Identifying imbalances has always played a key role in economic forecasting, and the 1999 outlook is no exception. Heading into the new year, two disturbing trends stand out because they cannot continue on their present courses and both of them put consumer spending at risk. How those situations resolve themselves will go a long way toward determining the economy's performance next year.
The first unsustainable pattern: Consumer spending is far outpacing the growth of household income. That trend has pushed the personal savings rate below zero for the first time in the postwar era (chart). The negative savings rate means that consumers are now spending slightly more than 100% of their aftertax income, as stock market gains supplant traditional savings, and as household borrowing speeds up again. The recent rebound in stock prices and the strong November employment report only reinforce this kind of extravagant consumer behavior.
Consumer spending in 1998 will grow in excess of 5%, including what appears to be at least a 4% pace this quarter. That increase coming so far into an expansion is unprecedented in the postwar era. Such a growth rate has been exceeded only in the years immediately following a recession, and it has come in handy in 1998, when the rest of the economy was beset by falling exports and growing corporate unease. This year, consumer spending will account for almost all of the overall growth in the economy. The other one-third of gross domestic product went nowhere.
SO WHAT HAPPENS to economic growth in 1999 if slower job growth or weaker stock prices cause consumers to save more--and spend less? That's where the second unsustainable trend comes in: The revenues generated by overall output have fallen well behind the total cost of providing wages, salaries, and benefits to employees. That's why corporate profits are falling, and they will sag further as long as revenues and costs continue to diverge.
The new round of layoffs making the headlines recently shows that Corporate America is already pushing to restructure itself back to profitability--and to ease investors' growing concerns about 1999 earnings. Faced with weak pricing and slower economic growth, executives know that the restoration of profitability will not come from the revenue side.
Instead, businesses will be forced to rein in their labor costs. During the past year, the total wage bill paid out by companies has grown 6.3%, while the dollar value of GDP has risen by only 4.5%. A split of that size--partly reflecting weak growth in prices--has almost never been seen except in a recession, which highlights the depth of the current profit problem facing businesses.
THE NOVEMBER EMPLOYMENT REPORT shows why consumers are still on a tear. But it also points to some moderation in 1999 spending, as businesses are already starting to pare their labor costs. Industries added 267,000 workers to their payrolls last month, many more than expected, and the jobless rate dipped to 4.4%, from 4.6%. Moreover, the Labor Dept. revised upward its earlier measures of September and October payroll gains by a combined 44,000, to show increases of 172,000 and 145,000, respectively.
Even so, payroll growth is slowing. Job gains so far in the second half of 1998 have averaged 205,000 per month. Growth is still strong, but it's down from 244,000 per month during the first half. Moreover, the November increase may have been exaggerated upward by the mild weather. Construction employment increased by 47,000, more than double this year's average monthly pace of 23,000.
Manufacturing continued to lead the job weakness. Factories shed 47,000 workers in November, bringing losses in manufacturing jobs since March to 245,000 (chart). As companies follow through on their recent swell of layoff announcements, manufacturers will continue to shed jobs in coming months, and some service-related payrolls, especially in finance, will see fewer new hires as well.
Slower job growth will hit the economy at a bad time. Consumers will be crucial to the outlook next year, because other sectors aren't likely to add much to growth. Housing already is beyond its demographically sustainable level. Exports are expected to remain weak amid global softness. And capital spending will slow, perhaps substantially, because of sagging profits, excess capacity, and tighter credit conditions.
SLOWER JOB GROWTH isn't the only consumer fundamental sure to soften next year. Household finances may also look less sturdy. That's because consumers' four major sources of cash--income growth, huge stock market gains, mortgage refinancing, and borrowing--won't flow as strongly as they have in 1998.
Real aftertax income, for instance, will be up about 3% this year--an excellent pace, even though it's way behind spending. However, with companies rethinking their work forces, labor shortages will ease next year. And as job growth slows, so will wage gains. In fact, hourly wages in November were up 3.8% from a year ago. While that's good, it's below the 4.4% rate hit in April. If GDP growth slows to less than 2% in 1999, job gains will likely average only about 100,000 a month, and income growth could soften to an anemic 2%.
Moreover, the poor outlook for corporate profits means that double-digit advances in stocks next year are not likely. Households had been using equity gains to supplement their savings. As long as stock prices soared, consumers felt they could save less--or not save at all. The stock market's impact on consumer spending is clearly evident in the recent savings data: Since the end of 1996, the savings rate has fallen from 2.6% to -0.2% in October. That reduction in savings accounted for about one-third of the increase in consumer spending during that time.
That leaves borrowing as a catalyst for spending. And consumers do seem to be ending 1998 on a credit binge. Installment debt in October jumped $9.7 billion, the biggest gain in nearly two years. In the meantime, homeowners are also tapping into home-equity loans. Together, these two forms of credit outstanding--installment and home loans--are equal to a record 22.7% of disposable income (chart). For now, household finances remain in good shape, but they will stay that way only if job growth and the stock market remain healthy.
So the outlook for 1999 is very much a catch-22. Businesses will have to shore up their profits by cutting labor costs, but those efforts will fall back on the main engine of 1999 economic growth--consumer spending. As a result, cost-cutting may end up cutting revenues as well.