trade deficit, exactly the case for the last year.) And thirdly . . . well, come to think of it, no need to go into this matter here. It'd be better to wait until the next article, a follow-up to this.

Suffice it to say that US GDP will probably bound ahead about 0.5 - 1.0% or so more this coming year (June to June) as a result of the dollar's fall, all depending on some complex matters such as the dollar's future trend --- it's risen 6.0% against the euro since late May --- and elasticities of demand for US imports and exports, as well as growth prospects in the EU, Japan, the rest of Asia, and Latin America, that aren't easy to calculate accurately. (Elasticity is an economic measure of how much a rise (or fall) in the price of a good will produce changes in the quantity demanded. If a 10% rise in the price of a Sony TV produces a 20% drop in demand, that means the demand curve is highly elastic: US consumers will be substituting away from Sonys to more price-competitive Korean TVs. If oppositely, the case with oil back in the mid-1970s, OPEC quadrupled the price of oil in 1973, then doubled it again in 1979, consumers couldn't easily sell off expensive and well-running US gas-guzzlers for gas-saving Japanese cars immediately, or all car-pool easily, and hence the initial quantity of oil demanded in the US economy remained very high. The demand curve was highly inelastic, though over time conservation and buying gas-saving vehicles tended to reduce the demand for oil noticeably . . . at any rate for about 15 years until the early and mid-1990s. At that point, the elasticity of the demand curve was higher.)

 

[2] Stock-market confidence. That's no doubt been a factor in holding back GDP growth, though by how much and how this would affect job-creation are not matters that can be easily estimated . . . not least because the performance of the stock market is normally not a leading indicator. It responds instead to profit-reports and profit-expectation of particular firms and industries, as well as expectations for business growth in the future . . . as well as expectations of stock-buyers how other stock-buyers will respond (a big complicating factor).

Specifically, at the bottom of the business cycle in a recession, the stock market is ordinarily below its high-point in the cycle, and as consumers start spending more and businesses begin to sell off their piled up inventory, and maybe even order more machines or build larger plants now that the heads of companies and small firms think business will be good in the future, business profits will rise, and the stock market starts reacting positively. Still, since most American corporations continue to finance business investment mainly by means of the stock market (borrowing from banks rose in the US economy but is a secondary source of investment income), it's possible and even likely that some GDP growth has been held back by the public's continued lack of confidence in the accounting practices of firms. On top of that, the normal reluctance of former investors in the stock market to come back after being burned badly after 1999 would reinforce a lackluster stock market performance. That said, the market began to pick up last fall, only to lose momentum as the war with Iraq began to be talked about in the UN and elsewhere. Still, since January this year, the Dow Jones average and other measures of the stock market --- even the Nassau --- have performed in a clear upward trend, generating the prospect that the bear market has ended and that a new bull market trend has emerged. If so, then that should further encourage corporations --- as sales pick up and profits rise --- to begin investing more than they have.

 

[3] And recall that if you total up the various shocks and dislocations to the economy since the start of 2001 --- the bursting of the stock-market bubble, then the accounting scandals, then the 9/11 attacks, then the Iraqi war and the uncertainty surrounding it, and even a fairly sharp rise in oil prices: all within a short period of two years or so --- we've been lucky, as Greenspan of the Federal Reserve noted in early June, that the US economy didn't fall into a severe and prolonged recession. It's testimony to the new flexibility, resilience, and sheer competitiveness of our economy that it has been able to absorb all this turmoil and still grow 2.4% last year. That said, we need to do better.

 

TO SUMMARIZE WHERE WE ARE SO FAR

All in all, it appears that several dislocating influences combined to cause the recession of 2001 and to hold the recovery since then, as measured both by growth in real GDP and in the job market. Those dislocations, as we noted, were the stock-market crash, the 9/11 attacks, the war with Iraq, and the accounting scandals, and these now seem to be in the process of being absorbed fully and overcome. That means that the pace of economic activity, at any rate, GDP growth, should pick up from now on at a sustained pace.

What remains unexplained up to now is how fast GDP growth needs to be to begin creating far more jobs than has hitherto been the case. And that --- as we'll see in the next article --- brings us back to the tricky question of whether the long-term improvement of the US economy's growth prospects (potential output) doesn't require an even bigger stimulus to aggregate demand --- fiscal or monetary or both --- than is now the case in order to kick-start job growth again. To repeat a key point we italicized earlier: if firms that are still competitive and making profits find that can now get along with less labor than in the past, then sales and profits will have to increase at a sustained pace for managers to decide that they need to call back laid-off workers or create new jobs too.

And that, in turn, will also take us into the theoretical controversy about fiscal vs. monetary stimuli, and the related question whether deflation, if it actually becomes a reality in the US economy (right now, it's hardly that), might not complicate the effectiveness of managing aggregate demand, especially by means of monetary policy.

As for fiscal policy, including the recent $350 billion tax cut --- which will be extended over several years, and subject to reconsideration further down the line --- we will see there's a long-standing controversy, known as the Ricardian effect (named after David Ricardo, the great English economist of the early 19th century who's the father of modern free trade theory), that throws doubt on its ability to stimulate growth. Why? Because, according to the revived theory associated with the conservative economist Robert Barro of Harvard --- who has also convinced a fairly large number of Keynesians as well --- the public, anticipating that cumulative fiscal deficits for as long as they pile up will also increase national debt and hence the need for interest payments, will begin to save all the dollars coming into its hand and saw them away: the reason, an expectation that ever higher interest payments on the national debt will require higher taxes in the future . It depends, as we'll see, on the expectations of economic actors --- in this case any household in the economy that has money to spend, and whether or not they think that deficits will be reined in and the tax cuts permanent or not.