U.S.: Has the Job Engine Blown a Gasket?
For months, the cruising altitude of the U.S. economy has depended much on the lift from resilient job markets. But after the March employment report, you had better tighten your seatbelt. The ride ahead may get rougher.
Don't panic. The state of the expansion is not as weak as the March loss of 86,000 jobs suggests. Part of the decline was likely payback for the unrealistically large 215,000 average monthly increases in payrolls over January and February. But yearly job growth has clearly slowed (chart), and the unemployment rate ticked up from an expansion low of 3.9% in October to 4.3% in March, with further increases to come.
The outlook hinges on how the softening labor markets affect consumer confidence and spending. Consumer outlays, two-thirds of real gross domestic product, have single-handedly kept the expansion going, more than accounting for real GDP growth in the third, fourth, and first quarters. Remember that until recently, healthy job and income gains and a booming stock market had fueled consumer spending. Now the stock market has gone bust, leaving households more reliant on their paychecks to sustain growth in their outlays.
A slowdown in consumer spending in line with the 2.5% or so trend of real household income is not a problem. But weaker job markets raise some red flags. One: Households, wary of layoffs, could pull back sharply. And two: Slower growth in jobs and income could expose consumer debt problems as households find it harder to service their rapidly growing debt loads. So, too, slowing demand could hurt businesses trying to protect their profit margins in a year of rising labor costs and slower productivity growth.
SO FAR, LABOR MARKET SOFTNESS is not in dangerous territory. The drop in March payrolls was an exaggeration of weakness, just as the large January and February advances were an overstatement of strength. Weather and statistical factors heightened the month-to-month volatility. The six-month trend gives a truer picture of job growth. Gains in private-sector payrolls averaged 67,000 per month during the past six months. That's barely more than half the 128,000 monthly pace of the previous six months, which itself was down from 237,000 in the six months before that.
The drain from job losses in manufacturing, totaling 434,000 during the past year, including March's decline of 81,000, has been enormous. Excluding factory payrolls, private-sector job growth has averaged a sturdy 124,000 per month in the past six months, not too far below the 144,000 average in the previous six months.
Job growth in the private service sector has also slowed, but, again, the March drop of 15,000 slots overstates the weakness. A steep decline in temporary help more than accounted for the service-sector slowdown. Remember that temps were an important factor in companies' efforts to keep up with demand in the '90s, and they were less costly than permanent hires, since few received benefits. That's why temp workers doubled from 1992 to 2000, accounting for more than 3.8 million jobs last year.
Now, with demand slowing, temps are the first jobs to go. Jobs from temp agencies have fallen by 279,000 since last September. Excluding these contingent workers, average monthly growth in private-service payrolls since September has actually risen to 139,000 vs. 133,000 in the prior six months. Moreover, although they are counted in service-sector jobs, many of these laid-off temp workers were hired out to manufacturing companies, another example of how the factory recession is hurting the economy.
The divide between activity in manufacturing and services remained as big as ever last quarter. Overall hours worked, a good proxy for output, fell in manufacturing in the first quarter at an annual rate of 7.9%, while first-quarter hours in the private-service sector rose at a 1.8% rate, only slightly below the fourth quarter's 2.2% pace (chart). That suggests that service-sector activity continues to buoy the economy.
STILL, THE UNEMPLOYMENT RATE is bound to rise from March's 4.3% amid signs of loosening labor markets. Weekly jobless claims through March have been rising. Labor Dept. data show that the duration of unemployment is rising and that the number of permanent job losers has picked up. And, on average, only 48% of companies added workers last quarter, the fewest since 1992.
Equally important, it took GDP growth of greater than 5% to push the jobless rate down below 4%. However, that growth rate was not sustainable, meaning neither was the low jobless rate. Even if the economy slowed to a 3% growth rate this year, which is now a pipe dream, unemployment would have risen a little. Now, the danger is that it may rise a lot.
AGAINST THESE TRENDS, the recent acceleration in wage growth seems anomalous. Hourly pay of production workers rose 0.4% in March after a large 0.6% gain in February, and pay growth from a year ago has sped up to 4.3% from a 3.6% yearly clip in September (chart). Some analysts have even raised the fear of stagflation, a period of economic stagnation and rising inflation.
However, that fear is not well grounded. Pay gains are speeding up for three reasons, and those factors should all fade in coming months. First, the lagged effect of unsustainably tight labor markets will wane as the jobless rate rises. Second, the effect of higher energy costs, which is pushing up wages through cost-of-living adjustments, will lessen as energy costs ease. This energy-driven wage impact showed up in reverse after the 1998-99 drop in energy costs. And third, the gain is partly the result of a quirk in how Labor measures hourly pay. As many companies cut back on their workweeks, the same weekly pay total can result in higher hourly pay in some Labor Dept. calculations.
Even so, rising wage bills come at a bad time for businesses that are struggling with little or no pricing power. In particular, businesses face an especially tricky problem with rising costs due to the cyclical slowdown in productivity growth, which appears to have been very weak, if not negative, in the first quarter. That weakness, plus the gain in workers' compensation, means unit labor costs increased substantially for the third quarter in a row. The combination of rising unit labor costs and no pricing power is squeezing profit margins hard. This pressure from the cost side of the profits equation comes in addition to the earnings woes resulting from weaker demand.
All this, of course, could come back to haunt the labor markets and, in turn, consumers and the economy. Amid slower demand, companies have little recourse in controlling costs but to hack away at expensive payrolls. The more that scenario plays out in coming months, the nastier this slowdown will become.
By James C. Cooper & Kathleen Madigan