- Job creation may be more robust than official statistics suggest
- U.S. employment situation
- Central bank meetings
We have a friend who is a first-generation American. His parents came from a country where business is conducted largely in cash, partly out of mistrust for banks and partly for strategic reasons. Family legend has it that his father still keeps large amounts of currency stashed around the house and that the old man’s will is a treasure map highlighting these hiding places.
This may not seem like the most advanced financial management strategy, but it does seem to be gaining new adherents. There are signs that the “grey economy” is expanding in many countries, in response to changes in tax policy and regulation. Today, it is easier than ever to work "off the books," as there are whole web sites devoted to this marketplace.
This trend complicates the analysis of labor markets and makes life more difficult for global policy-makers. Spreading tax evasion frustrates efforts to reduce fiscal deficits, and central banks are finding it more difficult to assess levels of economic activity and employment.
The oldest form of transacting is barter, which predates monetary transactions by millennia. The first coins didn’t appear until early Grecian times, by which point world gross domestic product (GDP) was already several billion dollars (in today’s terms). Commerce quickly gravitated to the monetary system; having a medium of exchange greatly reduced the difficulty of matching buyers and sellers.
The presence of money ultimately facilitated banking and central banking. Accounting for economic activity became significantly simpler. Yet making economic activity more measurable also made it easier to tax. It allowed more complete policing of transactions that were illegal or subject to regulation. And so off-the-books activity never completely disappeared.
By its very nature, the size of the "shadow economy" and the numbers of those engaged in it are difficult to measure. But estimates of its scale are surprisingly large: almost 15% of GDP in the " United States and higher than that in peripheral Europe. The $2 trillion in revenue that goes unreported to U.S. authorities leads to hundreds of billions in uncollected taxes. For European nations engaged in fiscal austerity, the revenue that might be achieved if grey transactions came into the light would be very much welcome.
We certainly don’t get monthly updates of these figures, but there are reasons to suspect that the attraction of working off the books is growing.
Rising tax rates. Whether based on income, profits or value-added, levies based on measurable economic activity can be avoided through shadow transactions. The international hunger for government revenue has led to a wide range of tax increases in various countries, increasing the return on covert activity.
- Stiffer regulation. Labor market “rigidities,” such as minimum wages, restrictions on adjusting staffing levels and the responsibility for health and pension benefits have also promoted the shift of work to the more flexible realm of the grey economy.
In the United States, the number of people leaving the labor force since the Great Recession has been substantial. Retirement and disability are two reasons given, but a transition to unofficial work may be an important contributing factor. In European countries, the employment-to-population ratio has also been declining, standing well below 50%.
This complicates an assessment of how far an economy is from full employment, a key ingredient in central bank discussions. In some cases, easing monetary policy may not be the best way to boost employment ratios if tax and regulatory issues are the main hindrance.
However, there also is a positive facet to the growing legions of unofficial workers. We have expressed concern about relative trends in personal consumption and personal income, which have left the U.S. saving rate at less than 3%.
But it may very well be that we are underestimating personal income by the amount of grey market earnings. Saving rates may functionally be quite a bit higher, reducing the need for greater frugality.
In Europe, rates of official employment are alarmingly high, especially among the young. But many could be earning at least a modest living by providing services that are not captured in the economic accounting.
It’s not clear what might be done about this phenomenon. Carrots and sticks have been proposed. Some levels of amnesty and lower taxes have been suggested on one side; tighter enforcement on the other. Neither will be particularly easy to implement, given the entrenchment of the grey economy across societies.
Our friend with the cash-basis father earned an M.B.A. not long ago. I asked him if he might leverage his advancing financial expertise to promote a greater use of modern financial institutions, instruments and services to his parents. Progress is slow, he reported; his dad is quite content remaining a shadowy figure.
Labor Market Improvement Just Enough for Steady Fed Policy
The April employment report wiped out the “spring swoon” mood. The civilian unemployment rate was down one notch to 7.5%. Payroll employment rose 165,000 during April, and upward revisions added 114,000 more jobs in the February-March period. These headlines present an improving labor market.
The participation rate held steady at 63.3% and the employment-population ratio moved up one tick to 58.6%. The long-term unemployment rate declined to 37.4%, the lowest since 2009, which is a noteworthy development. Erosion of job skills and a loss of productivity are the heart of the concern about long-term unemployment.
Details of the establishment survey showed that employment gains averaged 152,000 per month in the March-April period, compared with a 233,000-job jump in the three months ended February. The entire increase in payrolls was from the service sector, as factory hiring held steady and construction employment fell 6,000 in April.
Job growth was concentrated in professional and business services (+73,000), retail (+29,000), restaurants (+38,000) and health care (+19,000). Sequestration accounted for a loss of 8,000 federal government jobs, while state and local government jobs fell 3,000. Average hourly earnings moved up 0.2% in April, putting the year-to-year gain at 1.9%. The shorter workweek (34.4 hours, down 0.2 hour) is one of the few weak spots in the April report.
The April employment numbers do not suggest a significant and sudden slowing, despite the fiscal restraint. At the same time, the data do not offer enough justification for the Fed to consider a reduction or an expansion of its asset purchase program.
Contained Inflation – A Gift to Central Bankers
Earlier in the week, the Fed stood pat but modified its guidance around its asset purchase plan, while the European Central Bank (ECB) reduced the policy rate 25 basis points to 0.50% and the marginal lending rate to 0.50% from 1.0%. Contained inflation has enabled the accommodative stance of both central banks without tarnishing their credentials.
The Fed’s latest missive notes that the current asset purchase program can be tapered or expanded depending on the nature of developments in the labor market and inflation. The new language conveys the Fed’s concern for not only soft economic numbers and the adverse impact of fiscal restraint but also of low inflation readings.
In the United States, inflation as measured by the personal consumption expenditure price index stood at only 1.0% for the year ended in March. Core inflation, which excludes food and energy, came in at 1.1%. Declining prices for energy, medicines and clothing combined with stable housing costs have prevented an escalation of inflation.
Of these major components, it is plausible that energy prices could be reversed with scant notice, but energy prices in the futures market do not show an imminent threat. Wage costs, the largest component of production, are not accelerating rapidly. Projections of growth in the near term do not suggest likely inflationary pressures.
The ECB’s situation is markedly different. The eurozone is nearly certain to record a decline in real GDP in the first quarter, the fifth in the last six quarters. Its unemployment rate is upward of 12% and exceeds 25% in a few countries in the periphery.
The rapid decline of year-over-year inflation to 1.2% in April from 2.2% six months ago allows the ECB to enact an interest rate reduction, but the success of this action is limited due to market fragmentation in the eurozone. The lower policy rate will succeed if it trickles down to borrowing costs for small and medium enterprises, particularly in the periphery. However, there is a vast discrepancy in interest rates for businesses within the eurozone (see above chart).
Restricted supply of credit to small and medium enterprises is the main impediment the eurozone faces, and lowering interest costs cannot solve it. To this point, Mario Draghi indicated the ECB would work with other institutions to address this pressing problem. Central bank accommodation continues to remain in place to promote economic growth, for now.
© Northern Trust