Weekly Economic Update: January 7, 2011

Volume 58, Number 1 | January 7, 2011

There was no joy in Mudville following another lackluster employment report.  Payroll jobs rose a disappointing 103,000 in December, though revisions raised the total for the two previous months by 70,000.  Private sector payrolls grew by an average 128,000 a month during the fourth quarter, virtually unchanged from the 124,000 average during the third quarter.  Aggregate hours worked, a broader measure of employment that includes extra hours for existing workers, was up at a 2.5% annual rate in the fourth quarter compared to the third, almost exactly the same pace as the 2.4% gain in hours worked during all of 2010.  Bottom line, the recovery already may be in full gear, but it is a low gear — similar to the gains at the top of the economic cycle from mid-2004 through mid-2007 when hours worked averaged a 2.5% annual growth rate!

The good news for currently unemployed workers – and for the politicians – is that more of the future growth in hours worked is likely to come from higher employment rather than from more hours for existing workers.  The average workweek, which fell from 33.8 hours in the fourth quarter of 2007 to a low point of 33.0 hours at the trough in June 2009, has rebounded to 33.6 hours per worker.  Hours per worker has risen a steady 0.1 hours each quarter since the trough and soon should top out, especially given the long downtrend in this series as more workers move to part time jobs.  Still even if all the job gain is from more employment, job growth may never top the 225,000 per month for an extended period of time.  The best year for private job growth in the last cycle was the twelve months ended March 2006, with an average 226,000 gain.  That same twelve month period produced only 3.1% growth in real GDP.  The strongest year in the past expansion was the year ended March 2005, with 4.1% real GDP growth, but only 157,000 private sector jobs each month.  Strong growth comes from strong profits and high productivity.  Job growth gains later in the cycle as firms spend their profits and productivity growth fades.  Growth in the past two year has come with a profits and productivity boom.  If the new pro-business political environment encourages firms to spend some of their cash hoard it may lift employment and sustain growth – but significant acceleration is not likely in the cards.

An economy grows faster when it is adding hours per worker, than when it is adding jobs.  The reason is more hours per worker lifts income without reducing aggregate government benefit payments.  However, if a worker moves from the unemployment rolls to the workforce, their income only rises by the difference between unemployment benefits they were receiving and their new private sector pay.  This is the reverse of the safety net that protects the economy from downside shocks – which, unfortunately, dampens the positive aspects of employment gains as well.  Effectively, a reduction in the unemployment rate costs the private sector $2 in wages and benefits for every $1 dollar in new buying power.  The last cycle was easier to sustain, because we began from an already low unemployment rate so most of the gain in hours was pure spending power.  Indeed in the first two anemic years of growth (2001 and 2002) hours worked continued to fall and the unemployment rate rose as firms reestablished profits growth.  Bottom line, don’t expect a booming economy or a sharp decline in the unemployment rate in the year ahead, as the headwind of smaller benefit payments (that is a smaller budget deficit) will limit upside growth.  We are not arguing for a double dip or against smaller deficits, simply point out that there is no free lunch and a lower unemployment rate presents an increased compensation burden on US firms.

Lies, Damn Lies and Statistics

The upbeat news on employment this month was an unexpected plunge in the unemployment rate to 9.4% from last month’s elevated 9.8% reading.  Unfortunately, the details reveal a much less optimistic picture for the unemployment rate.  True, household employment jumped by a strong 297,000 workers, but that came after two months during which household jobs fell -469,000.  The notoriously volatile household report has seen only an average 100,000 monthly gain among private sector wage earners over the past six months, compared to a 157,000 average in the first half of 2010.  Moreover, half of the improvement in the unemployment rate came because the labor force fell by 260,000.  The broadest measure of unemployment actually rose from 16.3% to 16.6%!

Over the past year, the labor force has risen a miniscule 0.2%.  Over the past three years (since the fourth quarter of 2007) the labor force has risen only 0.2% — in total – compared to a 1.0% average between the fourth quarter of 2000 and the fourth quarter of 2007 (the seven years from start to end of the last cycle).  Demographics tell us that labor force should be rising about 0.8% per year, so the main reason the unemployment rate is not higher is that workers are leaving the labor force for retirement, to go to school, to spend more time raising families, or simply because they are discouraged.  As a result the labor force participation rate has fallen 2% since the start of the recession.  Retirees, those on student loans, and those on welfare benefits have found substitutes for unemployment benefits, but are still on the government rolls.  This makes the unemployment rate lower but benefits neither government nor business.  Where is the pent up demand for housing if the pool of potential workers hasn’t grown in three years – but the number of houses has?!


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