Recession: Is It Inevitable?
If you just looked at the stock market, you might think the threat of recession was gone and forgotten. Since hitting a low on Apr. 4, the Standard & Poor's 500-stock index is up 14%. One reason for the renewed confidence, of course, is the better-than-expected first-quarter economic data released on Apr. 27, which quelled fears of a recession. According to the government, gross domestic product grew at a 2% rate, while real consumer spending was up a solid 3.1%. Moreover, the housing market still appears to be strong. Indeed, even the May 4 announcement by the Bureau of Labor Statistics of a rise in the unemployment rate, to 4.5%, didn't seem to dampen investor enthusiasm. Wall Street appears to be counting on more rate cuts from the Federal Reserve and President George W. Bush's tax cut plan to bail out the economy.
But this optimism may be misplaced. For starters, the reported strength of the economy in the first quarter may turn out to be a mirage. If the economy is heading downward, history suggests that first-quarter GDP and consumer spending could be revised down drastically. Worse, over the past four decades, there has never been a sustained period of falling employment that was not accompanied by a recession.
There's no reason why 2001 should be an exception. Over the past three months, the number of employed workers has fallen by 645,000, as measured by the BLS survey of households. The number of jobs, estimated by a separate survey, has dropped for two months.
And that may be just the beginning. All the forces are in place for a sustained employment decline, which could pull down consumption and turn a slowdown into a full-fledged recession. For one thing, companies are under intense pressure to keep cutting jobs. The latest productivity report, released by the BLS on May 8, showed a sharp decline in productivity, with labor cost per unit of output rising at a 5.2% rate in the first quarter. After a hefty jump in the fourth quarter, that's the biggest six-month hike in labor costs since 1990--a rise that helped trigger a massive surge of layoffs.
Meanwhile, the tech slump is taking out more and more workers. In the latest round of bad news on the jobs front, on May 7 and 8, Dell Computer (DELL ), 3Com (COMS ), and National Semiconductor (NSM ) all announced layoffs. With both manufacturing and high tech in the tank, there are few signs of strength in the job market. The Conference Board's index of help-wanted advertising declined to 66 in March, the lowest level since 1993. And job growth in services, which had balanced manufacturing losses, is fading. The index of employment for nonmanufacturing companies, issued by the National Association of Purchasing Managers, has fallen below 50, a sign of contracting employment.
Especially hard hit are college-educated workers, who make up a big share of the tech labor force. According to the latest numbers from the BLS, unemployed workers with college degrees account for more than half of the rise in joblessness since the beginning of the year, far outpacing other groups. To an unprecedented degree, this is a white-collar downturn--and since college-educated workers account for about half of personal income in the U.S., that will have a big effect on spending.
To be sure, that doesn't mean the economy is headed for a deep downward spiral. Weaker labor markets do not necessarily mean a recession. And even if one hits, it may be short-lived. The combination of interest rate cuts and fiscal stimulus should start boosting growth in the second half of the year. Weak growth in 2001, moreover, does not imply that the productivity gains that characterized the New Economy are over. Indeed, the pressure to cut costs may keep productivity heading up in the quarters to come. Companies in some sectors seem to be holding up quite well. With the housing markets still robust, homebuilders such as Toll Brothers Inc. (TOL ) have reported strongly rising sales. At 7-Eleven Inc. (SE ), same-store sales were up almost 4% in March, after a slowdown that started last summer. CEO James W. Keyes says he adjusted to the weaker economy by offering consumers smaller, less expensive packages of milk, cigarettes, and beer.
Still, there are plenty of signs that disappearing jobs are translating into chastened consumers. Consumer credit rose at only a 4.7% annual rate in March, the slowest hike since '99. Retail sales are down for the past two months, and car and light-truck sales in April fell by 10% over the previous year. And as layoffs mount and incomes fall, households will start feeling the burden of the debt taken on during the boom. The latest numbers, from the fourth quarter of 2000, show that household debt-service payments are running at 14.3% of disposable income--well above the level in 1990, just before the last recession. That could force spending cutbacks. "We have a consumer population leveraged to the hilt. How do they pay their debts?" says Stuart Feldstein, president of credit consulting firm SMR Research.
The pressures on consumers are also showing up in the growing number of consumer companies reporting weak sales. On May 3, Newell Rubbermaid Inc. (NWL ), maker of a wide variety of consumer products, including Rubbermaid and Little Tikes, announced a 1.1% sales drop in the first quarter. The next day, Fort Worth-based RadioShack Corp. (RSH ), the nation's largest consumer-electronics retailer, reported a 2% drop in April same-store sales. "The current economic business slowdown [has] clearly impacted our business," says RadioShack Chairman and CEO Leonard H. Roberts.
Nor is employment likely to pick up anytime soon. Each day brings a flurry of layoff announcements. The crucial tech sector, which propelled much of the job and income gains of the 1990s, still seems to be on the ropes. After an uptick in March, analysts say PC sales weakened again in May, prompting a new round of price cuts from Dell, Compaq Computer (CPQ ), Hewlett-Packard (HWP ), and Gateway (GTW ). New orders for info-tech gear are tumbling and are already down 11% since their peak last June. Venture-capital outlays, down from roughly $105 billion in 2000 to about a $45 billion annual rate in the first quarter of 2001, according to researcher Venture Economics, still appear to be fading fast.
The venture-capital fall-off has a particularly potent effect on jobs. Venture capital is high-powered money--it goes to companies that need to spend right away on workers and equipment. Take away that money, and jobs vanish. Given the labor-intensive nature of most startups, it's possible that as much as half of VC money goes into paying for labor, such as programmers, salespeople, and the like. At $100,000 per job, the current $60 billion decline in VC outlays could cost as many as 300,000 well-paying jobs.
With much less fanfare, smaller companies are cutting, too. Among Friends Inc., a Winnetka (Ill.) retailer of home goods such as glasses and furniture, is planning to close its Marin County, Calif., store in September, after a 40% sales decline over the past year. It's also shifting from a mix of full-time and part-time workers at its other two stores to all part-time workers, says co-owner Kathleen J. Hendricks. That should reduce expenses 30% to 40%.
Falling employment will also drag down housing, which is one of the few sectors still driving growth. It used to be that housing starts and sales led a downturn as banks stopped lending and borrowers grew scared. But now, banks know they can sell the loans they make to Fannie Mae (FNM ) or Freddie Mac (FRE ). And "borrowers use adjustable-rate mortgages with the thought that when interest rates go down, they will refinance," notes Susan M. Wachter, a Wharton School housing economist.
But housing and other construction markets are likely to soften as employment drops, perhaps accentuating the downturn. "Housing is certainly going to be a negative going forward and not a positive," says Kenneth Rosen, a real estate economist at the University of California at Berkeley. He expects a 10% to 20% drop in construction activity starting in the second half of 2001, continuing into 2002.
So why are economists having so much trouble calling a recession? In the early stages of a downturn, the government's data for GDP, consumer spending, and employment typically overstate the economy's strength and are later revised downward. In the last recession, starting in 1990, the government initially reported GDP growth of 1.6% for the third quarter. But by '92, growth for that quarter had been revised below zero; the most current set of revisions shows a -0.7% decline. Real consumer-spending growth, originally reported at 3.6% for the third quarter of 1990, was later revised to 1.5%. And job growth, reported as 0.4%, was revised to -0.5%.
The same downward revisions are likely to happen this time, and for a simple reason: Government statisticians are missing a lot of information when they put out their quarterly and monthly GDP estimates. When the government issued its report on first-quarter GDP and consumer spending, it had data on only slightly more than half of $4 trillion in consumer spending on services. For the other $2 trillion, it used informed guesses or, as the Commerce Dept. politely calls them, "judgmental trends." During normal times, those informed guesses are pretty close. But when the economy changes direction--as it does at the start of a recession--they can turn out to be wildly off. More accurate data come in over a couple of years from annual surveys and other sources.
The U.S. could still avoid recession in 2001. But with three months of declining employment on the ledger and more job cuts to come, that doesn't look likely.
By Michael J. Mandel in New York, with bureau reports