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Hourly Wages Are Up. So What?

Economists have long viewed average hourly earnings as an early indicator of recovery. As business picks up, the argument goes, companies boost overtime pay or increase wages to attract new workers. From that perspective, the gauge offered something to cheer about in December. Average hourly earnings growth for production workers rose at an annual rate of 4.5% for the three months ended in December, up from 4% annually for the three months ended in November.

In this economic cycle, however, hourly earnings aren't a good indicator of recovery, warns Richard Berner, an economist at Morgan Stanley Dean Witter & Co. He says hefty cuts in temporary workers skew the composition of the labor force of production workers toward higher-paid, full-time employees, artificially inflating gains. On average, temps earn $8.66 an hour, vs. the $15.69 earned by full-time employees in private industry, according to the Bureau of Labor Statistics. Berner calculates that the shift away from temp workers alone added almost 1.3 percentage points to fourth-quarter earnings growth (chart).

Corporate America's increased reliance on temp help during the past decade is astounding. Temp employment tripled from the end of the early-'90s recession, to a peak of almost 3.6 million in September, 2000. Companies turned to temps in part because it's easy to meet fluctuations in demand by adding or cutting them. Nearly 40% of those jobs were in manufacturing, estimates Manpower Inc., the top temp agency. That explains why the economy began shedding temp jobs in October, 2000, well before the recession began in March. Temp employment mirrored the factory sector, which led this downturn, says Manpower CEO Jeffrey A. Joerres.

Maury N. Harris, UBS Warburg's chief U.S. economist, also cites the cut in temp jobs as a reason that earnings are overstated. Further skewing the data, he says, is that most of the recent job cuts have affected workers who have no more than a high school degree and therefore earn less than other workers.

The slower underlying growth in wages does have a silver lining, Berner adds. It is another sign that inflationary pressures from higher wages are still slight. That should help reverse the decrease in corporate profits, which tipped the economy into recession in the first place. Says Berner: "From that point of view, this is a bullish sign." In tough times, consumer sentiment is widely watched as a signpost for what's ahead. When it comes to predicting whether Americans will keep shopping, two favored indicators are the University of Michigan's Survey of Consumer Sentiment and the Conference Board's Survey of Consumer Confidence. In 1996, UBS Warburg came up with a third, the Index of Investor Optimism, based on a survey of 1,000 investors conducted by the Gallup Organization.

For all the interest these surveys generate, you'd think they were pretty accurate predictors. It turns out, however, that the chance a trend they've spotted will come to pass is only slightly better than 50%, according to The Index of Investor Optimism, a study by Nobel prize-winning economist Lawrence R. Klein of the University of Pennsylvania and Penn visiting professor Suleyman Ozmucur.

The study showed that since 1997, the Index of Investor Optimism has had a slight but statistically significant edge on the more established indexes in predicting spending. Klein and Ozmucur found that investors are just a little bit better than the public at large at gauging the economy. And the most recent survey shows that they're feeling more upbeat.

To make a really good forecast, Klein recommends using this survey along with 27 other indicators, including stock and bond market indexes, housing starts, and the unemployment rate. The U.S. has been the cause of both growth and contraction in the world economy in recent years. America's boom helped power the global expansion of the 1990s, and its slump helped drag down Europe and Asia. The effect was especially visible in manufacturing. European factories, for example, were doing fine until U.S. industry started shrinking in September, 2000. By December, 2000, the slump had spread to Europe (table). And though Japanese output peaked in August, 2000, the factory recession in Japan did not begin in earnest until December, 2000, when the U.S. slowdown bit.

A recent report by two economists at the International Monetary Fund looks beyond manufacturing to quantify the importance of overall U.S. economic health for the rest of the world. Vivek B. Arora and Athanasios Vamvakidis looked at two decades of data for 170 countries. They found that an increase of one percentage point in the growth of U.S. output per capita was associated with an increase of 0.8 to 1.0 percentage point in the average growth of other countries. Decreases in U.S. output likewise lowered growth elsewhere.

Developing countries seem to be the most sensitive to U.S. influence. The U.S. had more impact on global growth than the European Union and far more impact than the Japanese. "Growth in Japan does not seem to have a positive impact on growth of other countries," they write.

It's possible that the European Union will become more influential as the euro takes hold. But for now, the rest of the world has a big stake in the ability of the U.S. to sustain the productivity gains of the 1990s.

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