If It's A Recovery, It Sure Doesn't Feel Like Oneby
Most economists believe the recession ended three or four months ago. But an ABC News poll of 1,200 Americans taken in late July revealed that 85% of them thought the economy was still headed downhill. The Conference Board says consumer confidence has gone nowhere since the end of the war. And the U. S. Chamber of Commerce reports that business confidence is down in the dumps as well. To the public, it just doesn't feel like a recovery.
Behind these downbeat attitudes lies a depressing list of concerns: huge debt, overvalued real estate, federal and state fiscal woes, sluggish money growth, and the credit crunch. These drags are restraining demand at a time when businesses are trying to make money in a low-inflation economy, where pricing power is a far cry from what it used to be (page 20 24 ).
The sector where all this is hitting especially hard is services. As weak demand and prices batter many labor-intensive service industries, cost-cutting is becoming a top priority. Goods producers bit the bullet in the 1980s, as competition forced downsizings and productivity gains, in order to enhance profitability. Now, a major restructuring is taking place in services.
SERVICE JOBS ARE STILL IN THE TANK
This is a big reason why the recovery doesn't feel so good. Service industries employ three-fourths of all workers, and that means plenty of consumers are more than a little worried about their jobs--and rightfully so.
During the recession--from the third quarter of 1990 to the second quarter of 1991--private service jobs fell at an annual rate of 0.6%, one of the sharpest contractions in the postwar era (chart). Service output, however, didn't slow at all during the downturn. Real gross national product in private services grew at an annual rate mf 3%, the same pace as in the year preceding the recession. In the past, it took a sharp slowdown in service output to produce such a steep slide in employment.
Such a wide disparity this time around clearly reflects an effort to cut costs, improve productivity, and shore up profit margins. And it suggests that the current round of cost-cutting is more structural than cyclical.
One reason is that the squeeze on profit margins in service businesses is not letting up. Service-industry earnings stood at 7.1% of service GNP in the first quarter. This margin is little changed from 1990, and it has been shrinking since hitting 9.6% in 1986. Initial reports on second-quarter profits suggest no improvement.
With pricing power limited by slow inflation, profit margins will not improve substantially until service productivity picks up enough to offset the cost of labor. That will allow the pace of unit labor costs to ease back in relation to prices, thus making more room for earnings. The slowdown in service wages that has already begun, combined with low job growth, means the outlook for service companies will improve in the long haul.
Productivity always picks up in a recovery, as output outpaces employment. But the gains in service efficiency now developing appear to be more than just cyclical. Service employment began to slow down two years ago, well before the recession began, and there is no evidence that hiring will pick up any time soon.
Indeed, the Conference Board's index of help-wanted advertising ticked up in June, but it has been nearly flat since February. The American Management Assn.'s survey of corporate layoffs for the year ended in June showed the most widespread cuts since the survey began in 1987. And the National Federation of Independent Business says that the hiring plans of small businesses fell last quarter.
The upside of all this is a brighter outlook for inflation, since service prices had been the last bastion of price strength. The downside is that employment is not likely to grow any faster than the labor force in coming months. That means the jobless rate could be stuck at about 7% well into 1992. For consumers, who must lead a recovery, that's not much to feel good about.
THE FIRE UNDER PRICES IS FLICKERING
The inflation outlook is more comforting, however. The consumer price index rose a modest 0.2% in July, in line with the increases in the previous three months. Yearly consumer inflation fell to 4.4% last month, after peaking at 6.4% in October. Slower growth in service prices has led the improvement (chart).
Some of that decline reflects the gulf war's impact on energy prices. But even excluding food and energy, the core rate of inflation is also coming down. The core CPI rose a faster 0.4% in July, but yearly core inflation fell to 4.8%, after hitting 5.7% in February. Again, services led the way. Inflation in nonenergy services declined to 5.1% in July, from 6.5% in February.
Somewhat surprisingly, core inflation in goods prices has been more stubborn. Excluding food and energy, the CPI for goods in July rose 4.2% from last year, faster than the 3.5% pace in the previous year. That's a bit odd, given weak commodity prices, tame producer prices for finished goods, and excess capacity in manufacturing.
One explanation is higher taxes on goods such as gasoline and tobacco, along with sales-tax hikes in many states. But those effects will be temporary. The inflation fundamentals for goods are much more favorable teases recorded during the early stages of previous recoveries. And after adjusting for inflation, real volume remains 2% below its year-ago level (chart).
With sales still sluggish at best, retailers have been selling from their inventories, as opposed to placing new orders. Retail inventories fell 0.2% in June, and they have declined in seven of the last eight months.
Other industries also continue to cut their stock levels. Inventories held by manufacturers, wholesalers, and retailers fell 0.3% in June, and the May decline was revised to show a drop of 0.6%, instead of 0.5%. Since inventory liquidation last quarter was steeper than the Commerce Dept.'s initial reading, the slim 0.4% increase in second-quarter GNP could be revised down.
A pickup in car-buying has kept auto inventories low. Car sales rose by a strong 1.1% last month, the third consecutive gain. But domestically made cars performed poorly in early August, selling at a 6.2 million annual rate, down from 6.8 million for all of July.
Excluding autos, retail sales rose a modest 0.3% in July, with furniture and department stores pmsting healthy advances. Purchases of building materials, however, fell for the third month in a row.
Real retail purchases started this quarter slightly ahead of their second-quarter average, but maintaining that lead will be difficult. Household finances look shaky right now, because of the the weakness in service hiring and smaller wage gains generally.
In addition, consumers are staggering under an $18 billion hike in state taxes this year, the largest in 20 years, according to the National Conference of State Legislatures. That will erode purchasing power further.
Economists may trumpet the recovery, but in the face of sluggish demand, sagging profits, more layoffs, and higher taxes, it's no wonder that consumers and businesses disagree.