Reading Past the Employment Headline: Someone’s Got to Do It
Sunday, November 7th, 2010
Friday’s unemployment report was met with loud cheers and smiles when payroll employment was up by more than 150,000. Although the unemployment rate stayed the same, this was viewed as a clear sign that things were moving in the right direction. Once I heard all of that, I was anxious to see the real data (I stopped listening to all of the pre-release discussions by the usual talking heads on the three cable business channels long ago. After all, if the data are about to be released in 30 minutes, why not wait for the real thing?)
I was quite amazed at the stark difference between the headlines and the actual data, and I didn’t have to dig very deep to see it. The household survey, on which the unemployment rate calculation is based, stayed at 9.6%. The survey showed that the number of employed persons dropped by -330,000, and the number of people in the workforce dropped by -254,000. If those workers had not left the workforce, the unemployment rate would have been 9.8%! In the same report, the labor participation rate dropped to 64.5%; at the end of the 1990s it was nearly 68%. This was the worst level of labor participation in about 25 years.
Why the difference in reporting? It could be that reporters are just getting tired of the sideways nature of the economy and have become bored. I have long felt that there is a distinct bias on the part of journalists that the payroll survey data is better than the household survey which includes freelance and self-employed workers. If it’s not a payroll job, it seems, it’s not a real job. I guess the last 23 years of independent work I have been blessed with for the welfare of the family hasn’t been a real job. Oh, well. We know where the statistics are, and I guess they don’t.
These unemployment data are not likely to improve. Just this week productivity data for the third quarter were released, and productivity output was up 3% compared to the second quarter, almost doubling. Considering that GDP increased by 2% in the third quarter, there is no reason to add employees (on the macroeconomic level). Until GDP grows faster than productivity, employment will not improve. What’s more disturbing is that so few people seem to understand the relationship.
Remember our theme of efficiency over expansion. Businesses are investing to increase their productivity and reduce their costs, not to expand their production. The productivity is being used to pay for the increased costs they are seeing in raw materials, transportation, benefits, and regulatory compliance (current and forthcoming). Productivity is allowing companies to cope with sluggish revenues but still generate a positive bottom line.
This does not mean that businesses don’t want to expand; it means that they see no upside in expanding. In general, few businesses are sensing any increase in demand from their customers, so their calculation is that taking the risks of new ventures is not worth it. Instead, they focus on the internal operations of their businesses until such time the rewards of focusing outside are evident.
Unfortunately, productivity increases are not heading into employee wallets and purses. Last week’s personal income report showed a decline in disposable personal income (income after taxes). Over the last few months, these data have been averaging around zero, but for September it was -0.3%, when just as recently as May it was +0.4%.
So there is less take-home income from taxes and increasing workplace costs that rob workers of the fruits of their productivity. That bodes well for the holiday shopping season, right? No, it does not. But there are some news stories predicting that the holiday retail season will be good or that consumers will be buying higher priced goods. My suspicion is that there will be the usual headline discounts on many items, but that retailers did not stock up so much that they will have aggressive discounts at the end of the season. Look for a retail season that is not much different than last year, though retailers will go out of their way to say that it is different.
And why would we think that things are getting much better? The disappointing, but expected, GDP report did not show any notable growth. Most of the estimated 2% rise was related to stocking of inventory. It has been my suspicion that the inventory is the product of low financing rates (meaning that the carrying cost of inventory is lower than ever (for those who can get credit)), avoidance of upcoming price increases for goods, production today for production that will be more expensive later because of tax and benefit costs, and other reasons that avoid certain higher costs in the near future. For this reason, I believe that we’re in no danger of a breakout GDP quarter any time soon. The GDP report was also disappointing because it appeared almost certain that it would be at the level of Q4-2007, when the recession began. So we are still below the economic activity level at the time of the recession start, which means that we are still in recovery.
It may take some time for the recovery to be declared completed, however, even though real Q4-2010 GDP may exceed Q4-2007. The academics who determine the starts and conclusions of recessions and recoveries seem to rely more and more on employment trends as a key contributor to their decision.
The more forward-looking data this week were from the Institute of Supply Management. Both their manufacturing and non-manufacturing reports were fairly good, and in some aspects, very good. Both sector reports have been showing economic growth, and they have been more bullish than the government data show. My suspicion is that these data reflect a bit of survivor bias (bankrupt companies don’t participate in surveys) and also the effect of the weak dollar. The production is for “over there” but not for “over here,” and also for inventory building. It doesn’t lessen their value as directional indicators, but is a reminder that the indicators do not cover the full economy.
Speaking of a weaker dollar, who’s manipulating their currency now? Ben Bernanke has announced that the Fed will buy back $600 billion in bonds in an effort to stimulate the economy. Not that this has worked recently, but my suspicions tell me that the banks need to be propped up some more. Claims that the first easing was necessary to save the economy create this morbid thought of the “angel of death” who worked in a hospital in Long Island. He would secretly create a medical crisis for a patient and then resuscitate them to earn the praise of his supervisors. The scheme was found out, but is almost repeating itself on a monetary basis. Loose money lent at below inflation rates fed the housing and mortgage crisis, and now the only thing that will save the day is more loose money. It’s being called “Quantitative Easing 2”, or “QE2” for short. Paul Volcker, who might be the greatest Fed chairman in history, has already spoken against it.
Don’t Be Too Bullish on the Congressional Shift Yet
One hopes that the shift in Congress and the greater change in state legislatures in last week’s elections may create more urgency about dealing with business issues. Don’t bet on it right away. Elected officials from both parties like to pick and choose industries they will “help” rather than creating a general change in policies for all businesses.
As far as the House of Representatives goes, it could play out rather chaotically in the first few months of the year. I suspect the pattern will be the regular passage of legislation related to fixing or replacing health care and various regulatory and tax relief bills. These will pass the House with relative ease and then get blocked in the Senate.
As far as tax policy goes, there is a problem with the way small business incomes are viewed, and it distorts the way policy is created. Inside-the-Beltway analysts seem to think that “the rich” are always rich and have steady incomes, which is why higher tax rates would result in higher tax revenues. Unfortunately, historical data from the IRS and other sources have always shown that small business income is highly volatile. Great years are really great, bad years are really bad, and average years are often hand-to-mouth. These businesses survive the bad years by drawing from the windfalls of the great years. So the higher tax rates will only make it harder to create savings buffers for bad years in small businesses.
There are some things that may be acted on quickly. The 1099 reporting fiasco that was in the health care bill might be fixed in the lame duck session. The “Bush tax cuts” are likely to be extended, with some exceptions, for at least two years. Higher rates on high income earners, though counterproductive, may still be part of the fix. In fact, most everything that is done will have short time horizons, which will make the 2012 election the battleground for all things related to taxation and business regulation. The electoral posturing will start in January 2011 with the first pound of the gavel.
A two- or even three-year extension of the current tax rates will do little to help the economy in the long run. Even those rates were too high to promote economic growth. The key economic factor that is missing from a thriving economy is strong capital investment. Many capital projects are cash-flow negative for three or four years, which is well beyond the horizon of the proposed extensions. When calculating net present value using higher tax rates and a prudent estimate of future inflation (which will be higher than it is today), the threshold that must be passed to decide to invest in the project gets higher. It would be better to permanently abolish the Alternative Minimum Tax, but that will not happen. Only projects already underway will benefit from the temporary extension of current rates.
There is a good chance that first-year expensing may be part of the lame duck session. One hopes so. With future inflation likely, dragging out depreciation schedules means that the costs of equipment will never be fully recovered. This, too, suffers from the same myopia. First year expensing will benefit businesses already prepared to make investments if that incentive will expire in two years. There may be a surge in investment, but it will be a surge and not result in continuous reinvestment.
In the meantime, don’t rely on what may or may not happen in Congress or the economy. Keep watching technology, demographics, and other factors that are far more important to our future, and base your strategic initiatives on that analysis. In the short term, start preparing for higher materials costs as QE2 is already causing commodity prices to rise. Be vigilant, not cautious, and work to restructure your business with an eye toward 2015 and 2020.