__________
CAPITAL
By DAVID WESSEL

Better Answer to Tough Question on Jobs
Wall Street Journal, October 21, 2004; Page A2

In the final Bush-Kerry debate, moderator Bob Schieffer asked, “What do you say to someone … who has lost his job to someone overseas who’s being paid a fraction of what that job paid here?”

President Bush promised “policies to continue to grow our economy and create the jobs of the 21st century,” and then talked about improving public schools. Sen. John Kerry pledged “a fair trade playing field” and a tax code that doesn’t have “workers subsidizing the loss of their own job.” Neither looked into the camera and connected with that worker as Ronald Reagan or Bill Clinton might have.

A better answer would have gone like this:

“All over America, there are people who played by the rules yet are losing their jobs — some because workers elsewhere do the same work for less, others because computers do things that once only humans did.

“It is small comfort to tell them, though it’s true, that we’re richer today than our grandparents imagined because we haven’t walled ourselves off from the rest of the world nor sought to restrain the advance of technology. It is small comfort, though true, that today’s puzzle isn’t that we’re losing jobs — we’re always losing jobs — but that for reasons even experts can’t explain we aren’t creating enough new ones.

“Those of us who benefit from low-cost imports — or who have well-paid export jobs that wouldn’t exist if we didn’t allow imports and outsourcing — must not ask those who lose jobs to go it alone. But Bill Clinton had it right 10 years ago: ‘The resentment of people who keep working harder and falling further behind, and feel like they’ve played by the rules and have gotten the shaft, will play out in different and unpredictable ways. But our responsibility is to do what is right for those people over the long run. And the only way to do that is to open other markets to American products and services even as we open our markets to them.’”

What does this mean in practice?

Candidates need to confront those who offer slogans, not solutions. Protectionists would block imports of factory goods or outsourcing of service jobs, ignoring the likelihood that interfering with the forces of trade and technology will prevent the creation of more jobs than it will save. Free traders with secure jobs proclaim that the only way to get the benefits from open markets is to tolerate the pain of people they’ll never meet. Gene Sperling, a former Clinton adviser, offers this pithy put-down: “Protectionists have nothing to say to the future. Free traders have nothing to say to the present.”

If trade and technology make us richer, then we can afford to help pay for health insurance and protect pensions forced to bear the cost. The hodge-podge of tax credits and “adjustment assistance” for workers who can link their job loss to imports isn’t working; it needs an overhaul. And there is merit in what wonks call “wage insurance” that temporarily makes up some, though not all, of the gap between the wages of a lost job and those of a new one.

This will be expensive, and needs to be designed to avoid turning healthy workers into taxpayer-supported couch potatoes. But the alternatives are costly too — able-bodied but unskilled workers finagling their way onto disability rolls, families falling out of the middle class, cheering audiences for misguided politicians who shout that the only way for Americans to prosper is to keep Indians and Chinese in poverty.

Such programs are derided as “Band-Aids,” and they are. The U.S. government also has to get the big things right. That means pushing China and others to stop bending trade rules or manipulating currencies and pressing Europe and Japan to get their people spending so the U.S. isn’t always the consumer of last resort. It means setting U.S. taxes so they cover government spending at least in good times, rewriting perverse tax laws that encourage companies to invest elsewhere and managing the unquenchable American thirst for health care without giving employers new excuses not to hire.

And, finally, comes education. Americans will earn more than foreign workers only if they’re more productive, and they can be more productive only with ever-better education and skills. Education can be oversold: A college degree isn’t a guarantee against losing a job to trade or technology.

But education remains, as Mr. Sperling puts it, “the best insurance policy for succeeding in the existing and future economy.” That means streamlining the creaky system for getting vulnerable workers the skills still in demand in the U.S. and doing better at fixing public schools so the next generation of Americans can compete with what surely will be better-educated workers elsewhere in the world.

Write to David Wessel at capital@wsj.com4

CAPITAL
By DAVID WESSEL

Bush, Kerry Are Both
Right on the Economy
July 1, 2004; Page A2

President George W. Bush says the economy is “strong and getting stronger.” Challenger John Kerry says, “We can do better.” The Bush campaign says cruise lines are carrying 74% more passengers than in 1996, half of them folks earning less than $60,000 a year. The Kerry campaign says health-insurance premiums rose 40% between 2000 and 2003. The Bush campaign says that Americans’ after-tax incomes are rising faster than inflation. The Kerry campaign says hourly wages aren’t.

Tweet! Time out for perspective from the sidelines. Each campaign’s assertion is factually defensible. Here are four more meaningful ones.

The economy is doing better. But it’s not yet good.

The U.S. economy — finally — seems to be firing on all cylinders. Employers — finally — are hiring again. It is hard to chart an economic indicator that hasn’t turned up. That is why the Federal Reserve yesterday began raising interest rates1 from half-century lows.

It is easier for Americans to find work than it was six months ago, but not yet easy. Employers added about 950,000 jobs in the past three months. But that is still 1.3 million shy of the March 2001 peak — and not nearly enough jobs to absorb the 3.4 million people who have joined the labor force since then.

Mr. Bush rightly says his tax cuts helped, and were designed to pay lasting dividends. But Democrats make a strong point when they say different tax cuts and spending have produced more jobs sooner — and ask who will pick up the check for borrowing done on Mr. Bush’s watch.

Profits have done a lot better than wages lately.

The most encouraging economic development in the U.S. is the persistence of strong growth in productivity, the amount of goods and services for each hour of work. Rising productivity is why Americans enjoy more than their grandparents without working more.

But the benefits of this added productivity largely have fattened profits, not wages. The slice of the national economy pie going to wages — now about 63% — is lower than it has been since 1966. Commerce Department data show after-tax corporate profits at 9.6% of gross domestic product, the highest since the government began counting this way in 1947, blogger John Irons of Argmax.com points out. That is pinching middle-class workers. Yes, they are stockholders, too, but they live on their wages, not their dividends.

This trend isn’t Mr. Bush’s doing, though he hasn’t done anything to resist it. A Democrat might have pushed tax cuts less generous to the rich, or backed an increase in the minimum wage. But no matter who wins in November, the profit trend probably won’t persist. As unemployment falls, history suggests workers will claim a more normal-size slice. Wages will rise; profits will be squeezed.

A return to the boom economy of the late 1990s, alas, isn’t likely.

Underlying a lot of Bush-Kerry banter are the warm memories of the late 1990s with its pleasurable mix of low unemployment and inflation, rising wages and business investment, federal budget surpluses and soaring stocks.

Candidate Bush can’t admit that he can’t deliver former President Bill Clinton’s second-term economy. Candidate Kerry can’t promise to bring it back, though he wouldn’t mind if swing-state voters think he can.

Neither man’s economists believe we can return to the 3.9% unemployment that prevailed at the last presidential election, and the Fed isn’t going to let that happen anyhow. The late 1990s was an unsustainable bubble. It isn’t coming back. The question, nearly impossible to answer, is how much of the late 1990s we can reasonably aspire to.

Presidents get too much blame and credit for some things, and too little scrutiny for others.

Making scorecards of what happened on any president’s watch is easy, but easily misleading. Mr. Clinton didn’t create the prosperity or bubble — you pick — of the late 1990s. Mr. Bush didn’t cause employers to be so exceptionally slow to hire after the recession ended. Presidents don’t have that much power.

But presidential economic policies do matter; it is just that effects doesn’t show for a decade, maybe even a generation.

So tear up those job-tally scorecards. Look at three things the president can influence: How will the U.S. reduce the federal deficit and prepare for the approaching, costly retirement of baby boomers? How can federal leverage improve public schools and put college within reach of more Americans? What will the federal government, the largest purchaser of health care, do to make sure all (or nearly all) Americans get health care and get the most value for health-care dollars with the least waste?

Write to David Wessel at capital@wsj.com

“Old habits die hard. Often, criticism leveled at policymakers is well founded. I certainly have offered up my share. But as 2003 ends and 2004 begins, we find ourselves at a point where the performance of the U.S. economy is about as good as it gets. The stock market is up 20 percent this year, inflation and interest rates are low, productivity growth is high, and U.S. exports are rising strongly. The biggest danger going forward arises from ill-founded criticism aimed at policy measures employed to achieve this excellent outcome and the (fortunately low) chance that policymakers will heed such criticism.”

As Good as It Gets

By John H. Makin
Posted: Monday, December 22, 2003
ECONOMIC OUTLOOK
AEI Online (Washington)
Publication Date: January 1, 2004

Old habits die hard. Often, criticism leveled at policymakers is well founded. I certainly have offered up my share. But as 2003 ends and 2004 begins, we find ourselves at a point where the performance of the U.S. economy is about as good as it gets. The stock market is up 20 percent this year, inflation and interest rates are low, productivity growth is high, and U.S. exports are rising strongly. The biggest danger going forward arises from ill-founded criticism aimed at policy measures employed to achieve this excellent outcome and the (fortunately low) chance that policymakers will heed such criticism.

Deficit Obsession Dangers

The loudest cries of criticism have been reserved for the sharp transition from a U.S. budget surplus of over $200 billion in the 2000 fiscal year to a $380 billion deficit in 2003. Conservatives and liberals alike are already decrying an expected budget deficit of $500 billion in the current fiscal year. Criticism of rising budget deficits, an old habit among would-be policy wonks trying to sound profound and prudent, is just silly at this point. It would be like criticizing firefighters for pumping half the water out of a pond to put out a fire. Sure, there is less water in reserve for another fire, but why have the water there in the first place if you don’t intend to use it to put out fires? Going from a budget surplus of 2 percent of GDP to a deficit, still below 4 percent of GDP, is appropriate in an economy with excess capacity, especially when much of the swing comes from two rounds of demand-boosting tax cuts that simultaneously improve resource allocation.

U.S. budget deficits have risen because of two rounds of tax cuts that have added substantially to disposable income and helped to improve resource allocation in the United States. In this unusual business cycle, in which a large stock of excess capacity has prolonged the adjustment process, boosting demand with tax cuts is both prudent and effective. Government spending growth has also accelerated, and while spending growth is a less desirable form of stimulus than tax cuts, with capacity utilization at low levels and demand growth outside of the United States exceptionally weak, this is not the time to rein in spending growth. Domestic demand is languishing in Japan and Europe, and although it is strong in China, demand growth there is being largely satisfied by Chinese producers.

The deficits’ decriers have been promising all year that rising U.S. budget deficits would push up interest rates and crowd out private borrowers. This has not happened. Interest rates on U.S. government ten-year notes, at about 4.25 percent, are exactly where they were a year ago. Adjusting for inflation, real interest rates on ten-year notes are just above 3 percent–very close to their long-term average.

One of the main reasons–beyond a steady fall in inflation–that higher budget deficits have not boosted interest rates is the need for higher budget deficits to sustain growth. Private borrowing by corporations and households has been particularly weak in recent months. As a result, money supply growth has slowed sharply. Corporations have been able to finance their moderate investment spending (largely directed at maintaining capacity) out of internal cash flow. At the same time, household borrowing for mortgages and purchases of consumer durables has leveled off since the mid-year surge tied to record low interest rates.

Many market players have been betting on higher interest rates for the past several months only to be frustrated by a drop in interest rates that usually occurs after the appearance of economic data suggesting only moderate demand growth and stable-to-falling inflation. The modest 57,000 increase in November payroll employment reported early in December is the most recent example of weaker-than-expected activity.

Rather than complaining about large budget deficits, it would be more appropriate to view them as the byproduct of the extraordinary demand stimulus required to keep the U.S. economy from slipping back into recession and thereby throwing the world economy into a nasty recession. In fact, by next fall, after an election season filled with hand-wringing by Democratic candidates about rising budget deficits, we shall probably discover, again, that tax cuts stimulate enough economic activity to pay for themselves, at least in part. The budget deficit in this fiscal year will probably be closer to $400 billion than the currently touted $500 billion total, provided that no policy reversals interfere with sustained growth.

Inflation Paranoia

Perhaps even more baffling than the complaints about rising budget deficits are the complaints from some quarters that the Federal Reserve is risking a return to high inflation by failing to raise interest rates.

Even some Fed policymakers continue to flirt with the siren call of the need to move interest rates up to “neutral” levels lest inflation return with a vengeance. The fact is that inflation is still falling. The latest report on inflation–the November Consumer Price Index Report–recorded a year-over-year change in core CPI of 1.1 percent–down from the previous month’s 1.3 percent and a low for the cycle. Disinflation is continuing. The three-month annualized core CPI inflation rate at 0.8 percent is well below the 1.1 percent year-over-year rate.

In its recent policy statements, the Fed has essentially shifted away from hints that it fears an undue acceleration of disinflation to a message suggesting that inflation will remain low for a long time. After its December 9 meeting, the Fed said, “The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.”

As the Fed has downgraded the risk of an unwelcome fall in inflation, it remains vigilant. According to the October minutes of the Federal Open Market Committee meeting released on December 11, “members emphasized that the prospects for persisting slack in labor and other resources in combination with substantial further increases in productivity were likely to hold inflation to very low levels over the next year or two. Indeed, many saw modest further disinflation as likely, at least over the year ahead.” Such comments accurately anticipated the tepid November employment increase.

Low and falling measures of inflation like the core Consumer Price Index or the Core Personal Consumption Deflator are the right guides to monetary policy, not higher oil and commodity prices. Policymakers look at core price indices, exclusive of volatile goods and energy prices, not so much because those components are volatile but because price increases for essentials like food and fuel are equivalent to tax increases and not appropriate signals for tighter monetary policy. The initial response to the first oil price surge in late 1973 was a surge in inflation. The first instinct of central banks was to tighten monetary policy, but they soon realized, to their horror, that tightening in response to a higher inflation signal based on higher energy prices amounts to responding to a backward shift in the aggregate supply schedule with a downward shift in the aggregate demand schedule. The resultant drop in output and employment is painful.

The truth is that, in sharp contradiction to the call for Fed tightening in anticipation of higher future inflation, actual inflation may fall over the coming six months. The jump in purchases of housing has freed up many rental properties and so the rental component of the core CPI index may actually show falling inflation in 2004. The same is probably true of insurance rates after the post-9/11 surge experienced in the year or two following that tragedy. Beyond that, cost-conscious employers are moving aggressively to cap the sharp increase in costs of medical coverage for their employees. All of these developments would depress core inflation further.

The Fed has indicated a desired range for inflation, without specifically setting an inflation target. Year-over-year core inflation between 1 and 2 percent, with more comfort at the higher end of that range, has been suggested as a goal. It is entirely possible that year-over-year core measures of inflation will slip below 1 percent, the lower end of the Fed’s desired inflation range, during the first half of 2004. That would force the markets to rethink the current expectation priced into futures contracts that the Fed will begin to raise interest rates by May or June of 2004.

The dangers of a premature response to calls for a balanced budget or to respond to imagined fears of future inflation are evident from the experience of Japan over the last decade. In April 1997, after a year of strong recovery, the Japanese government sharply increased taxes and threw the economy back into recession. Further unfounded fears of inflation in Japan between 1998 and 2001 resulted in a passive monetary policy and deflationary expectations in Japan that have yet to be overcome. Indeed, much of the Fed’s current thinking about the dangers of deflation is based on an extensive study of Japan’s experience with that dangerous phenomenon.

The Eminently Sustainable Current Account Deficit

A close cousin of the much-bemoaned U.S. budget deficit and attendant fears of a resurgence of inflation is the U.S. current account deficit accompanied by a weaker dollar. The U.S. current account deficit measures the total of American dissaving–its spending in excess of income. Such dissaving has become extraordinarily welcome in a world still plagued by inadequate demand and its counterpart excess capacity. Those decrying the U.S. current account deficit today are thinking of a world like that of the 1970s, where excess demand was an issue, unlike today’s world of chronic excess capacity. Given U.S. overheating, dissaving would boost U.S. inflation and interest rates and weaken the dollar. But as we have already noted, today U.S. interest rates and inflation are actually falling, while the dollar is weakening–all a reflection of substantial U.S. excess capacity.

In today’s world of less than full employment, it is foreigners who will not allow the U.S. current account deficit to disappear, because they need the demand growth for their products that it implies. Indeed, the central banks of Japan and China have spent over $200 billion during the past year to prevent their currencies from appreciating. They have become the residual buyers of the rising supply of U.S. government securities used to finance demand-enhancing tax cuts and higher government spending. To suggest that Asian governments might suddenly decide to sell the U.S. government securities that they have been buying with abandon, in an effort to prevent deflationary appreciation of their currencies, is patently absurd.

Asian central banks have persisted in their dollar purchasing and the equivalent–their accommodation of rising U.S. twin deficits–despite a concerted effort led by President Bush for them to cease and desist. China is especially busy building up excess capacity with deflationary potential for the global economy. Perhaps, recognizing this, the president has even resorted to trade sanctions–actual and threatened–in an effort to extend to currency markets the free-market principles that are supposed to operate in markets for international trade in goods and services.

Easing Needed in Europe and Japan

The dangers of resorting to the policy orthodoxy that includes reducing budget deficits and fighting nonexistent inflation in the United States are especially acute given the somewhat delicate condition of the world economy. A brief respite from acute global excess capacity during the second half of 2003 has been the byproduct of a surge of U.S. demand growth fueled by tax cuts, higher government spending, and easy-money refinancings that has boosted exports in Asia and Europe. Now, as policymakers are declaring a sustainable global economic expansion, U.S. demand growth is slowing. Meanwhile, Europe and Asia are drifting with tighter fiscal policy and neutral to passive monetary policy lulled by the third quarter surge in their exports. Rather than calling for tighter monetary and fiscal policy in the United States, those concerned with a sustained global economic expansion should be calling for easier fiscal and monetary policies in Europe and Japan.

The calls for sharp reductions in the U.S. budget deficit and a Fed response to imagined inflation threats will probably not cease. Those making the calls have persistently failed to recognize that this is not a typical cycle, in which threats of excess demand growth and overheating are primary. This is a cycle that was not brought on by Fed tightening in response to overheating, but rather one that emerged as a response to a buildup of excess capacity and a sharp fall in stocks, whose prices reflected unrealistic expectations of earnings. The Fed has been reducing interest rates since January 2001, and we have had two rounds of major tax cuts. The upshot of all this is the somewhat disquieting fact that we have yet to see a sustained period of U.S. growth much above 3 percent in the absence of extraordinary policy stimulus. If productivity growth is 3.5 or 4 percent and population growth is 1 percent, then we need 4.5 to 5 percent demand growth to stabilize labor markets even if economic conditions in Europe and Japan stabilize or improve.

Inflation Targets Needed

Although most central banks including the Fed have declared the risks of an unwelcome, substantial further fall in inflation as behind us, those risks remain. It would be far better if the major central banks of the world set explicit inflation targets of 1 to 2 percent and jointly eschewed intervention in currency markets. In Japan, those steps would force the Bank of Japan aggressively to print money to finance purchases of long-term government bonds, commodities, and land until deflation was replaced by modest reflation. Likewise, the European Central Bank would be forced to cut interest rates if a U.S. growth slowdown and a falling dollar signaled a further deflationary appreciation of the euro. China could and should abandon its yuan peg and moderate or reverse the resulting currency appreciation by allowing its currently landlocked savers to venture into global capital markets.

As we move into 2004, 2003 may really start to look like it was as good as it gets. The big risks to a sustainable recovery are not large U.S. budget and current account deficits and higher inflation. Rather the risk is that fear of the byproducts of the right policies–larger budget and current account deficits–will lead to damaging tax increases and restraints on global trade. Fears of the inflation bogeyman ought to be kept in check by lower inflation numbers, but if the Fed behaves as markets currently expect and starts raising rates at mid-year, the U.S. economy could suffer a nasty relapse into subpar growth and rising unemployment.

John H. Makin is a resident scholar at AEI.

Washington Post
U.S. Consumer Debt Grows at Alarming Rate
Debt Burden Will Intensify When Interest Rates Rise

By William Branigin
Washington Post Staff Writer
Monday, January 12, 2004; 12:46 PM

Feeling besieged by all those post-holiday credit card bills? Struggling to dig out from an avalanche of debt?

You are not alone.

According to the latest figures from the Federal Reserve, America’s consumer debt has topped $2 trillion for the first time, continuing what debt experts view as an alarming surge in recent years.

To some, the nation’s consumer debt, which dwarfs that of any other country, represents the kind of “bubble” that the stock market grew into during the 1990s.

“It’s a huge problem,” warns Howard S. Dvorkin, president and founder of Consolidated Credit Counseling Services Inc., a nonprofit debt-management organization. “You cannot be the wealthiest country in the world and have all your countrymen be up to their neck in debt.”

Robert D. Manning, a leading expert on the credit card industry, sees families as likely to come under even greater stress as interest rates — currently near historic lows — inevitably rise.

“That’s one of the trends that’s really going to kill the American consumer in the next downturn,” he says. “It’s just impossible to keep these interest rates this low for much longer.”

Tied to the record consumer debt levels has been a surge in personal bankruptcies, which reached an all-time high of 1.6 million households in 2003.

In its latest statistical release on consumer credit, the Federal Reserve reported Thursday that consumer debt reached $2.004 trillion on a non-seasonally adjusted basis in November, the latest reporting period.

The figure covers most short- and intermediate-term credit extended to individuals, including car loans. It excludes loans secured by real estate, such as home mortgages. When mortgages are taken into account, the nation’s households owe close to $9 trillion, Manning says.
The $2 trillion figure represents a doubling of America’s consumer debt in less than 10 years. According to the Federal Reserve, the debt topped the $1 trillion mark for the first time in December 1994.

Of the total, commercial banks are owed the largest share, nearly $624 billion. More than $740 billion of the total is revolving credit, while $1.264 trillion is nonrevolving.

On a seasonally adjusted basis, the consumer debt reached nearly $1.995 trillion in November, also a record. The only good news in the Federal Reserve figures, debt experts said, was that the seasonally adjusted debt grew at an annual rate of 2.4 percent for the month, down from 5 percent in October and 6.9 percent in September.

But the overall problem may be worse than the latest record debt level indicates, said Manning, author of the book, “Credit Card Nation: The Consequences of America’s Addiction to Credit.” He traces the problem to a credit economy in which credit cards have become “yuppie food stamps,” akin to a “social-class entitlement” rather than an earned privilege. Now, government figures show that three out of five U.S. families have credit card debt.

“What’s alarming is that [the consumer debt figure] doesn’t accurately reflect the true distress on various segments of the American population,” he said. Not included in the Federal Reserve figures are “new kinds of hybrid financial institutions and new loan products,” such as those offered at rent-to-own stores. There, interest rates typically work out to more than 200 percent a year, and sometimes more, Manning said. In one such store catering to middle-class African Americans, he said, the annual interest rate came to 800 percent.

Overall, Manning said, “the cost of borrowing on credit has tripled in real terms since the early 1980s.” While many credit card companies offer zero percent introductory interest rates to customers with good credit, he said, the rates typically jump after the introductory period, and many Americans do not qualify for the low rates in the first place.

Although the credit card industry says average household consumer debt comes to $9,000, Manning said, it is actually closer to $13,000 when the roughly 40 percent of households that pay their balances each month are taken out of the equation.

“In the old days, the best customer was someone who could pay off their loan,” said Manning, a professor at the Rochester Institute of Technology in Rochester, N.Y. “Today the best client of the banking industry is someone who will never pay off their loan,” because then the client is more likely to incur fees. In 2002, the average household consumer debt translated into $1,700 a year in finance charges and fees, he said.

In the long term, Manning said, the burgeoning debt “means our standard of living has to go down.”

Dvorkin agrees. “It’s going to result in people having to work longer,” he said. “Effectively, if this continues, the average American will not have enough to retire on and will not be able to retire.”

The record consumer debt also dovetails with other social problems, Dvorkin said. More than half of all marriages end in divorce, and “the number one cause of divorce is financial pressures,” he pointed out.

After reaching a new record last year, personal bankruptcies “will continue to grow,” Dvorkin said. “It’s very scary.”

On one hand the markets have had excellent performance for 2003. However they might not be accurately reflecting the risk of running low federal interest rates and an ever expanding fiscal deficit.

“The Great American Job Machine has long powered the US business cycle. It drives the income growth that fuels personal consumption. That internally generated fuel is all but absent in the current upturn. The US economy is mired in a jobless recovery the likes of which it has never seen. This has profound implications for the economic outlook, the political climate, trade policies, and the global business cycle.

Contrary to popular spin, the US labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses — a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments — temporary staffing, education, and healthcare — which collectively added 286,000 positions in the final five months of last year. The “animal spirits” of a broad-based hiring-led revival by US businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost-areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services. ”

Global: False Recovery

Stephen Roach (New York)

The Great American Job Machine has long powered the US business cycle. It drives the income growth that fuels personal consumption. That internally generated fuel is all but absent in the current upturn. The US economy is mired in a jobless recovery the likes of which it has never seen. This has profound implications for the economic outlook, the political climate, trade policies, and the global business cycle.

Contrary to popular spin, the US labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses — a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments — temporary staffing, education, and healthcare — which collectively added 286,000 positions in the final five months of last year. The “animal spirits” of a broad-based hiring-led revival by US businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost-areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services.

The modern-day US economy has never been through anything like this. Fully 25 months into this so-called economic recovery, private-sector jobs are still about 1% below levels prevailing at the official trough of the last recession in November 2001; at this juncture in the typical recovery, jobs are normally up about 6%. Had Corporate America held to the hiring trajectory of the typical cycle, fully 7.7 million more American workers would be employed today. Moreover, the current hiring shortfall far outstrips that which was evident in America’s only other jobless recovery — the upturn following the recession of 1990–91. In that instance, it took about 12 months for the job machine to kick back into gear. By our calculations, the current job profile in the private economy is now 2.4 million workers below the trajectory of the jobless recovery a decade ago.

Forward-looking financial markets have long presumed that America’s backward-looking malaise is about to change — that hiring is just around the corner. The optimists have continually drawn encouragement from declining levels of jobless unemployment insurance claims, improved purchasing managers’ sentiment, and a pickup in employment as reflected in the so-called survey of households. It’s only a matter of time, goes the argument, before businesses resume hiring. After all, Corporate America is now making money again, and such sharply improved profitability is presumed to allow businesses to step up and deliver on job creation. Furthermore, hiring is widely thought to be on the other side of America’s latest productivity miracle; the argument in this instance is that there’s only so much that companies can get out of their workforces before they have to start adding headcount again. Yet we’re fully 25 months into recovery and it just isn’t happening. In my view, this is not a story of those ever-fickle lags. Something new and far more powerful appears to be at work.

The global labor arbitrage remains at the top of my list of possible explanations (see my October 6, 2003 essay in Investment Perspectives, “The Global Labor Arbitrage”). It depicts the interplay of two brand-new forces — offshore outsourcing in goods and services together with the advent of Internet-driven connectivity. Such IT-enabled outsourcing has taken on new urgency in today’s no-pricing-leverage climate of excess global capacity. The unrelenting push for cost control leaves return-driven US businesses with no choice other than to push the envelope on productivity solutions. The result may well be a new relationship between US aggregate demand and employment

The “imported productivity” provided by offshoring has become especially evident in IT-enabled services — where the knowledge-based output of a remote low-wage white-collar workforce now has real-time, e-based connectivity to production platforms in the developed world. One of the clearest examples of this is a significant shortfall of job creation in America’s IT and information services industry. In the upturn of the early 1990s, employment in this industry had increased nearly 4% by the 25th month of that recovery; by contrast, in the current cycle, such jobs are down over 1% — even though the US economy is far more IT-intensive today than it was back then. At the same time, knowledge professionals’ headcount in India’s IT sector has risen from 50,000 in 1990–91 to an estimated 625,000 workers in 2002–03.

I don’t think these trends are a coincidence. More likely than not, they are the flip sides of the same coin — a shift of comparable-quality labor input from the high-wage US services sector to the low-wage Indian services sector. And, of course, this trend is only the tip of a much bigger iceberg, as offshoring now spreads up the value chain to include professions such as engineering, design, and accounting, as well as lawyers, actuaries, doctors, and financial analysts. Long dubbed the “nontradables” sector, the IT-enabled globalization of services is now in the process of transforming this vast sector into yet another tradable segment of the US economy — posing a formidable challenge to the once unstoppable Great American Job Machine.

There can be no mistaking the important implications of this jobless recovery. Lacking in job creation as never before, it follows that there is equally profound shortfall of wage income generation. Normally, at this juncture in a US business cycle expansion, private wage and salary disbursements — fully 45% of total personal income and easily the largest component of household purchasing power — are up by 8% (in real terms). Yet 24 months into the current expansion, this key slice of income is actually down nearly 1% — the functional equivalent of about a $350 billion shortfall in real consumer purchasing power.

Lacking in such internally generated income, saving-short American consumers have had to draw support from secondary sources of purchasing power — namely massive tax cuts, an outsized build-up of debt, and the extraction of cash from over-valued assets such as homes. This is a tenuous foundation of support for any economy. It has led to subpar national saving, a record current-account gap, and sharply elevated household debt service burdens — a steep price to pay in order to fund the insatiable appetite of the American consumer. A persistence of this jobless recovery will only up the ante on these imbalances — raising serious questions about the ultimate sustainability of the current upturn, in my view. For a US-centric global economy, that’s an equally disconcerting risk.

Nor can the political implications of America’s jobless recovery be taken lightly. If the economy falters for any reason between now and the upcoming presidential election and the unemployment rate starts to rise, labor-related issues could figure prominently in the political debate. That raises the risk of trade frictions and heightened protectionist perils. In the event of unexpected economic distress in an election year, the Bush administration — already quick to use steel tariffs as a politically expedient policy ploy — could well embrace the cause of China bashing, which has become popular sport in Washington today.

Targeting India as a threat to once-sacrosanct service-sector jobs is also a possibility in such an environment, as would be as assault on US multinationals that are leading the charge in offshoring; there are already rumblings of just such a backlash (see Senator Charles Schumer and Paul Craig Roberts, “Second Thoughts on Free Trade,” The New York Times, January 6, 2004). As remote and patently destructive as these measures might seem, the risks of such possibilities can only increase if job-related issues rise to the fore in a politically charged climate. Negative implications for an already weakened US dollar would be especially worrisome in that context. Downside risks to global growth would undoubtedly intensify as well.

None of this was supposed to happen. Typically, the demand response to policy stimulus elicits hiring and income creation — providing incremental injections of purchasing power that then spur a sequence of self-reinforcing cycles of more spending, hiring, and income. Such “multiplier effects” are the essence of any dynamic, self-sustaining model of the business cycle. They convert the policy-induced sources of cyclical uplift into autonomous, self-sustaining growth in the private sector. This is the core of the internal dynamics of the all-powerful US business cycle.

Unfortunately, the theory behind such a cyclical dynamic just isn’t working. Starved of job creation and wage income generation, consumers need supplemental sources of growth. To date, America’s monetary and fiscal authorities have been more than happy to comply. The Fed has provided the interest-rate support to asset markets that drives the wealth effects underpinning consumer demand. Washington’s penchant for deficit spending has also provided an extraordinary boon to household purchasing power. Yet there’s little opportunity for removing these life-support measures. To the contrary, until the economy kicks in on its own, the monetary and fiscal authorities could well be called upon to keep upping the ante. Therein lies the conundrum: With the Fed’s policy rate now near zero and America’s budget deficit at a record, the authorities are all but running out of options.

In the end, America’s protracted shortfall of jobs and internally generated income has created a new and powerful leakage in the system — a leakage that ultimately renders traditional multiplier effects all but inoperative. Not only does that draw into serious question the case for a cumulative and self-sustaining recovery in the US economy, but it could well elicit dangerous policy responses from Washington. Jobless recoveries unmask the false foundations of a cyclical upturn. That’s precisely the risk financial markets are missing.