The first Friday of each month is filled with tension for those in my line of work. The U.S. employment data, arguably the most important international economic release that we receive, comes out on those days. Forecasts can be made or broken by the outcome, so I become very focused and anxious in the moments leading up to the report. Colleagues who dare offer good morning cheer at those times receive a dismissive sneer in return.
Today, at least, my mood lightened almost instantly when the October figures popped up on the screen. The report was impressive across the board:
- Payrolls grew by 271,000 last month. Job creation has averaged 215,000 over the past six months and 235,000 over the past 12 months. These are very strong levels.
- The unemployment rate fell to 5%, half the level it reached at the depth of the 2009 recession. The broader measure of unemployment, which accounts for those working part-time and “discouraged” workers who have left the labor force, fell below 10% for the first time during this cycle. This measure had peaked at more than 17% in 2009.
- Hourly wages advanced very nicely and now stand 2.5% higher than they were 12 months ago. That is the best reading since 2009 and provides evidence that labor supply is diminishing. It is also a positive for consumer spending going forward.
Federal Reserve officials have been debating whether the Phillips Curve (which relates unemployment and inflation) was still in operation. Today's release suggests that those effects still exist and may give Federal Open Market Committee participants added confidence that inflation will approach the 2% target over time. A December rate hike is a very strong possibility. Fed officials have been hinting as much for the past week.
The only things that could derail this outcome are a really poor November job report (unlikely) or an international event. On that latter front, the Chinese equity market just returned to bull- market territory, reducing the fear of imminent danger that kept the Fed on hold in September.
We think that the Fed will pair its rate increase with a clear message that further increases will be very gradual. That tactic will hold out best hope for sustaining the expansion without disrupting markets.
So I am much calmer now than I was first thing this morning. Now, if you will excuse me, I have to go apologize to everyone on my floor for being so surly.
Participating in the Recovery
The labor force participation rate (LFPR) has dropped for the last 15 years in the United States. The decline has been much-discussed because it reflects on the overall well-being of the nation and bears importantly on monetary policy decisions. Some clarity on the meaning of the LFPR and the reasons for its downward trend are important background for today’s economic debate.
The Bureau of Labor Statistics calculates the unemployment rate, LFPR, and the employment-population ratio. Those employed and officially unemployed make up the labor force. The official unemployment rate is calculated by dividing the number unemployed by the labor force. The LFPR is the ratio of the labor force and the non-institutional population over 16 years of age.
A decline in the unemployment rate is usually understood as a good situation where unemployed workers get jobs. But the unemployment rate can also decline if unemployed workers leave the labor force and reduce both the number of unemployed and the labor force.
The current economic expansion is more than six years old, but the ratio of those employed to the total population shows only a small increase after a plunge during the Great Recession. This is due, in part, to a steep decline in labor force participation. In the post-war period, the LFPR mostly maintained an upward trend until the peak in April 2000 (67.3%). Its descent was gradual between 2000 and 2007. The Great Recession led to an acceleration of the decline in the LFPR. It has dropped to 62.4% in October 2015 from 66% in December 2007.
The aging of the U.S. population is one of the primary reasons for the decline of LFPR. There are an estimated 10,000 Baby Boomers retiring each day at the moment. A Council of Economic Advisers (CEA) study estimates that 55% of the decline in the LFPR from the end of 2007 to the end of 2014 was entirely due to demographic reasons.
Beyond that, the CEA estimates that poor business conditions explain 17% of the decline in the LFPR, with other secular factors accounting for the remainder. Different studies show a range of estimates for the influence of demographic, cyclical and structural contributions to the decline in the LFPR; the CEA’s estimates are in the mid-range of the literature.
Details of the CEA study show that aging and cyclical influences fully explained the drop in the LFPR during 2007-2012, after which other factors became more important. What are these other factors, and what might be done to address them?
The first is the marginalization of less-educated workers. Research has determined that low educational attainment is associated with reduced labor force participation among prime-aged workers. The changing workplace demand for higher skills and education places the less-educated at a disadvantage in the labor market.
This trend has been in operation for some time; the participation rate of prime-age men (24-54 years) has been largely declining since 1954. But what had been a gradual trend has become more pronounced in recent years. In the wake of the recession, firms have gotten leaner and used offshoring and automation to a greater degree.
At the start of the recession in December 2007, there were 1.3 million marginally attached workers in the United States. This component rose to a cycle high of 2.8 million in January 2012. Many of these individuals stepped away from the labor market to pursue additional education or to await more-fertile opportunities. The most recent count of those marginally attached to the labor force stands close to 2 million, suggesting that the strong economy has enticed many to return. But there remain 500,000 people who are still missing from the labor force, representing an opportunity for further progress.
A lack of family-friendly policies is one of reasons for the lower participation rate of women. Some households have chosen to go from two earners to one since the recession, as the opportunity cost of not working has fallen below the cost of outsourcing home-based responsibilities like child care.
There is also a sense, which is hard to confirm, that some of those who exited the labor markets are still working in areas outside the boundaries of statistical surveys. Piece-rate and home-based activity are examples here.
In sum, the LFPR has declined by more than demographic factors alone would suggest. That indicates that there is a reservoir of available talent that may yet be drawn back to full participation and that we haven’t quite reached full employment. The reservoir has diminished in recent years, but has not yet run dry.
There is a complex set of factors behind the drop in the LFPR, and it is difficult to identify how they will evolve in the near term. Aggressive monetary policy can remedy some root causes, while others will need to be addressed through different strategies. The Fed must appreciate its limitations on this front.
At Your Service
The impressive economic progress recorded by China over the past generation has been founded on manufacturing and exports. Thanks to heavy industry, China has doubled its real gross domestic product (GDP) five times over the last generation.
But a series of headwinds has slowed China’s manufacturing sector. Demand from the developing world has been uneven since 2009. Developing Asian nations with lower labor costs have taken Chinese market share. Chinese authorities have become more conscious of the environmental impact of factories. And the long supply lines between China and some of its client nations have challenged delivery and led trading partners to contemplate more- proximate alternatives.
As its main engine of progress slows, China will be forced to seek other avenues to sustain growth. The Chinese service sector will be counted on to take up the slack. Services compose a much smaller fraction of GDP in China than they do in other countries, but they have been growing in importance over the past decade.
The service sector in China is growing more rapidly than manufacturing is and will soon surpass manufacturing in sheer size. It already employs more people than manufacturing does, and this differential is likely to grow significantly in the decade ahead.
There is plenty of room for advance in Chinese services such as research, accounting, finance, logistics and consulting. This could enhance productivity in Chinese manufacturing, potentially making it more competitive with its neighbors. Functions that Western firms outsourced long ago (maintenance, security, data processing) are still done within many large Chinese companies and not always efficiently. And services have a much smaller carbon footprint.
Services have the advantage of tapping directly into the expanding incomes and rising time values of Chinese consumers. Day care, restaurant meals and travel have all become more popular and prevalent in China. Retail sales are growing by double digits, and health care will become increasingly important as China’s population ages.
Service growth has the added benefit of generating more domestic consumption, which is a much smaller fraction of the Chinese economy than it is in most developed countries. This reduces reliance on the performance of export markets.
The service sector was a highlight in the third-quarter GDP report for China, helping keep growth in line with the stated target of “nearly 7%.” However, cynics were left to wonder whether the results were credible. The quality of Chinese economic data has long been questionable; the current Chinese Premier once observed that the figures were “man-made and therefore unreliable.”
Analysts have been able to cross-check Chinese manufacturing results with external data. As an example, Chinese export totals can be compared to imports from China that arrive in other countries, and electricity usage can reveal industrial trends. But services, which are largely consumed domestically, are much more difficult to verify. And even the most advanced economies struggle to measure service output accurately. So if policymakers were inclined to pad their totals, service sector results would be a prime vehicle for doing so.
Among the subjects of suspicion is the Chinese financial services industry, where some analysts note a significant discrepancy between the amounts banks claim as revenue and the payments that Chinese firms report making to them. In the wake of this summer’s correction in the Chinese equity market, the contribution that finance makes to GDP might be expected to decline further.
It is very common for developing countries to become more service-oriented as they mature. It is a natural transition that occurs as wealth is created. So the shift seen in China is not altogether surprising and is very much welcome. But if it is being exaggerated to sustain reported economic growth, it will not receive the reception that the Chinese hope for.
(c) Northern Trust