The labor market is always churning. Consider that in any recent month, some 3.8 million Americans were separated from their jobs, whether by layoff or by choice. At the same time, slightly more than 3.8 million people began new jobs, resulting in a small net gain in payrolls. This dynamism is the hallmark of a highly flexible labor market that can adapt quickly to changing economic conditions.
In the current business cycle, however, the net result of this churning is far different than it has been in the past. As Federal Reserve Chairman Alan Greenspan noted in February, gross separations from employment have been about what one would expect, based on past experience. But gross hiring is running far below the historical pattern. Greenspan's explanation: Companies continue to identify and implement new efficiencies, allowing them to meet increasing orders without stepping up hiring.
But extraordinary growth in productivity is only the bottom line of the story. The details are much more telling. They show that businesses have rarely, if ever, faced such an overwhelming set of economic disincentives to hire U.S. workers.
To begin with, capital has never been so cheap relative to the cost of labor. The price of new equipment, down more than 3% per year in the late 1990s, has continued to decline since the recession ended, and ultralow interest rates mean that financing is historically cheap. Meanwhile, the hourly cost of labor has not slowed. Overall compensation is up 4% from a year ago, as the soaring cost of benefits offsets slower wage growth.
Then there are the inflation-crushing effects of global competition, which continue to weigh on pricing power, forcing companies to search for new efficiencies. Plus, the spread of globalization -- which moved from the market for goods in the 1980s to the financial markets in the 1990s and now to the labor markets -- means plenty of cheap foreign labor is increasingly employed in the huge service sector, which accounts for 83% of U.S. payrolls.
These job-market head winds are not likely to diminish anytime soon. And despite an economy growing 4% or more, payrolls are likely to lag behind their normal recovery pattern for some months to come.
THESE FORCES, which underlie the enormous productivity gains in recent years, explain why several usually dependable labor-market indicators have tended to overpredict payroll growth in recent months. That's especially true for one of the government's most reliable gauges, new weekly claims for unemployment insurance. On a four-week moving average, new claims dropped to a three-year low of 344,000 in the week ended Mar. 13. Because they track layoffs, new claims typically have been a good predictor of payroll changes. But given the current divergence between firing and hiring trends, a drop in jobless claims has not translated into new jobs the way it has in the past.
THE ATTRACTIVE COST of new high-tech equipment relative to those expenses associated with new hires gives businesses every economic incentive to boost output by using more machines and fewer workers. That's especially true in this recovery, because labor costs have not slowed as much as past experience would suggest, given the amount of labor-market slack.
Sure, companies have kept a lid on wage and salary increases since the last recession. As would be expected in a weakening job market, the growth of pay slowed to 3% in the year ended in the fourth quarter of last year, down from a 3.8% annual pace when the recession began in early 2001. But after slowing in 2001 and 2002, benefits are accelerating again. In 2003, benefits, which now account for 28% of all compensation, rose 6.5%. Not only is that rate faster than the 5% gain posted just as the recession began but it's also the fastest pace since 1990.
According to the latest data from the Labor Dept., private employers paid out, on average, $22.92 per hour worked in the fourth quarter. Of that, $6.43 was devoted to benefits. The rise in health-care benefits is gathering the most attention. Medical insurance rose 10.5% last year. But health care is not the only cost weighing on employers' bottom line. While health insurance cost $1.50 per hour, legally required benefits, from social security to workers' compensation, took up a larger $1.96.
Businesses are getting around these costs by depending more on contract workers and temporary help. And the cheaper wage structures overseas result in lower benefit costs, in addition to the fact that the governments of many other nations offer universal health-care coverage.
WHAT IS MAGNIFYING the impact of rising labor costs on hiring patterns in this recovery is that, unlike in past upturns, companies cannot lean on higher inflation to help them out. They still have very little pricing power. In this new era of global economics, that situation will not improve much this year.
Despite all the hubbub over the China-driven rise in commodity prices and possible inflation concerns, U.S. businesses have little new power to pass along the higher costs to consumers. For example, General Motors Corp. (GM ), stymied by climbing steel costs, is fearful of both disruptions in its supply chain and its inability to pass along the higher costs in a competitive market.
The latest price indexes tell the story. Yearly inflation for finished producer goods, excluding energy and food, is 1%, up from about zero a year ago. But consumer-goods prices are falling faster now than they did a year ago. In February, prices for consumer goods, less energy and food, fell 2%. The year before, they declined 1.4%.The point here is that global competition is never inflationary. It's just the opposite, since it heightens the need for businesses to cut costs. That pressure has spurred the pursuit of efficiency and put the squeeze on new hiring. Globalization is exerting an even greater drag on hiring in this recovery. Thanks to cheap communication lines and technological advances, U.S. companies can tap foreign workers to perform more jobs in the service sector, which had been the main engine of job growth in past recoveries.
To be sure, the American job machine is not broken. It is a cinch that, at the current pace of economic growth, payrolls will be rising faster by the end of the year than they did at the beginning. But it's also certain that a return to rapid job growth will take a while.
By James C. Cooper & Kathleen Madigan