INSIGHTS: JOBS, JOBS, JOBS – AND NOTHING TO SHOW FOR THEM?
If Federal Reserve policymakers were to look solely at headline labor market indicators, they might be tempted to conclude that the U.S. economy had finally reached cruising altitude. Theunemployment rate has fallen from a peak of 10 percent in 2009 to 5.5 percent, within the range considered to be full employment. Nonfarm payroll growth has averaged 275,000 a month over the last year, a pace last seen in the roaring ’90s.
Yet nothing else has that ’90s feel: not the pace of economic growth, not capital investment, not productivity growth, not even Nasdaq 5000. The juxtaposition of solid job growth and tepid economic growth describes what the current expansion lacks: dynamism and innovation. These are the forces that drive productivity growth, allowing companies to produce more with less and provide a higher real wage to workers.
Almost all of the increase in real GDP since the start of 2010 has come from growth in labor inputs, according to Douglas Holtz-Eakin, president of American Action Forum, a center-right think tank, and a former director of the Congressional Budget Office. Labor inputs include the number of jobs and the number of hours worked. The contribution of productivity has been miniscule.
Nonfarm business productivity growth averaged 1.3 percent since the end of the recession compared with a long-term trend of 2.3 percent dating back to 1947. With the exception of a short-lived spurt in 2009, productivity never experienced its typical pro-cyclical surge as businesses satisfy increased demand by working existing employees harder.
“Firms are adding workers to meet demand instead of getting existing workers to become more productive,” Holtz-Eakin says. “The question is why.”
One answer is the declining pace of new business formation, historically the main source of job creation. There is a considerable body of research establishing the link between “creative destruction” and productivity growth. Small start-ups tend to be more productive than large, entrenched businesses. As the new supplant the old, labor and capital are put to more efficient use. Voila productivity.
In addition, the share of new firms as a percent of total establishments has been shrinking for three decades. In the 1980s, new firms accounted for 12.4 percent of all businesses, according to the Kauffman Foundation. (The Census Bureau’s most recent Business Dynamic Statistics are for 2012.) In the 1990s, new entries were 10.8 percent of the total. Between 2008 and 2012, the share dipped to 8.3 percent.
The decline has been broad-based across all sectors and geographic regions. Slowing population growth in the West, Southwest, and Southeast (a supply-side effect) and increased business consolidation explain the reduced pace of firm formation, according to a study of major metropolitan areas by Robert Litan, a non-resident senior fellow at the Brookings Institution.
Certainly new rules and regulations act as barriers to entry, but Litan’s three-decade study encompasses periods of both deregulation and reregulation.
The pace of start-ups has shown little improvement from the all-time low set in 2010. Initially, potential entrepreneurs may have been hampered by a lack of access to credit caused by new Dodd-Frank rules. Even as credit conditions loosened up, venture capital shied away from early-stage investment in start-ups, waiting to see proof of revenue and profitability before committing capital, says Kauffman senior fellow Ted Zoller, a professor of entrepreneurship at the University of North Carolina’s Kenan-Flagler Business School.
The ongoing shift to an economy dominated by less-productive services industries is another possible contributor to anemic productivity growth. Even with a resurgence of American manufacturing, services account for almost 80 percent of U.S. output.
Productivity is set to take another dive in the first quarter if the Federal Reserve Bank of Atlanta’s GDPNow model is correct. Its “nowcast,” based on publicly released economic indicators to date, points to first-quarter real GDP growth of 0.3 percent. The model was just updated Tuesday to reflect weak reports on February retail sales, industrial production and housing starts. And it’s sure to be a part of the discussion at the Fed meeting currently underway.
Many economists are pointing to weather as the culprit. The one statistic seemingly unaffected is employment. In fact, the jobs numbers seem so out of sync with everything else that analysts at Arbor Research and Trading LLC decided to quantify the gap. They compared the increase in nonfarm payrolls to the implied change based on a composite basket of major economic indicators, including industrial production, durable goods orders and personal income. They found that nonfarm payrolls outpaced the composite by more than 1 million jobs in the past year. “The last time the gap was that wide was during the dot-com bubble,” says Benjamin Breitholtz, senior vice president of Arbor’s quantitative analytics group.
Another gap has opened up between consensus economic forecasts and actual data as reflected in Citigroup’s Economic Surprise Index. The index has taken a precipitous dive in 2015, with reality underperforming expectations by a long shot. The discrepancy may be a manifestation of forecaster optimism—the perennial 3-percent-growth-next-year—rather than any new, dire straits in which the U.S. economy finds itself.
If only some of that optimism would rub off on entrepreneurs.
ON THE ECONOMY: SPEED RACER
Here he comes. Here comes Speed Racer. He’s a demon on wheels. He’s a demon and he’s gonna be chasin’ after someone. He’s gainin’ on you so you better look alive. He’s busy revvin’ up a powerful Mach 5, and when the odds are against him, and there’s dangerous work to do, you bet your life Speed Racer will see it through. Go Speed Racer, Go Speed Racer, Go Speed Racer, Go! This was the theme song to the Japanese anime which aired on Fuji TV from April 1967 to March 1968 and for some reason on Blinky’s Fun Club in Denver when I was a kid. (By the way, according to Wikipedia, Blinky holds the record as longest-running television clown in history, as well as the longest running children’s television host in the United States.) The song was by Nobuyoshi Koshibe and was rearranged with lyrics by Peter Fernandez
Over the past few months, we have been conducting a number of impact studies for various clients, and there has been one dramatic change from earlier studies that is persistent across industries. That is a dramatic decrease in the so-called induced effect. Induced economic effects occur based on the re-spending of wages in the general economy. People working for the industry that we are examining, or for firms supplying goods and services to that industry, take their wages and re-spend them on homes, cars, food, clothing, vacations, you name it. The popular term for this economic impact is the “multiplier effect,” as the re-spending multiplies the economic activity of the industry being examined into the general economy.
This multiplier effect has decreased dramatically over the last few years. Normally we might think that this was a problem with our models or with the underlying BEA databases, but a more careful examination of how the multiplier effects are created shows that there has been a dramatic shift in the American economy, and this shift may be one reason why the Keynesian stimulus measures used by the government and the Federal Reserve have been so ineffective.
First, for those of you who read the Monthly Manifesto or the Guerrilla Economics Blog on a regular basis know, I have a serious problem with Keynesian economic doctrine. This does not mean that I do not think that Dr. Keynes was a highly skilled economist who made major contributions to the field, just that I don’t think that anyone should blindly follow a doctrinal approach to economics. That said, one of the key principles of Keynesian economics is something called the Velocity of Money.
The velocity of money is simply the ratio of GDP to the money supply. It measures the rate at which money is exchanged from one transaction to another, and in the Keynesian construct which is all demand driven it is a key component of economic growth. All things being equal the more each unit of currency is used in the course of a year, the faster the economy is growing.
Keynesians believe that economies that exhibit a higher velocity of money relative to others tend to be further along in the business cycle and should have a higher rate of inflation, all things held constant. However, over the course of the last business cycle in the United States, the measured velocity of money has collapsed. The figure below measures the velocity of money (M1) over time using data from the Federal Reserve. As the chart shows, the estimated velocity of money in the US Economy fell dramatically following the last recession, and is down by nearly 30 percent since 2010. For our purposes, this means that each dollar generated by the direct and supplier sectors of an industry are re-spent less frequently in the general economy and therefore, the induced effects are much smaller. In fact, the overall induced impact is down almost in lock step with the velocity of money.
For the economy in general, the velocity of money statistic is more a symptom than a cause. The economy is not struggling because spending is slow, but rather spending is slow because the economy is struggling. The money supply is growing much faster than GDP sending velocity downward. This is because the government created trillions of dollars of new money and money like debt over the past few years, and there has been little demand for investment in new activities. Rather all of the money has either been held at the Federal Reserve which pays banks a small but certain interest on it, or has been shifted to non-productive assets like stocks or speculative real estate. In other words, the asset bubbles (see blog post) are the inverse of the decline in the velocity of money.
As our guest columnist points out, all of the cheap money has not translated into higher investment or higher wages, but rather to asset price bubbles. This is driving down the Keynesian multiplier effects in the economy, while at the same time dissuading deflation which would help the economy on the supply side.
A lot of people question the importance of economic impact modeling, but an examination of micro economic markets can often be the canary in the coal mine. Now more than ever, the economy needs to let Speed Racer rev up his Mach 5, and get the velocity moving again.
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