U.S.: Labor's New Flexibility Cuts Two Ways

While business benefits, temporary workers are taking the hardest hit

The 1990s marked a dramatic rise in the flexibility of the U.S. labor markets. In particular, the sharply increased use of contingent workers and variable pay allowed companies to more closely align their labor costs with output. The result: Business was better able to hold down fixed costs even as they coped with soaring demand in the mid-to-late 1990s.

Now, with demand and output falling, the downside of that flexibility is a key factor shaping the outlook for the labor markets, consumers, and the economy. Temporary workers are taking a beating in this recession, accounting for a disproportionately large share of the losses in jobs and incomes (chart). And a greater number of jobseekers can only find part-time employment.

But on the plus side, the hit to permanent staffers may not be as great as in past downturns, so morale may not suffer as much as in the past. And so far, workers' pay continues to grow at a healthy pace. That is one factor giving consumer spending its resilience. In addition, the profits outlook will benefit because laying off temp workers carries fewer charges than shedding full-time employees.

To be sure, the Labor Dept.'s November job report was grim, which undoubtedly played into the Federal Reserve's Dec. 11 decision to lower interest rates for the 11th time this year. The Fed cut its overnight federal funds rate by a quarter point, to 1.75%, noting "tentative" signs that the weakness in demand was abating, and that inflation is expected to edge lower next year. Still, it held the door open for another cut next year, citing risks in the outlook that were still slanted toward weakness.

THE JOBS DATA showed that businesses lopped off another 331,000 workers from their payrolls last month, after shedding 468,000 in October. Losses of this size are only seen in recessions. Plus, the unemployment rate continued its upward climb, reaching 5.7%. That's up more than a full percentage point since July, and the rate is sure to peak at well over 6% next year. Note, however, that hourly earnings increased a sturdy 0.3% from October and 3.9% from the year before. Pay growth has slowed, but not by much.

The recession's heavy impact on contingent workers is partly responsible for that anomaly, along with its skewed effect on low-skilled and low-paid workers generally. To the extent that those at the lower end of the pay scale are taking the hardest hit, the overall average of earnings is not affected as greatly.

Since March, when payrolls peaked and the recession began, employment at temporary-help agencies has dropped by 375,000. That accounts for 30% of the 1.2 million jobs lost so far in the recession. The striking point here is that temp agencies account for only 2.2% of total payrolls. Throughout the late 1990s, income brought home by such temp workers typically grew 15% to 20% annually, but pay plunged 9% in the year ended in November.

Temp-agency hires are only a small part of the contingent work force, as defined by Labor in its biennial survey of such workers. Labor also includes some workers elsewhere classified as self-employed or independent contractors. Also, within the temp-agency category, some 21% are employed in manufacturing, which has borne the brunt of this recession. At the time of the last survey in February, there were 5.4 million contingent workers under Labor's broadest definition, comprising 4% of total employment.

THE DEMOGRAPHICS of this group reveal that, to a large extent, the workers who are getting hurt the most in this recession are the ones who were helped by the economy's unsustainable strength in 1999 and early 2000: the least skilled and the least paid, who found work as the jobless rate fell to an equally unsustainable low of 3.9%. Labor says that contingent workers are more than twice as likely as noncontingent workers to be under age 25, that they are slightly more likely to be black or Hispanic, and that those age 25 to 64 are more likely to be high school dropouts and less likely to have graduated from college.

But the trend to lay off the least-skilled extends to full-time workers as well (chart). The November job report shows that workers with a high school diploma or less and no college, who make up 40% of all job holders age 25 or older, have accounted for 90% of the 1.4 million jobs lost in that age group since the recession began. Employment for those with college degrees, about 30% of the group, has actually risen.

In addition to the recession's skewed impact on low-paid workers, other factors will help limit the slowdown in incomes. Clearly, the labor markets will continue to soften in coming months, but employment is declining from an historically high level, and the jobless rate is rising from an exceptionally low level. The result: Labor markets, while loosening, are still relatively tight.

First, note that the percentage of the population who have a job, while down from a record 64.8% in April, 2000, to 63% in November, 2001, has never been this high in a recession. In fact, it is still higher than it was before the 1990-91 recession. In addition, compare today's 5.7% jobless rate with the rate eight months into the 1990-91 recession, which stood at 6.8%, on its way to a peak of 7.8% after the recession ended.

THE GOOD NEWS is that the worst erosion in the labor markets may have already occurred. New weekly claims for jobless benefits are well off their October peak, although they remain somewhat above their pre-September 11 level (chart). Plus, the total volume of claims fell sharply in late November, although that probably overstates the trend of improvement.

Looking ahead, the higher productivity of the work force is also a bright spot in the outlook that will bolster both consumer buying power and corporate profits. Productivity growth, which the Labor Dept. revised downward in the third quarter to 1.5% from an originally reported 2.7%, is still remarkably strong. Moreover, productivity seems likely to rise in the fourth quarter as well. Overall hours worked through November are falling at an annual rate of about 4%. Even if economic output shrinks by 2% this quarter, productivity would still grow on the order of 2%.

Amid such an unusually strong productivity performance in a recession, businesses can offer higher real wages to workers and at the same time keep a lid on their unit labor costs. As a result, consumer buying power can still rise, even as businesses get a head start on shoring up their profit margins.

Flexibility and resilience have been two hallmarks of the labor markets throughout this business cycle. So don't judge the economy's health only by the top-line results of the monthly job data. This is a fundamentally different economy than it was 10 years ago, and those differences will favorably affect the outlook for the coming months.

By James C. Cooper & Kathleen Madigan

    Before it's here, it's on the Bloomberg Terminal.